27 Nov 2013

Yet More Incontrovertible Evidence That Krugman Believes the Fed Can Create Bubbles

Federal Reserve, Krugman 33 Comments

[UPDATE in text.]

This is really funny, to see the Krugman defenders in the comments being reduced to such grasping. (In fairness, at least one of the people involved is motivated not by his love for Keynesian policies, but by his love to contradict me.) So let me offer yet even more damning quotations to show that Paul Krugman believes that the Fed had the power in the past, and retains the power today, to create asset bubbles, UPDATE: that one such mechanism to cause such bubbles is to lower interest rates, and that such bubbles can stimulate aggregate demand in order to pull the economy out of a recession.

(Those of us on the Krugman Beat have known about these for years, but I thank Bob Roddis for apparently keeping the links in a notebook by his bed.)

OK here’s Krugman in a May 2005 NYT op ed titled “Running Out of Bubbles” (but Krugman probably didn’t pick that title, FYI). I am going to reproduce virtually the entire column, because it is eerie how much it sounds like exactly what hard-money types (especially Austrians) have been saying since 2008:

Remember the stock market bubble? With everything that’s happened since 2000, it feels like ancient history. But a few pessimists, notably Stephen Roach of Morgan Stanley, argue that we have not yet paid the price for our past excesses.

I’ve never fully accepted that view. But looking at the housing market, I’m starting to reconsider.

In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. “There is room,” he wrote, “for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing.”

As Mr. McCulley predicted, interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst.

Now the question is what can replace the housing bubble.

Nobody thought the economy could rely forever on home buying and refinancing. But the hope was that by the time the housing boom petered out, it would no longer be needed.

But although the housing boom has lasted longer than anyone could have imagined, the economy would still be in big trouble if it came to an end. That is, if the hectic pace of home construction were to cool, and consumers were to stop borrowing against their houses, the economy would slow down sharply. If housing prices actually started falling, we’d be looking at a very nasty scene, in which both construction and consumer spending would plunge, pushing the economy right back into recession.

That’s why it’s so ominous to see signs that America’s housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble.

The important point to remember is that the bursting of the stock market bubble hurt lots of people – not just those who bought stocks near their peak. By the summer of 2003, private-sector employment was three million below its 2001 peak. And the job losses would have been much worse if the stock bubble hadn’t been quickly replaced with a housing bubble.

So what happens if the housing bubble bursts? It will be the same thing all over again, unless the Fed can find something to take its place. And it’s hard to imagine what that might be. After all, the Fed’s ability to manage the economy mainly comes from its ability to create booms and busts in the housing market. If housing enters a post-bubble slump, what’s left?

Mr. Roach believes that the Fed’s apparent success after 2001 was an illusion, that it simply piled up trouble for the future. I hope he’s wrong. But the Fed does seem to be running out of bubbles. [Bold added.]

Last thing: It would not surprise me in the slightest if someone point-blank asked Krugman, “Are you admitting that continued QE will make it more likely that we will have asset bubbles?” and he said, “No I’m not admitting that, that’s a dirty lie.” But if he said that, he would be Kontradicting his established framework.

As with his warnings about skyrocketing interest rates, Krugman’s op ed above could (almost) have been written by Peter Schiff. It’s yet another example of Krugman being a decent economist when he wants to criticize big spending, loose money Republicans.

33 Responses to “Yet More Incontrovertible Evidence That Krugman Believes the Fed Can Create Bubbles”

  1. Major_Freedom says:

    So Krugman is an Austrian when Republicans control the White House/Congress, and he’s a Keynesian when Democrats control the White House/Congress.

    Well, seems like if we want Krugman to be an economist, then one solution is to keep Republicans in control of the White House/Congress. Of course, that has its own costs.

    So what do we want? Krugman acting like an economist, or perpetual Democrat rule?

  2. Major_Freedom says:

    “After all, the Fed’s ability to manage the economy mainly comes from its ability to create booms and busts in the housing market.”

    That’s pretty definitive. Notice the word “create”. Not “exacerbate”. Not “encourage.” No, it’s a creation of central banks.

    We just need to add that the reason why the Fed creates booms and busts in the housing market is the same reason it creates booms and busts in other interest rate sensitive markets. If the Fed can create booms and busts in the housing market, then it can create booms and busts in long term capital goods, consumer borrowing and spending, the stock market, the bond market and yes, asset markets (as if none of the previous things are assets).

  3. Gamble says:

    Bob now you are fueling the anarchist fire with statements like, “As with his warnings about skyrocketing interest rates, Krugman’s op ed above could (almost) have been written by Peter Schiff. It’s yet another example of Krugman being a decent economist when he wants to criticize big spending, loose money Republicans.”

    Because you are proving modern American Representative Government is really about team power. Republicans and Democrats approve of such and such behavior when they are in power however when the other guy does, watch out.

    So really politics has nothing to do with principle, economics, employment, the good of the people. Politics is all about indulging the lust of power.

