09 Oct 2013

Tyler Cowen on Treasury Default

Economics, Federal Reserve, Krugman, Scott Sumner, Tyler Cowen 4 Comments

This is my favorite Tyler post of all time, with the only possible exception being his unwitting out-of-sample defense of Austrian business cycle theory.

First, Tyler uses his extraordinarily powerful mind to concoct a scenario in which the economy collapses from the debt standoff:

As the evening of October 16th approaches, John Boehner is preparing to invoke the Hastert Rule when a car accident intervenes and he is temporarily out of commission. Coordination collapses and some Republicans believe that on the 17th debt payments can continue while some other federal obligations are violated instead. A combination of insufficient payment prioritization (for bizarre technical reasons) and angry Social Security voters, who irrationally fear missing their deposits, means that some payments are in fact missed on Treasury securities….Interest rates skyrocket and there are numerous collateral calls from clearinghouses and thus a squeeze on Treasuries. Everyone is scrambling after Treasuries and suddenly T-Bill liquidity is quite scarce….

By mid-morning of the 17th the payments system has shut down entirely. The Fed tries everything possible, but even with a flood of monetary liquidity, T-Bills are “not what they used to be” and no flow of reserves can make up for this. The monetary authority cannot become the fiscal authority in the span of an hour or a day, especially when it doesn’t have a fully credible fiscal authority behind it. The payments system remains gridlocked. Elsewhere, the Italian 10-year rate shoots over eleven percent, so the ECB has to invoke Outright Monetary Transactions, but the Germans get nervous and don’t go whole hog with this program. A lot of European credit markets shut down too. A major clearinghouse is nationalized.

A full sorting out of the payments mess takes months. In the meantime gdp has shed five or ten percent and borrowing costs are permanently higher. Credit stays slow and the United States enters another major recession. Scott Sumner issues a call for higher nominal gdp.

And in addition to the Sumner jab, Tyler tops it off with a Krugman Kontradiction:

Addendum: By the way, we used to read that an attack of the bond market vigilantes would be good for the economy, but it seems this is no longer the case when the vigilantes are led by Republicans. Hint: an attack of the bond market vigilantes is not good for the economy.


4 Responses to “Tyler Cowen on Treasury Default”

  1. Jonathan says:

    I am always intrigued by ex Austrians. I would love to see their reasons for leaving the gang but I never have. John Gray a Hayek scholar also baffles me.

    Great spot on his 2005 post… he should have listened to his imaginary Austrian friends advice and I wonder if now all those predictions have pretty much come through he would change his mind?

    I wonder if the problem with discovering Austrian theory is that you really just end up discovering that there is little role for people like yourself to ‘teach’ economics… really you just have the law, and thats it apart from some discussions at the margin about how extreme to go but from a starting point like today with state involved in some way or other with pretty much half national income in most places thats rather a distant worry.

  2. valueprax says:


    Help me out, I am crude, Rothbardbot Austrian and I don’t follow the technical mumbo jumbo. In the “out-of-sample” link, I notice the date is 2005 and we’re at about step 4 or 5 in his list, where 1-3 have already occurred. Since I don’t follow the “out-of-sample” phrase I assume the point here was that he basically laid out exactly what has happened so far but was using that to create a silly ABCT explanation that he doesn’t believe in, thus illustrating how silly HE is?

    Or am I leaning on my crude, Rothbardbot Austro-libertarian priors too much there and just seeing what I want to see because I am a partisan ideologue rather than a serious, scientific thinker?

    Second, were you just highlighting the KK because Tyler Cowen noticed the same thing you did and it’s less controversial for him to say it because he isn’t a Rothbardian lapdog attack animal like you? Because it seemed like he was then saying, despite the KK, that a bond vigilante attack is “bad for the economy” and I couldn’t tell in that subtlety if you were agreeing with that or just including it to make the quote cohesive and true to form?

    I would think you would disagree with that last bit, but then I have really strong, crude Austrian priors and I automatically believe the government is bad, no matter what, so bond vigilantes attacking it would be good, no matter what, completely unreasonably, so I just want to double check my knowledge here.

    • valueprax says:

      And by knowledge, of course I mean Good Ol’ Boys Club official member back-slappin’, high-fivin’ bigoted bias and willful duplicity.

      (Ken B, DK, JCat, any of you reading? Did I get all that right?)

    • Bob Murphy says:

      Valueprax, what I said wasn’t really right. If you’re “testing” a model you might calibrate it on some data (like stock returns from 1900 to 1990) and then see how your model “predicts” on the data from 1991 onward. So there you’re saying it’s a good (or bad) fit on the “out of sample” data. Of course it will look like a good fit on the “in the sample” data, since that’s what you used to calibrate your parameters etc.

      But Tyler actually made a genuine prediction, which is even stronger, if you’re into the whole Popperian thing.

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