30 Jul 2010

OK Dr. Krugman, Here’s a Possible Problem With Lower Longer Term Rates

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[UPDATE below.]

In a previous post I expressed incredulity at this passage from Krugman’s blog:

We don’t know how well the Gagnon plan would actually work — but there’s no harm in trying, and large potential benefits. The only possible reason for the Fed not to be more aggressive now is fear of embarrassment, of not getting big results.

The Gagnon plan involved things like the Fed aggressively buying 3-year Treasuries to bring their rate down from 90 basis points to 25 bp.

What stunned me wasn’t so much the fact that Krugman was in favor of the plan, but that he saw no possible downside.

Well, I was talking with a woman today who works at a major investment firm. She explained that defined-benefit corporate pension plans are in trouble because of the drop in interest rates. Consider a company that promised an employee $1 (in present value terms) of pension benefits back in 2000. Suppose it was a responsible company and fully funded the pension plan, so that it set aside $1 in assets at the same time.

But since interest rates have collapsed since 2000, and since assets have underperformed, the pension liability is much higher (because the discount rate is lower) while the counterbalancing assets have not risen nearly as much.

I brought up the fact that many economists are saying that the Fed ought to engage in “unconventional” policy by buying longer term Treasuries to push down those rates too. She said matter-of-factly that it would render every corporate pension plan insolvent.

UPDATE: Let me make sure you see the big picture here. Krugman is so sure that more aggressive policy can’t possibly hurt, because Krugman does his analysis in terms of a very crude model that has a central bank, aggregate demand, “the” interest rate, “the” price level, and some other components. In that model, there’s not even corporations, let alone corporate pension plans, so it wouldn’t even occur to Krugman to worry about the possibility that his recommendation might bankrupt every pension plan in the country.

Indeed, whenever economists express timidity about lowering interest rates, the only thing (except from the Austrians) that you hear is, “Retired people live on bonds and they could be hurt.” That is the only thing you get. Non-Austrians otherwise think the only flaw with reducing the price of borrowing money, is that it might lead to higher prices at some point. They typically see nothing else wrong with the Fed wildly moving certain prices away from their current values.

3 Responses to “OK Dr. Krugman, Here’s a Possible Problem With Lower Longer Term Rates”

  1. Yancey Ward says:

    The government can borrow the money and bail out the pension plans. No problemo!

  2. JimS says:

    Dr. Murphy

    Isn’ that the real plan, to collapse pension funds and give cause to take over that as well? Or perhaps I am coming off as too much of a conspiracy theorist?


  3. Teqzilla says:

    Truly, the biggest problem in combating keynesianism is just how dumb it is. It’s like someone saying that the sky is green. There is no sophisticated rebuff available, all your left with is pointing out that its blue. And to someone whose never seen the sky – as the typical person has never seriously contemplated economics – one claim seems as good as another.