I’m like Columbo. I notice just a slight turn of phrase that other investigators would consider innocuous, yet I realize it shines a spotlight on the killer.
Remember: Krugman is now saying that Gross et al. were wrong about QE2 because they suffer “liquidity trap denial” (his actual term lately). That is, these people were just-so-sure that the government’s big budget deficits were going to send interest rates up, that when it failed to occur, they desperately fumbled about for an excuse, and landed on, “Aha! The Fed’s QE programs are holding down Treasury yields!”
Now since this is the way Krugman is framing what happened, you can understand why he himself is now painted into a corner where he has to say that QE2 didn’t have much of an impact on interest rates at all, and that’s why the end of the program didn’t make long-term rates go up. Again, the problem (as Krugman now frames it) is that Gross et al. didn’t realize that long-term rates were low because of the liquidity trap.
That’s why Krugman’s March 2009 post, on the launch of the first QE program, is so revealing. Here are the relevant parts again:
The big policy news this week has been the Fed’s decision to buy $1 trillion of long-term bonds, going beyond the normal policy of buying only short-term debt. Good move — but it’s probably worth pointing out that yes, this does expose the Fed, and indirectly the taxpayer, to some risks…
The Fed is…creating a new liability: the monetary base it creates to buy these bonds. In effect, it’s printing $1 trillion of money, and using those funds to buy bonds. Is this inflationary? We hope so! The whole reason for quantitative easing is that normal monetary expansion, printing money to buy short-term debt, has no traction thanks to near-zero rates. Gaining some traction — in effect, having some inflationary effect — is what the policy is all about.
[I]f and when the economy recovers, it’s likely that long-term interest rates will rise, especially if the Fed’s current policy is successful in bringing them down…
My back of the envelope calculation looks like this: if the Fed buys $1 trillion of 10-year bonds at 2.5%, and has to sell those bonds in an environment where the market demands a yield to maturity of more than 5%, it will take around a $200 billion loss.
I’m not complaining; I think quantitative easing (it’s really qualitative easing, but I give up on trying to fix the terminology) is the right way to go. But we should go into it with our eyes open.
Look at the passages I’ve underlined, and in particular the last parenthetical remark where Krugman complains about terminology. For the Krugman vs. Gross debate, that parenthetical throw-away line is actually the murder weapon.
Why is Krugman complaining about terminology here? He’s arguing that the big deal with QE isn’t how much money the Fed is creating, but rather the assets it is buying with that money. Hence the Fed’s purchases have changed qualitatively, not quantitatively.
With that distinction in mind, go review again the other things I underlined above. Now do you see it?
Krugman is quite clearly saying (my paraphrase of course): “The Fed has bought short-term Treasuries and pushed down short-term rates to zero. That is a dead end; we’re in a liquidity trap, after all. Since it hit a wall, the Fed is going to try buying long-term Treasuries, to push down long-term Treasury rates. This might work, but if it does, there will be risks of capital losses if rates rise suddenly. I’m OK with those risks, but let’s not ignore them.”
Does everybody see that? And so, is it really accurate or fair for Krugman to now be claiming that Gross was in “liquidity trap denial” for thinking that QE2 had pushed down long-term Treasury rates?
NOTE FOR PURISTS: Krugman famously pointed out a theoretical mechanism in the late 1990s by which a central bank could still “gain traction” when short-term rates were 0%, by credibly promising to be irresponsible in the future. However, that is a different mechanism from what Krugman seems to be arguing above. Krugman’s late 1990s advice for the Bank of Japan didn’t involve changes in asset purchases right now, instead it involved credible words right now to convince the public about what the Bank of Japan would do in the future. So please don’t tell me that Krugman’s talk of “inflation is the goal” in the above is an invocation of his Bank of Japan unconventional policy stuff; it’s not.
Thanks to Keshav for the Krugman link I used in the first half of this Mises CA post… Incidentally, if you thought, “Well duh, of course interest rates stayed low, because the Fed did Operation Twist and then QE3!” then you should really read this one. It’s not as open and shut as you’d like it to be. I can especially understand why Scott Sumner thinks the normal thing is for long-term Treasury yields to rise when the Fed buys bonds.
