An Oldie But Goodie
Reading Krugman’s op ed on the “fiscal phantom menace” I was struck by this assertion:
You’ve heard the story many times: Supposedly, any day now investors will lose faith in America’s ability to come to grips with its budget failures. When they do, there will be a run on Treasury bonds, interest rates will spike, and the U.S. economy will plunge back into recession.
This sounds plausible to many people, because it’s roughly speaking what happened to Greece. But we’re not Greece, and it’s almost impossible to see how this could actually happen to a country in our situation….
So let’s step back for a minute, and consider what’s going on here. For years, deficit scolds have held Washington in thrall with warnings of an imminent debt crisis, even though investors, who continue to buy U.S. bonds, clearly believe that such a crisis won’t happen; economic analysis says that such a crisis can’t happen; and the historical record shows no examples bearing any resemblance to our current situation in which such a crisis actually did happen.
If you ask me, it’s time for Washington to stop worrying about this phantom menace — and to stop listening to the people who have been peddling this scare story in an attempt to get their way.
Is it really possible that the same guy who wrote the above, also wrote this back in 2003?
…last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.
…we’re looking at a fiscal crisis that will drive interest rates sky-high….But what’s really scary — what makes a fixed-rate mortgage seem like such a good idea — is the looming threat to the federal government’s solvency.
…How will the train wreck play itself out? ….my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.
We’ve known about that gem for a while now, but it’s absolutely astounding to read it again in light of Krugman now saying such threats are impossible according to economic theory. Did Krugman think US debt was denominated in yuan back in 2003? Or is it possible that today’s deficit scolds aren’t the idiots/liars-taking-money-from-Pete-Peterson that Krugman portrays?
I think that neither in 2003 nor now would Krugman think that there was any chance of a US debt default.
However in 2003 when we were not at theZLB he would have thought that running up debt would have caused a likelihood of the govt monetizing the debt and generating inflation which would have been bad in a non-ZLB economy
Now we are in the ZLB running up debt is costless and as it stimulates AD it is a good thing according to Krugman. Even if running up debt does raise concerns about future inflation Krugman seems to believe that that would be a good thing because it would also have a stimulating effect.
I am sure there is much to disagree with in this analysis but I don’t see any contradictions in it.
How about thinking ahead? If the comparable really low debt was a problem in 2003, then the comparable higher debt now, and much much higher debt later if Krugman gets his way when the economy finally is out of the ZLB will do what? I mean his policy is supposed to get the economy on track, which includes no more ZLB right?
Krugman has a whole chapter in his “end this depression now ” book that attempts to explains that even the massive amounts of spending he thinks we need to get the economy out of the liquidity trap would be easily manageable for an economy of the US’s size.
I’m not endorsing this view, just pointing out what he say.
Of course there’s room. Any amount of government spending won’t ever get them to spend more than GDP.
Transformer,
The point is that if it was justified to be concerned about high debt in 2003 it should also not be a big issue if you are worried about the actual debt or final debt when we are out of ZLB.
Do you agree?
He is contradicting himself if in 2003 he says
“we’re looking at a fiscal crisis that will drive interest rates sky-high”
and
“…How will the train wreck play itself out? ….my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.”
And in his book “end the depression now” it would be suddenly easily manageable with an x-fold amount of debt to get rid of it (Without ZLB!). In 2003 he called for sky high interest rates and reckless politicians just printing their way out of the problem… That is not a problem with more debt? Hu?
I really like to see you reconcile that.
2003 was also before Hurricane Katrina, and before the shutting down of the Space Shuttle Program. Obviously we can’t compare the two.
Just say it.
2003 was Bush running deficits, but 2012 is Obama running deficits… and that’s the real reason why we can’t compare the two.
It’s rather interesting to see you try to defend Krugman’s post, when Krugman himself has admitted he made a mistake in that post:
http://krugman.blogs.nytimes.com/2012/01/02/mistakes-and-how-to-deal-with-them/
You are a true believer, aren’t you?
