18 Oct 2011

Krugman on Europe: “I Do Believe in Fairies!”

Economics, Krugman 18 Comments

(In deference to some who were concerned about my rough treatment of a youngster, I should note that I am not actually quoting Krugman in the post title.)

Anyway, Krugman today seems to be explaining movements in interest rates based on “confidence”:

There has been a rhythm to the euro crisis: again and again, investors start to realize how bad things look, and spreads rise; then policy makers put together some sort of response, which produces a partial (but only partial) return of confidence, until it becomes clear just how inadequate that response was; then return to step one.

I can only conclude that Krugman is trying to resurrect Tinkerbell.

A few days ago I took a stab at this, and I think I was misunderstood. So let me try it this way: Suppose bond vigilantes weren’t attacking Greece and other Eurozone governments right now. Which would Krugman pick?

Door #1: “Oh man, I guess IS-LM is wrong.”

Door #2: “Man these austerians are idiots. They say that big budget deficits lead investors to worry about default, which then causes interest rates to spike. But if that were true, wouldn’t we see huge spreads on Greek, Italian, and Spanish debt? Try looking at the data, guys.”

My money is on Door #2.

18 Responses to “Krugman on Europe: “I Do Believe in Fairies!””

  1. Daniel Kuehn says:

    Out of concern for your rough treatment of an old man, I think I must point out that Gene probably would have called you intellectually dishonest for what he perceived to be an intellectually dishonest claim no matter what the age of the person you were criticizing.


  2. Daniel Kuehn says:

    To be honest, I’ve never been quite sure what he’s talking about when he refers to the “confidence fairy”.

    • Bob Murphy says:

      That’s funny, DK. I (think) I know exactly what Krugman is talking about when he refers to the confidence fairy. I’m just pointing out that he has a plausible case with the US, but not with all the countries currently being attacked by bond vigilantes.

  3. kavram says:

    Are the two options really mutually exclusive? Couldn’t you explain it by saying that a drop in confidence causes investors to sell off bonds of the country in question, which increases “money demand” and shifts the LM curve upwards, therefore raising interest rates?

    Maybe I’m missing something tho, it’s been a couple of years since Macro 101…

    • Bob Murphy says:

      Kavram, I’m not saying that the IS-LM framework is incapable of handling the European situation.

      What I’m saying is that Krugman is being selective. If low interest rates and lack of confidence fairies in US is supposed to prove that IS-LM and John Hicks are geniuses, while austerians are idiots, then why doesn’t the opposite outcome mean the opposite thing in Europe?

      Put another way, the standard loanable funds model is working “with flying colors” in Europe right now, and it can be tweaked to handle the US. But Krugman looks at the two cases, and concludes that IS-LM wins and the people using the loanable funds model are idiots.

  4. Major_Freedom says:

    A few days ago I took a stab at this, and I think I was misunderstood.

    For what it’s worth, it was crystal clear to me. Hmph.

    My money is on Door #2.

    If only the option were available. Keynesianism is nonfalsifiable, no matter how Krugman wants to dress it up.

    Not only that, but the fact that he adheres to a contradictory “IS-LM” model, only shows that he is still stuck in dark age macroeconomics from yesteryear. The IS-LM model was originally advanced as a counter-argument against the classical argument that a fall in wage rates and prices can cure unemployment. But one of the premises behind the IS-LM model, the declining marginal efficiency of capital, is that wage rates and prices are rising, not falling. Well sure, if you make an argument against a straw man, then you can refute anything you want!

    That’s why Krugman has to use IS-LM only part of the time, when the data just so happen to be in line with the broken clock.

  5. AP Lerner says:

    It’s funny, you read these spats back and worth between Keynesians and Austrians, and it kind of reminds me of the Peloponnesian War. Of course, we all know how irrelevant Sparta and Athens are these days. You guys are fighting the last war. Update your text books, models, or whatever you are relying. The gold standard is dead.

    • Bob Murphy says:

      And as AP Lerner has made clear in the other thread, by “the gold standard is dead” he means that right now one central bank has the freedom to do what it wants. All others are “on the gold standard” in the sense that Iceland and Greece are. Right AP? I don’t want to put words in your mouth. When you say the gold standard is dead, you mean for (at most) one central bank in the world at a time?

      • MamMoTh says:

        Technically Greece is under a gold standard, but Iceland is not. Although Iceland has foreign debt, so it can become insolvent.

        • Major_Freedom says:

          Metaphorically, Greece is under a gold standard. Technically, they’re under a fiat system with no power to print their own money.

          Let’s not bastardize the gold standard by claiming that anything not an “optimal currency region as per MMT” is a gold standard.

          • MamMoTh says:

            Technically, Greece is an issuer of a currency and hence subject to the same constraints and dynamics as if it were issuing its own currency backed by gold or dead monkeys.

            • MamMoTh says:

              edit: Greece is a user of a currency

    • Richard Moss says:


      Ancient Athens and Sparta were the source of some of the most revered figures, institutions and historical events of Western Civilization, and you reference them to make a point about irrelevance?

      • AP Lerner says:

        Key words in your statement: ‘revered’, and ‘historical’.

        • Major_Freedom says:

          Hey, kind of like the US Continentals.

        • Richard Moss says:

          Yes, I am glad you agree.

  6. Rob says:

    Keynesians believes that in a liquidity trap that governments should be able borrow at close to zero interest rates. However assuming that the IS-LM model takes into account risk premiums then I’m not sure that high interest rates for the PIIGS really undermines the model (who would lend money at close to zero to someone likely to default ?)

    So he may take door #2 in your example or he may take neither door and accept the possibility that increased risk may later increase IRs. From what he has said about bond vigilante’s in the US he appears not to believe it is impossible they may return – just that they are not out right now.

  7. Yosef says:

    Didn’t Krugman say a version of Door #2 when it comes to England?

    England is also seeing a lack of vigilante attacks, and Krugman has taken that to mean that austerity was wrong (one recent example: http://krugman.blogs.nytimes.com/2011/10/13/low-rates-as-a-sign-of-failure/)

    Interestingly, low rates are a sign of failure, and high rates are a sign of failure.

    [Though unlike the Euro zone, England is able to print its own money and Krugman would argue that they are different and so…]