  4. Ken B says:

    Well it’s nice to see you admitting that back in 2008 you hard money types weren’t giving Krugman his due.

    🙂

    I don’t recall anyone saying Krugman denied that in the past the fed had created/exacerbated/pumped bubbles.
    I know a doctor who tells me swallowing anthrax spores is quite safe. he concedes *breathing* them is dangerous indeed. When I asked if exposure to anthrax from my neighbour’s anthrax pill factory must cause the disease, or a least a high risk of it, he said “Not in currrent conditions where none of it is airborne, the pills present almost no risk, and help cure lethargy.”
    “what if the factry made nasal spray?” I asked.
    “Oh, well then he could cause a lot of disease no doubt. But that’s not the situation here in Krugtown. And it won’t be for a long time if we have proper zoning.”

    • Tel says:

      I didn’t start dissing Krugman until around 2009 when his whole tone changed from disagreeing with high deficits and railing against government war expenditure, to suddenly becoming an unabashed apologist for absolute statism.

      As I have mentioned earlier… with the NYT, the simplest explanation that fits the observations is that Democrats can do no wrong.

      Having said that, bringing up examples from Krugman 2005 is too much like shooting fish in a barrel. More entertaining when he gets Kaught out from week to week, like with Obamacare.

      By the way, if Kentucky can make a working healthcare web shopper, that seems to imply that it was pure incompetance and wasted budget at the Federal level. Obviously as a technical challenge it isn’t all that difficult, you just have to hire competant people. Given that the Federal obamacare is still in the hands of the people who wasted last budget, I see no reason to believe they can’t waste a much larger budget as well.

  5. Keshav Srinivasan says:

    Bob, if all you’re trying to show is that “Paul Krugman believes that the Fed had the power in the past, and retains the power today, to create asset bubbles, and that such bubbles can stimulate aggregate demand in order to pull the economy out of a recession”, then we have absolutely no disagreement.

    • Bob Murphy says:

      OK let me update it then, Keshav, cause there’s one more thing…

      • Keshav Srinivasan says:

        Even with that update, we still have very close to no disagreement, except I might amend your update slightly: ” that one such mechanism to *potentially* cause such bubbles is to lower interest rates”. Other than that, we seem to be in complete agreement.

        • Ken B says:

          Keshav, I want to get this clear, else we’ll be in a snarl. Is this statement accurate:

          “Krugman is admitting that textbook central bank action to fight high unemployment will yield a string of bubbles”.

          Not may, not can, not potentially, but will.

          Have you changed your opinion and now read this from Krugman
          “The underlying deficiency of demand will call for pedal-to-the-medal monetary policy as a norm. But bubbles will happen — and central bankers, always looking for reasons to snatch away punch bowls, will use them as excuses to tighten.” is a statement that the pedal to the metal monetray will cause those bubbles” Same caveats.

          • Keshav Srinivasan says:

            My opinion has been the same throughout. I don’t Krugman thinks that his preferred monetary policy will necessarily cause bubbles, and his “bubbles will happen” statement is not about bubbles being caused by monetary policy.

            • Gamble says:

              Keshav I think you may be exhibiting irrational exuberance…

            • Ken B says:

              I agree with you, and I agree that has been your position throughout, and I think your concordat with Bob is shrewdly worded to express that, and I think unless you state it baldly like you just did you’ll be misrepresented.

  6. RPLong says:

    I don’t know enough here to make an intelligent comment, so I’ll ask a potentially stupid question in hopes that someone can answer it for me:

    Would a hypothetical Krugman-defender have a relevant point if he asserted that “things are different at the zero lower bound”?

    • Ken B says:

      Had Krugman stated that explicitly I think it would have averted Bob’s misreading. (Maybe. ) But Krugman clearly believes *something* about the current state means loose money presents almost no risk of creating a bubble, and that’s — based on his repeated statements — a prime contender.

      FWIW I think it’s an excellent question.

    • Jonathan Finegold says:

      I don’t think Krugman entertained the idea, back in 2005, that the U.S. was at the zero lower bound — he started applying his theory once we were in recession. (And, given that interest rate reductions worked to stimulate the economy in the early 2000s, we couldn’t have been at the ZLB.)

  7. Ken B says:

    Let’s go to tape! I have found a recording of Bob and major freedom in discussion with Paul Krugman. I was shocked, shocked by what they hear Krugman say.

    https://m.youtube.com/watch?v=CiYfzcEwQ9o&desktop_uri=%2Fwatch%3Fv%3DCiYfzcEwQ9o

  8. Jeremy R. Hammond says:

    “A snarky but accurate description of monetary policy over the past five years is that the Federal Reserve successfully replaced the technology bubble with a housing bubble” — Paul Krugman

    I’m having a Thanksgiving sale on my book “Ron Paul vs. Paul Krugman: Austrian vs. Keynesian economics in the financial crisis”. Get it RIGHT NOW for $0.99, an 81% discount from the regular price of $4.99:
    http://www.amazon.com/gp/product/B007QHMEUO/ref=as_li_ss_tl?ie=UTF8&camp=1789&creative=390957&creativeASIN=B007QHMEUO&linkCode=as2&tag=forepolijour-20

    Here’s an excerpt relevant to this post, Bob:

    [BEGIN]

    Krugman again argued in the New York Review of Books in September 2010 that the Fed had had no choice but to lower interest rates following the collapse of the dot-com bubble. “It’s hard to see,” he wrote, “even in retrospect, how the Fed could have justified not keeping rates low for an extended period.” However, now his argument was that “it would be wrong to attribute the real estate bubble wholly, or even in large part, to misguided monetary policy.”