His apology was that his predictions of debt vigilantism in 2003 didn’t come to pass, which (in case you didn’t notice) would tend to favor his overall world-view.
BTW: If your “true believer,” comment was aimed at me – its misplaced. I’m not a Krugman supporter. I believe that you have to understand his ideas before you can decide if you agree with them or not , and FWIW, I think I understand them and I don’t agree with them.
His apology was that his predictions of debt vigilantism in 2003 didn’t come to pass, which (in case you didn’t notice) would tend to favor his overall world-view.
Predictions imply theories, Transformer. He conceded his theory in 2003 was wrong. His theory in 2003 contradicts his theory in 2012. It’s not like he has held the same theory the entire time, and it is only a question of when that theory is confirmed or falsified. If you read his two posts carefully, you will see it.
“Is it really possible that the same guy who wrote the above, also wrote this back in 2003?”
Yeah, what happened to this guy? When I read some of his older writings he seems fairly even keeled and logically concerned about things. Now, it seems a lot of what I read of him is fairly partisan, and crankery towards people who don’t hold the views of his inflationary fetishisms. Was he also like this in the early 2000s and I just never read it?
Some bank awarded him some prize or other… possibly a soul was exchanged in the deal but souls are invisible so all we can see for sure is the prize.
Hang on. Are you saying Krugman has a different view on the impact of budget deficits during depressed times and normal/booming times? I really hope he makes that clear at some point.
Like saying “The key thing to remember is that current conditions — lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate — won’t always prevail. As long as those conditions DO prevail, it doesn’t matter how much the Fed increases the monetary base, and it therefore doesn’t matter how much of the deficit is monetized. But this too shall pass, and when it does, things will be very different.” Or “I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation.”. He should say that in a blog post. Like this one: http://krugman.blogs.nytimes.com/2011/03/25/deficits-and-the-printing-press-somewhat-wonkish/
No Yosef, it’s more a question of whether a Democrat or a Republican is in the White House.
Obviously. I laughed when I read this thinking I can’t believe it but I know someone in the comments will try to explain this away
Krugman. LOL.
Gene I think the lowercase “lol” is more effective.
It’s funny to see that Callahan is now using laugh out loud in his comments.
Yosef, I would hardly call March of 2003 “booming times.” They certainly weren’t by Krugman’s standards.
http://data.bls.gov/timeseries/LNS14000000
In March of 2003 unemployment was still rising (it peaked in June 2003 at , three months after Krugman’s column) so his sky is falling mantra was written as conditions were near bottom yet still worsening.
Chirs, I agree that 2003 isn’t booming times. I was just making the point that Krugman has different recommendations during depressed time vs. regular time (which mean both booming or recessions where the Fed is not at the zero lower bound.) I was just pointing out that it’s not a contradiction to make different recommendations under different conditions.
Exactly. In 2003 Bush was President.
One of the great missed opportunities for amusement caused by Romney’s loss is that we won’t get to witness 2003 Krugman’s return through the political time warp.
krugman says:”These are difficult times for the deficit scolds who have dominated policy discussion for almost three years. One could almost feel sorry for them, if it weren’t for their role in diverting attention from the ongoing problem of inadequate recovery, and thereby helping to perpetuate catastrophically high unemployment.”
The debt is causing inadequate recovery and high unemployment.
No way… Krugman wrote that second excerpt? That looks like something Peter Schiff would have wrote.
What Krugman is saying or should be saying is that higher interest rates won’t be associated with a deflationary slump (as in Greece), but rather inflation, for a country with an independent monetary policy. Bob agrees with that, I think.
The problem with using deficits to generate a boom is that it’s kind of all or nothing. It either has no effect, or far too much of an effect. No effect while people believe the government will pay its debts, then hyperinflation when people believe the government is incapable of paying its debts.
