Krugman’s Gross Mistake
The title is the best part of my latest Mises CA, but I think I raise a decent issue in the text too. The conclusion (but I really do handle some of the nuances in the post, so critics please read the whole thing first):
Bill Gross made a very public prediction that Treasury rates would spike when QE2 ended, and (apparently) he bet a lot of money on that view. He was wrong. At the time, Krugman predicted that Gross would be wrong. Krugman was right.
However, now that Gross has left (lost?) that job at Pimco, Krugman is recounting the tale in a way that doesn’t quite work. Krugman is arguing (now) that the end of QE2 didn’t cause rates to spike, because QE2 itself never pushed rates down. But if that’s the case, then why has Krugman been freaking out so much about premature monetary tightening? Why didn’t Krugman oppose QE2 in the first place? It’s true that there are unconventional mechanisms by which the Fed can stimulate Aggregate Demand even when interest rates are already at the zero lower bound, but Krugman has several times argued that [these] mechanisms are dubious and policymakers should go with what we know works: deficit spending.
Thus we circle back to the essential problem: If Krugman is (now) arguing that QE2 never held down interest rates, why doesn’t he support Yellen undoing all the asset purchases made during QE2? It won’t make interest rates rise, right?
As far as I know QE2 ended in June and already in Sept. Operation Twist (QE 2.5) was started with talk about it already in August. That means there wasn’t really that much time without the FED using another tool to push long term rates down… Having a market already used to having a Fed doing everything to keep stocks rising, big banks and government from being insolvent, I have to say that Krugman is right in so far that it really was a poor call by Gross.
Gross should have known that QE2 wasn’t the last Hammer the Fed would use… And as long as the Fed does this the only other thing that could push rates up is price-inflation, which is hard to predict, and as far as I know wasn’t one of Gross’ arguments for higher rates.
Anyone here who believes that the Fed stops hammering now with QE3 ending finally?
I haven’t done the math, so I will rely on metaphor, which can’t possibly go wrong! Presumably Krugman believes that even at the ZLB, the central bank can affect the economy, just not in the direction he wants, right?
I mean, if you’ve been pushing on a string for a while, then you can safely pull it *for a while* without having an effect on the far side of the string, but at a certain point, you are able to move whatever it is on the other end, just not in the direction you want.
J Mann sure, that’s fine. So again, if Krugman thinks QE2 didn’t push down rates, that meant the string was already slack when QE2 began. Hence, we could’ve not done it, and the only difference would’ve been in how bunched up the string got.
Isn’t QE meant to be a policy that by design is only carried out when interest rates are at zero ? Otherwise it would not be needed as conventional monetary policy by interest rate targeting would work.
So:
– If QE ends and the economy is still at the lower bound then interest rates will not rise (they will stay at zero)
– If QE ends because the economy has escaped the zero lower bound then interest rates will indeed rise.
I agree with you that Krugman is off target on this occasion.
I think you’re right that when Krugman is thinking of unconventional policy he’s thinking only in terms of the unconventional mechanisms. I disagree with your point that Krugman should therefore oppose QE in the first place. Acting on an expectations channel (or for that matter a long-run rates channel, which is much the same thing) is difficult and uncertain but in the middle of a depression that doesn’t mean you don’t do it. After all, there’s no law of nature that you can’t do QE and deficit spending.
That whole dance of how monetary policy and fiscal policy work together at a time like this has everything to do with the behavior of conventional monetary policy and the impact of fiscal policy on interest rates at the zero lower bound. And that’s precisely what Krugman has always said Gross misses. So unless I’m misunderstanding something (or missing an essential element from your main post), I think Krugman’s point now is not different and quite closely related to his skepticism of Gross back then.
DK I think my strongest piece of evidence is Krugman complaining that the ECB raised interest rates in 2011. How were they able to do that? Was Europe outside of the liquidity trap in 2011 but the US was still in it?
Isn’t a CB always able to raise rates by tightening monetary policy (as the ECB did in 2011) even if it is in a liquidity trap ? The liquidity trap would only prevent it further lowering rates below zero.
As a side note: I agree with always, but not always with tightening. During a heavy price inflationary period like the 70ies tightening will lower rates, see what Volcker did.
skylien the standard story is that Volcker came in and jacked up interest rates. Do you think that’s wrong?
There are many nuances to the story: Short vs. long-term, nominal vs. real, Fed actually controlling money not interest rates, etc. But I think the standard economists have all that in mind–and do so correctly–when they say “the Fed controls interest rates and QE2 pushed them down.”
Well, you know the saying, that sometimes you have to go left to be able to go right?
If Volcker never had jacked up (overnight) rates do you think the 10 year bond would have peaked in 1980?