    Yet how could Krugman reconcile his argument here that the Fed was not “wholly, or even in large part” responsible for creating the housing bubble with his earlier arguments that the Fed should lower interest rates to spur investment in housing? How could he reconcile this argument with his earlier statement that “Millions of Americans have decided that low interest rates offer a good opportunity to refinance their homes or buy new ones” (May 2, 2001)? Or with his observation that “those 11 interest rate cuts in 2001 fueled a boom both in housing purchases and in mortgage refinancing” (October 1, 2002)? Or with his acknowledgment that it had been “the Fed’s dramatic interest rate cuts” that had “helped keep housing strong” (December 28, 2001)? Or his statement, “Repeated interest rate cuts encouraged families to buy new houses and refinance their mortgages” (December 22, 2002)? Or his remark that “Mortgage rates did indeed fall briefly to historic lows, extending the home-buying and refinancing boom that has helped keep the economy’s head above water” (July 25, 2003)? Or, “Low interest rates … have been crucial to America’s housing boom” (May 20, 2005)? Or, “interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt”(May 25, 2005)? Or, “A snarky but accurate description of monetary policy over the past five years is that the Federal Reserve successfully replaced the technology bubble with a housing bubble” (August 7, 2006)? Or, “Back in 2002 and 2003, low interest rates made buying a house look like a very good deal. As people piled into housing, however, prices rose—and people began assuming that they would keep on rising. So the boom fed on itself” (July 27, 2007)?

    • Major_Freedom says:

      Now it’s a soveriegn debt bubble. The last bubble I believe.

      • Ken B says:

        So you’re saying Krugman is right, and pedal to the metal won’t cause a bubble? You surprise me.

        • Bala says:

          As always, you don’t surprise me. What (I think) MF means is that if there is no driver managing the economy and the money supply, there will be no scope for pedal to the metal policy.

          • Ken B says:

            Besides a logic book you need to buy a sense of humor.

            • Bala says:

              Good recommendation from a person who cannot for life stop being scientistic. How’s the Church of Scientism coming up?

              Oops….. I forgot that you have problems com

            • Bala says:

              iPhone in a hurry…..

              *comprehending what you read.

        • Major_Freedom says:

          Oh no no no, make no mistake, I hold very firmly that “everything” is in a bubble, technically speaking. After all, ABCT applied to 2008-2009 does not exclude sectors other than housing. It is foolish to believe that Fed stimulus only affected housing, and everything else was affected as if a free market in money existed.

          What I mean by the sovereign debt bubble is the current bubble, I mean that like housing, and like the Nasdaq, it is the most acutely affected sector such that it will appear ex post that a bong market bubble and bust occurred.

          The housing market collapse was, IMO, just the first major sector to go under a correction, and that if Bernanke just let individuals correct the market without his “help”. then more sectors would have gone under correction, such as automobiles, banking, etc.

          Pedal to the metal policy, if you had actually asked me instead of pulling a silly LK “So you’re saying…?”, will only exacerbate the “everything” bubble, and distort “the capital market” even more.

          The sovereign debt bubble is, I believe, the sector that is most susceptible to a large correction first, such that ex post we’ll all be saying there was a bond bubble.

          • Keshav Srinivasan says:

            How would you respond to this argument that it’s impossible to have a bond bubble?

            angrybearblog.com/2010/08/bond-bubble.html

            • Major_Freedom says:

              I would respond by saying that this paragraph:

              “So for the bond market to be a “bubble” investors would have to start thinking they can make unusually large capital gains in the bond market. But everyone knows that if you buy a 10 year bond that at the end of 10 years all you will get back is your original investment. In the meantime you will get the coupon and what you can earn by reinvesting that coupon. Yes, if rates continue to fall in the short run you will be able to sell the bond for more than you paid, but you total return has to remain limited because in 10 years the possibility of capital gains must converge on zero. As long as this is true the possibility of a bond bubble must remain something reporters and pundits can pontificate on but nothing more than that.”

              has a number of errors.

              1. It is not the case that investors have to expect “unusually large capital gains”. The author is being misled by attributing real gains to nominal gains.

              2. The fact that there is so little further gain to be made via capital gains, from even lower interest rates, is actually not inconsistent with bonds being in a bubble.

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