Inflation by monetary policy is better than inflation by going broke…and this is something that Krugman used to believe (see his Japan paper), but not so much any more.
I checked the cost of living stats for Greece a little while ago and prices are going up for a typical family. A lot of people call that inflation.
Nikos was kind enough to follow up my comment on Greek inflation which I will paste here:
So that brings up some interesting points, firstly inflation (in terms of price inflation) is fraught with measurement difficulty. Price of what exactly? Including or excluding indirect tax? Of course VAT is only the start of it, because all sorts of corporate tax gets passed down at the consumer price level. I don’t have a smart answer for that, but at least keep the problem in mind. Yes I’m aware that some Austrians think that the only real way to measure inflation is by money supply, but that’s another story I guess.
Beyond that, most of Austrian economic theory hinges on a competitive free market system. In the case of a monopoly you can get counter-intuitive results. Let’s suppose you have a competitive market for some widgets and then consumers decide they want to pay back their mortgage and demand is reduced. Logically you expect prices to fall, but in a monopoly market the maximum profit is when the marginal cost of producing one more item equals the marginal effect of dropping the price of widgets. When demand reduces it is possible to have a situation where the monopoly will just increases prices in response to that.
The reason should be clear — if the monopoly producer has some fixed cost component (e.g. rent on a large factory or fixed interest on a loan) that cannot be renegotiated, then as volume reduces the unit cost goes up so the monopoly makes more profit by deliberately throttling production volume. Yes, this does require that the marginal unit cost curve is sloping downwards at the production volume in question, but that can easily happen if an economy of scale exists:
http://en.wikipedia.org/wiki/Economy_of_scale
See the “bathtub” shaped graph in the top right corner, if you are on the downward sloping portion of that then it happens.
If you believe that the government is going to pay off the debt could you please tell me when? Also, I’d like to talk to you about some great waterfront property I have for sale cheap in Florida as well as a bridge in the NYC area.
Tom, government paying its debts is not the same thing as it paying *off* its debts. The US government at present always pays its debts: there has been no default. That has nothing to do with whether it ever reduces the deficit to zero.
If the inflation rate ever gets higher than the interest rate on the debt then to all intents and purposes you have a default.
Good point.
For an investor there is no real difference between a fear that a country who issues debt in a foreign currency may default on part of the debt , and fear that a country that issues debt in its own currency may debase its currency and reduce the value of the debt in real terms.
In both cases investors will drive up interest rates to insure against this risk.
So I think the difference between Greek and US interest rates is not based just on the fact that one issues debt in it own currency and one does not but also on the perceived comparative risk of debtors not getting paid back in full.
Transformer:
For an investor there is no real difference between a fear that a country who issues debt in a foreign currency may default on part of the debt , and fear that a country that issues debt in its own currency may debase its currency and reduce the value of the debt in real terms.
Actually there is a difference. Each investor faces a different price inflation. Inflation doesn’t affect all things with prices equally.
Also, a bond investor who receives inflated money as payback, may receive that new money first before others, in which case they would experience the inflation as higher income rather than higher prices of the things they buy. Only once they spend the money will prices rise, but by then they would already own what money can buy.
Compare that to the same bond investor being outright defaulted on, and it is clear that inflation for them is superior to default.
There is more complexity than traditional pedagogical models that are highly aggregated and simplified would have you believe.
My point is that risk of inflation and risk of default will both affect interest rates so there is nothing special about issuing debt in your own currency that somehow makes it safer – as MMters sometimes assert.
Obviously there may be all sorts of differences in reality that will affect how different individuals will evaluate the risks associated with different bonds.
My point is that risk of inflation and risk of default will both affect interest rates so there is nothing special about issuing debt in your own currency that somehow makes it safer
To be fair, that isn’t what you said.
Now you say inflation and default will “both affect interest rates”. But “affect” them how exactly? Certainly not in the same way or to the same degree. It would still be wrong to say a bond investor is indifferent between the two.