We already know the Democrats aren’t really the party of peace…turns out the Republicans aren’t laissez-faire champions either. I feel so disillusioned. The intro:
In my last post, I challenged the conventional view that the Democratic Party was the dovish one, in contrast to those hawkish Nixon Wage PriceRepublicans. I pointed out that Democrats had been in the White House during both World Wars and the major escalation in Vietnam, and that Barack Obama has utterly repudiated the hope that he would represent a new direction for America after George W. Bush. In the present post, I want to do something similar for the equally popular–but also erroneous–view that the Republicans support the free market.
As I did with the Democrats on war, here let me list some major violations of free-market principles that occurred during Republican administrations:
A few people have been emailing, complaining that their comments aren’t showing up. I don’t know what is causing it, but for some reason I’m not seeing the comments on my end; they are ending up in limbo somehow. Since I don’t know what’s causing it, I can’t give you tips on how to fix it; obviously others are able to post.
(In the interest of full disclosure, yes I have deleted some comments this week, either because banned people came back, or because non-banned people were posting pure insults. Also note, there is a difference between someone earnestly making an unfair analogy about an opponent’s position, versus someone posting a pure insult. Look how much you learn at this blog.)
I argue yes, within limits. The weird thing is that I think everybody in this dispute agrees on the caveats, we just summarize the reality in totally opposite ways (i.e. “yes” vs. “no”).
The title is the best part of my latest Mises CA, but I think I raise a decent issue in the text too. The conclusion (but I really do handle some of the nuances in the post, so critics please read the whole thing first):
Bill Gross made a very public prediction that Treasury rates would spike when QE2 ended, and (apparently) he bet a lot of money on that view. He was wrong. At the time, Krugman predicted that Gross would be wrong. Krugman was right.
However, now that Gross has left (lost?) that job at Pimco, Krugman is recounting the tale in a way that doesn’t quite work. Krugman is arguing (now) that the end of QE2 didn’t cause rates to spike, because QE2 itself never pushed rates down. But if that’s the case, then why has Krugman been freaking out so much about premature monetary tightening? Why didn’t Krugman oppose QE2 in the first place? It’s true that there are unconventional mechanisms by which the Fed can stimulate Aggregate Demand even when interest rates are already at the zero lower bound, but Krugman has several times argued that [these] mechanisms are dubious and policymakers should go with what we know works: deficit spending.
Thus we circle back to the essential problem: If Krugman is (now) arguing that QE2 never held down interest rates, why doesn’t he support Yellen undoing all the asset purchases made during QE2? It won’t make interest rates rise, right?
My sources tell me no.
Adam Ozimek launches this odd complaint against RR:
He’s an economist who regularly complains that economics is less scientific than it thinks, and says things like he doesn’t think economists really know what much more about the world than we did 50 years ago. But then Russ also has perhaps the best economics podcast in the world where he interviews leading economists about their research. It’s true Russ often provides a voice of skepticism, pushing back and asking hard questions. It’s a great part of the podcast. But the vast majority of the time Russ is clearly having people on because he thinks we can learn from hearing about their research. He’s hardly constantly disagreeing with them like you’d expect if he thought most of what they have done doesn’t tell us anything.
It begs the question, if economists haven’t really learned anything in the last 50 years then why in the world would you spend so much time interviewing economists about their research? Why not interview economic historians about what economists were saying 50 years ago? There is a huge disconnect between Roberts’ intensely skeptical attitude when he makes sweeping statements about the field, and the content of his detailed conversations with experts, and really the entirety of his Econtalk project.
I don’t see any problem here; I agree with all of the views Ozimek attributes to Russ, and I also think Russ does a great and valuable thing with Econtalk. There’s no question-begging or other type of problem here.
Here’s a hint of why: An economist from 50 years ago would know exactly what I mean.