(In deference to some who were concerned about my rough treatment of a youngster, I should note that I am not actually quoting Krugman in the post title.)
Anyway, Krugman today seems to be explaining movements in interest rates based on “confidence”:
There has been a rhythm to the euro crisis: again and again, investors start to realize how bad things look, and spreads rise; then policy makers put together some sort of response, which produces a partial (but only partial) return of confidence, until it becomes clear just how inadequate that response was; then return to step one.
I can only conclude that Krugman is trying to resurrect Tinkerbell.
A few days ago I took a stab at this, and I think I was misunderstood. So let me try it this way: Suppose bond vigilantes weren’t attacking Greece and other Eurozone governments right now. Which would Krugman pick?
Door #1: “Oh man, I guess IS-LM is wrong.”
Door #2: “Man these austerians are idiots. They say that big budget deficits lead investors to worry about default, which then causes interest rates to spike. But if that were true, wouldn’t we see huge spreads on Greek, Italian, and Spanish debt? Try looking at the data, guys.”
My money is on Door #2.