19 Aug 2009

More Convenient Data Sampling By Krugman

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A reader asked me to investigate this Krugman blog post. Echoing DeLong, Krugman is arguing that the fiscal conservatives are wrong to worry that Obama’s deficits will push up interest rates:

Brad DeLong has been writing about the falsity of the claim that large-scale government borrowing in a liquidity trap will lead to soaring interest rates. I was looking for some corroborating data, and came up with a picture that surprised me, though it shouldn’t have. Here it is:

Net federal saving is, roughly, the budget surplus (so it’s negative if there’s a deficit.) It turns out that there’s a strong correlation between budget deficits and interest rates — namely, when deficits are high, interest rates are low.

On reflection, it’s obvious why: a weak economy both drives up deficits and drives down the demand for funds, while a strong economy does the reverse. Thus the surpluses of the late Clinton years were associated with high interest rates, while the current recession has depressed both rates and revenues.

OK now I’m not sure that Krugman of doing this on purpose, but the time frame he chose for his data is very convenient. (On the one hand, I want to give him the benefit of the doubt, because the FGDEF series that he chose only goes back to 1999. On the other hand, I’m not sure how he even found that series on FRED; if you go through the obvious categories, the first series you find is FYFSD, which goes way way back.)

Anyway, regardless of how he ended up with the above graph, it is nonetheless very misleading. As I alluded to in the parentheses above, we can’t use the exact same series to go back further in time, since the one Krugman chose for federal net savings doesn’t go back any more. However, we can switch to the nearly equivalent FYFSD (federal surplus or deficit), and we can see just how robust the apparent relationship above is.

First, let’s switch the series but keep the same time scale, so it’s clear that I’m not rigging the game. So below is the same chart as Krugman has above, except I’ve taken out his FGDEF series and put in the FYFSD series:

Not a perfect match, but close enough, right?

OK great, now let’s go back to 1962, instead of stopping at 1999 as Krugman did in his blog post:

Well how ’bout that. Over the whole period–as far back as the 10-year Treasury rate series goes on FRED–you don’t see the two lines moving in lockstep. If anything, they move in opposite directions. That is, in periods when the government borrows heavily, interest rates tend to go up, and in periods when the government runs a big surplus, interest rates tend to dip down.

Now of course, you could try to explain away the big moves. For example, in the early 1980s Volcker jacked up interest rates, and this pushed the country into a severe recession which then put strains of the federal budget.

OK that’s fine. But clearly, Krugman’s initial surprise was correct. In general, interest rates and federal savings rates do not move in lockstep. Supply and demand work, even when it comes to the government.

One last point: Brad DeLong did not, as far as I can tell, make a general claim about the two series. Rather, DeLong was merely saying that in a liquidity trap you get the abnormal result that government borrowing doesn’t push up interest rates. So DeLong is unscathed by the above.

But we can’t say the same for Krugman. Even though he used DeLong as a springboard, his explanation for his (initially surprising) graph was a general one about recessions and interest rates. He wasn’t limiting the discussion to rare periods of liquidity traps, unless every recession features a liquidity trap.

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