I’m not going to say this even qualifies as a “Kontradiction,” but it’s close. By now, every serious geeconosphere wonk should know that Paul Krugman’s recommendation to Japan back in the day, was that its central bank should credibly commit to future inflation. That would cause the public to expect a lower purchasing power of money in the future, meaning that even if nominal interest rates were stuck at zero, the real interest rate would be negative, inducing the public to go spend. Here’s Krugman summarizing his case in November 2009:
We’re in a liquidity trap, with interest rates up against the zero bound. This means that conventional monetary policy isn’t sufficient. What should we do?
The first-best answer — that is, the answer that economic models, like my old Japan’s trap analysis, suggest would be optimal — would be to credibly commit to higher inflation, so as to reduce real interest rates.
But the key thing to recognize about this answer is that it’s all about expectations — the central bank only has traction over expected inflation to the extent that it can convince people that it will deliver that inflation after the liquidity trap is over. So to make this policy work you have to (i) convince current policymakers that it’s the right answer (ii) Make that argument persuasive enough that it will guide the actions of future policymakers (iii) Convince investors, consumers, and firms that you have in fact achieved (i) and (ii).
In reality, we haven’t even gotten anywhere near (i): the conventional wisdom is still that any rise in expected inflation above 2 percent is a bad thing, when it’s actually good.
So some readers have asked why I’m not making the same arguments for America now that I was making for Japan a decade ago. The answer is that I don’t think I’ll get anywhere, at least not until or unless the slump goes on for a long time.
OK so back then, Krugman was saying the “first best” answer, based on a rigorous economic model, and what he himself told the Japanese, was to manipulate the public’s expectations about future policy. But, since that had some practical roadblocks, a fall-back was to rely on deficit spending today.
Contrast that treatment with Krugman’s analysis of a recent paper promoting supply-side solutions:
There’s a new Vox paper suggesting that supply-side policies — structural reform that makes workers more productive, prices more flexible, or whatever — may be the answer to a liquidity trap. Some people may seize on this claim. So it’s worth pointing out that a casual interpretation here gets it all wrong.
Here’s what we already know: in the looking-glass world of the liquidity trap, supply-side improvements are generally counter-productive…
So how does the Vox paper get a different story? By assuming that the payoff to supply-side improvements doesn’t come until the economy has already spontaneously emerged from the liquidity trap, and so these perversities are gone. The idea then is that consumers, rationally perceiving this future improvement, feel richer and spend more now.
Oh, Kay. It might be true, although it depends on consumers being very well informed. I don’t know anyone in the Princeton economics department, let alone Main Street USA, who does family budgeting based on perceptions about how reforms in tax law or labor regulation will affect incomes five years from now. But whatever.
Clearly not an actual contradiction, and perhaps not even a Krugman Kontradiction. But it seems Krugman is much more sympathetic to the idea of central bankers promising higher future inflation, than to the idea of Treasury officials promising lower future taxes. It seems that Main Street USA, when doing the family budgeting, must read more Scott Sumner than Art Laffer.