The bond yield is affected not only by the credit worthiness of the US but also by inflation (whom am I telling this), therefore I think it is not correct to say that the Fed can push them up always with tightening wouldn’t you agree?
Yes I think so Transformer. Did the ECB sell off more assets in 2011 than the total of QE2? (I haven’t looked at the numbers, but I’m guessing not.) I’m saying it’s hard to say ECB raised rates but Fed didn’t lower rates.
Bob, Keynesians believe that in a liquidity trap, the following three things are true:
1. Conventional expansionary monetary policy doesn’t lower short-term rates
2. Conventional contractionary monetary policy *does* raise short-term rates
3. Unconventional monetary policy has no effect on short-term rates.
Why is that an inconsistent set of beliefs?
OK Keshav so:
(1) The Fed doing QE2 didn’t push down short-term rates, because they would’ve been 0% even without QE2.
(2) If the Fed hadn’t done QE2, that would’ve been contractionary, and raised interest rates.
You don’t see any problem there?
Bob, I don’t think Krugman would agree with Statement 2. I don’t think anyone is arguing that failure to enact QE2 would have raised short-term rates.
Keshav wrote:
Bob, I don’t think Krugman would agree with Statement 2. I don’t think anyone is arguing that failure to enact QE2 would have raised short-term rates.
Well except Ben Bernanke (in my latest Mises CA post)…
But OK Keshav, when the ECB raised rates in 2011, how did they actually do that? Did they sell off more assets (perhaps as a share of GDP or something) than the Fed bought during all of QE2? (I’m not being sarcastic.)
Bob, Bernanke in that quote was discussing the effect of QE2 on long-term rates. I thought we were talking about short-term interest rates. Isn’t the whole notion of a liquidity trap about short-term rates?
Keshav, if you look at the actual Fortune articles quoting Gross’ views–the ones that Krugman and DeLong link to, to show what they’re attacking–the charts all show 10-year Treasury yields.
Keshav if you want to say the Fed pushed down 10-year and 30-year yields, but not T-bills, OK that’s a defensible view, but I don’t think that’s what Krugman is arguing.
Bob, isn’t the entire point of Quantitative Easing (from a Keynesian perspective) to reduce long-term rates, because short-term rates won’t go any lower?
For instance, look at this post by Krugman:
http://krugman.blogs.nytimes.com/2009/03/20/fiscal-aspects-of-quantitative-easing-wonkish
“The whole reason for quantitative easing is that normal monetary expansion, printing money to buy short-term debt, has no traction thanks to near-zero rates…. But here’s the rub: if and when the economy recovers, it’s likely that long-term interest rates will rise, *especially if the Fed’s current policy is successful in bringing them down*.”
By the way, you’re right, if Gross was talking about long-term rates, then Krugman has no justification for attacking Gross, since Krugman himself said in 2009 that long term rates would “likely” go up after quantitative easing is over. (I haven’t actually looked at Gross’ quote.)
Wow Keshav all I can say is, please do (when you get the time) read Krugman’s posts from the last two days on Gross, and also the ones he links of DeLong. DeLong is posting 10-year Treasury rates when he (DeLong) tries to reproduce what Gross’ mindset may have been.
Let me put it this way Keshav: We all agree Gross bet against Treasuries, right? Do you think he just bet against 3-month T-bills?
Here Keshav let me save you time:
==> Krugman in this post is quite clearly saying that Gross thought when the Fed stopped buying Treasuries, that their yield would rise.
==> In that same post, Krugman links to DeLong. It is even more crystal clear that DeLong is evaluating Gross on the basis of the 10-year Treasury yield.
There’s no trouble raising interest rates in a liquidity trap, is there? The trouble with a liquidity trap is in lowering rates.
We were in a liquidity trap pre-QE. Krugman supposes that if QE is removed we’ll still be in the liquidity trap. He is not opposed to QE but seems to express doubts that it changed the fundamental problem. He thinks Gross is arguing that the only reason rates are so low is because of QE (not despite QE).
What I don’t understand about Krugman’s post is why he disagrees with DeLong’s view of Gross. That doesn’t seem as obvious to me.
So if this is what you are getting at I agree with you that there is no reason why Fed tightening couldn’t raise rates. I don’t think Krugman would suggest there is. I think he is saying that tightening does not imply raising rates in a liquidity trap and he thinks Gross is saying it implies that.
I think Krugman is mad at Gross as someone that he thinks has a lot of his theory and priorities right but underappreciates the liquidity trap. I think Krugman is mad at the ECB because they have a lot of theory and priorities wrong AND they underappreciate the liquidity trap.