Inflation is a risk in saving any money. But there is a difference between losing some of the value and an outright default.
If there are more profitable or less risky investments elsewhere then those should be taken advantage of.
In the case of higher future inflation, higher future interest rates should prevent the government from inflating away *all* of it’s debt.
To the extent people get a better deal on buying debt than holding cash, you could say they got a good deal since they didn’t invest their money elsewhere.
Krugman responded and admitted his mistake.
http://krugman.blogs.nytimes.com/2012/01/02/mistakes-and-how-to-deal-with-them/
So, is Krugman’s latest version a law of the universe now?
In his original mea culpa…
http://krugman.blogs.nytimes.com/2010/09/01/mistakes/
…Krugman contentiously concludes with “So yes, I’ve been wrong. Let those who are without error cast the first stone.”
Given the number of first stones (and errors) he has cast over the years it would be nice if he would go back, read those words, and follow his own advice instead of belittling others when he has to admit his mistakes.
krugman says :
“Far from fleeing U.S. debt, investors have continued to pile in, driving interest rates to historical lows.”
and then krugman says:
“ So our government, unlike the Greek government, literally can’t run out of money. After all, it can print the stuff. So there’s almost no risk that America will default on its debt”
Hey Mr. Paul K , when you make up your mind, get back to me…
Progressives are in power. They can do no wrong. If things do go wrong, it will be the fault of anyone but them.
Who is still buying US bonds other than the Fed (or banks buying bonds with money that came from the Fed)?
Has Krugman been topping up his portfolio?
I’ve been saying that “debate” with commies, Keynesians and assorted statists is basically a waste of time. Like Krugman, I must admit I was wrong. Some MMTer who calls himself “y” made this especially for me:
http://www.flickr.com/photos/90510624@N03/8222583190/in/photostream
Isn’t the internet awesome?
y = insane.
But then there is the always thoughtful Mr. Callahan:
http://noahpinionblog.blogspot.com/2012/11/keynes-hayek-by-nicholas-wapshott.html?showComment=1353972129707#c5255794588528043988
I’m not trying to start something on Prof. Murphy’s blog but that comment was just pointless bullying and brown-nosing. It’s only FYI for future reference. I’m dropping it.
I love it how all Callahan can say is “Roddis is disgustingly wrong.” In other words “I can’t refute you, so I will not engage you and just say you’re wrong.”
You must have hit a sore spot.
simply unbelievable. can you say strawman? lol
Why do Keynesians think that price modifications via funny money dilution are more practical, moral, efficient, whatever etc…. than the parties themselves simply modifying the terms of their agreements? 11 U.S.C. § 1322(b)(2) still prohibits modification of mortgage obligations secured by the debtor’s principal residence in chapter 13 bankruptcy.
[The plan may] modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence,
http://www.law.cornell.edu/uscode/text/11/1322
From the “Krugman Ignores His Own Theory and Misses An Important Piece of European History” post, Bob Murphy quotes Krugman saying:
What [a critic of the fiscal scaremongers] doesn’t note, however, is that the problem with bond vigilante scare tactics runs even deeper than that — because it’s actually quite hard to tell a story in which a loss of confidence in U.S. bonds hurts the real economy. Why wouldn’t it just drive down the dollar, and thereby have an expansionary effect?
The only way that driving the dollar down would have an “expansionary effect” would be because people did not realize that the prices and wages they accepted were being lowered without their knowledge or permission. And Gene Callahan wants to know the importance of Hayek saying on TV in 1977 that the purpose of “The General Theory” was as an ad hoc policy proposal designed to inflict the same thing on British workers. No news there.
So again, why can’t we just explain the situation to people like adults that monetary policy has resulted in their wages and prices being too high? Why the Keynesian emphasis in practice upon subterfuge through money dilution and how is that possibly “democratic”? And why are opponents of the policy fools and idiots?
I enjoy your comments.