I’m going to be laying into my two favorite bloggers–Paul Krugman and Scott Sumner–for their slippery handling of the recent rise in Treasury yields. As I’ve said several times on this blog, I think Krugman and Scott do this a lot (Krugman is more annoying about it); it’s just that this is a particularly obvious example. However, I don’t want to give the impression that everybody I fight with on this blog, does the same thing. So in the interest of balance, let me officially thank Tyler Cowen for admitting there is a problem, and (dare I say it?) Brad DeLong for being so good about listing ways he botched things in the past.
OK on to the fun stuff:
==> For years, Krugman has been saying that people like the Austrians are wrong for blaming “artificially” low interest rates on Bernanke’s “aggressive” policies. For example, when Bill Gross of PIMCO thought the end of QE2 buying would lead to a spike in Treasury yields, Krugman took him out to the woodshed numerous times, and also said that anybody who invested based on Gross’s views lost a lot of money. (E.g. look here and here.) As usual with Krugman, this wasn’t just a feeling in his belly; he was saying he (Krugman) had a buttoned-down model to explain his views, whereas Gross couldn’t even come up with a good theory to explain his position.
==> For his part, Scott Sumner has also taken me specifically to the woodshed for thinking the Fed is holding down Treasury yields.
==> In that context, the following chart from Justin Wolfers is a bit problematic for my confident blogging friends:
OK, that looks sorta consistent with the perspective coming from my blog and other Austrian-friendly sources, right? Doesn’t mean we have a monopoly on truth, but it sure means that Krugman and Sumner need to either (a) ignore this completely or (b) when commenting on it, do so with some humility and explain why it totally contradicts what they’ve been telling people for years.
In this essay about the Fed’s recent policy shift, Krugman continues with his woe-is-me-I-hate-being-Cassandra narrative. You wouldn’t get even a hint that maybe something is a bit odd here, and that the response to the Fed announcement–according to Krugman’s own explanation of how to interpret swings in stock and bond prices–means the Fed’s buying has been holding down Treasury yields.
(Subtle point made in the interest of fairness: There is a difference between QE2 winding down according to schedule, versus a surprise announcement of a change in the wind-down date of QE3. However, Krugman has in the past gone further than merely criticizing Bill Gross’ specific call; Krugman has more generally said that the Peter Schiff-types are wrong for thinking low interest rates are “artificial” and caused by Bernanke, as opposed to the economic slump.)
Now if Krugman is a bit slippery, Scott Sumner is jaw-dropping in his audacity. In response to Arnold Kling saying the past two weeks present a bit of a problem, Scott writes:
The correlation between nominal interest rates and NGDP (or RGDP) growth is overwhelming positive. Nothing that happened this week contradicts that. Indeed nothing that happened this week contradicts what I’ve been saying for the past 4 1/2 years…
So what have we learned this week? To me this is one data point, indicating tight money is slightly more likely to raise long term rates than I had previously assumed….
PS. The fact that Krugman, Cowen, Kling, myself and many others were surprised by the surge in rates over the past few weeks actually speaks well of our understanding of macro. It shows that we’ve been paying attention, that rates don’t usually behave this way. As for those who “got it right,” you have some “splaining to do” about the surging yields in Japan in response to more QE. [Bold added.]
By all means, go read him in full context to see if I’m distorting his meaning.
Or how about this? Gavyn Davies was complaining in an FT article that the recent jump in interest rates showed that the Fed’s exit (from QE) may be more difficult than we had been led to believe. After all, if just tweaking announcements about the end of the program caused 10-year yields to rise that much, what happens when Bernanke says, “We’re letting our portfolio go back to pre-recession levels”? (That’s my question, not necessarily Davies’ spin.) Davies brought up an historical precedent for his worries:
[A] previous big Fed exit, announced on February 4, 1994, was even more dramatic. It was a day that triggered such turbulence that it is etched in the memory of all bond traders. Working as a Goldman Sachs economist, I was on the bond trading floor when the Fed released an innocuous-sounding statement. The FOMC had decided “to increase slightly the degree of pressure on reserve positions . . . which is expected to be associated with a small increase in short-term money- market interest rates”. Pardon? After a few moments, there was an explosion of noise as realisation set in.
The market was unprepared for the Fed change, Investors were over-leveraged and knee-deep in Mexican debt and mortgages. Equities emerged relatively unscathed. But before the bloodbath ended that November, the survival of the US investment banks was at stake.
Here’s what Scott said in response:
The tipoff is the “equities emerged relatively unscathed” remark. I’ve been around for 58 years and can’t recall a more boring and uneventful year than 1994. That means Fed policy was working. Boring is good! Yes, there was some turmoil in the bond market, but bond markets don’t matter, what matters is NGDP. And that was fine.
The sooner we remove finance from monetary economics the better. All it does is lead to fuzzy thinking, as we also saw in my previous post. [Bold added.]
I’m not offering these quotes to blow up market monetarism. What I’m asking is that my really sharp free-market colleagues who have sided with Sumner over the Rothbardians on this stuff, step back and really think hard about how flippant Scott is being. Are we really willing to throw out microeconomics so much, that “bond markets don’t matter”? Is it really true that the Fed buying trillions of dollars of government debt, hasn’t seriously screwed up the economy in ways that have not yet fully shown their awful consequences?