Krugman’s column today discusses the fallacy of composition in virtue.
Basically, it goes like this: if I am virtuous and save to try and pay off my debt, and you and everyone else are also virtuous and save to try to pay off your debts at the same time, the net result is that no one of us will be able to pay off our debts!
As the economy shrinks from lack of demand, the ratio of debt to income actually grows larger even though people are trying to save more. Hence, it is self-defeating to think that everyone can be virtuous simultaneously, starting from the current position.
It’s a familiar argument to anyone steeped in Keynesian economics. Adam Smith entirely missed this macroeconomic possibility when he wrote:
“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom” (Wealth of Nations, 1981, 456-7).
One of Krugman’s familiar solutions to the problem is to have government dissave during recessions. Another is to have the Federal Reserve inflate prices to reduce the real value of the overhanging debt.
A more interesting approach that he endorses today is to simply write-off the bad debt, wiping the balance sheet clean and enabling former debtors to buy again.
This radical, communistic idea has been endorsed by … the Bible:
"At the end of every seven years you shall grant a release of debts. And this is the form of the release: Every creditor who has lent anything to his neighbor shall release it; he shall not require it of his neighbor or his brother, because it is called the LORD's release" (Deuteronomy 15:1-2).