Tag Archives: paul krugman

Have you been advocating that fiscal stimulus is unnecessary for the past four years? Do you want help in defending your position? Are you a die-hard monetarist? Are you annoyed at how right Paul Krugman has been? What follows is your best shot at disproving him. Tread with trepidation.

If there’s one rational expectation in economics, it’s that Paul Krugman is an inflationarydollar-debasingausterity-thumpingirresponsiblefiscalist imp that needs to be controlled. And over a decade ago in 1998, the good doctor wrote:

The way to make monetary policy effective, then, is for the central bank to credibly promise to be irresponsible – to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs.

Back then, he had to end that phrase noting that “this sounds funny as well as perverse”. That’s a sea change from today, where this is taken as a foregone conclusion in wonkonomics. I see petitions for Larry Summers, Janet Yellen, and Christina Romer as great Fed chairs. That’s wonderful, and I’d be happy with any one of them (particularly Romer). But someone has to give me a detailed explanation why there isn’t a roaring movement – from Scott Sumner to Brad DeLong – calling on Barack Obama to nominate Paul Krugman for the most prestigious job in the country.

In January, Krugman politely declined a loud calling for his nomination as Treasury Secretary, preferring to remain an outside man. A latter-day Socratic gadfly, if you will. I agree, Paul Krugman in high political government would be a very bad thing. As I see it, such a position is best filled by a technocrat who can organize a willing coalition to frame the President’s economic policy into law. Paul Krugman is not that man.

Jack Lew is not involved with markets on an daily basis. We don’t much care how thick his briefcase might be. On the other hand, the Fed chair has the incredible burden of forming the most important expectations across international finance. We’ve all written many articles about how better monetary policy would slash deflationary expectations. We’ve talked about helicopter drops and QE infinity. We’ve talked about 4% inflation, and nominal targets.

Krugman is the intellectual father of irresponsibility, quite literally. If there is one man in this world who can convince markets that America will tolerate above-trend inflation, it is Paul Krugman. If there is one man in this world who can falsify Krugman’s own theory that we need more fiscal stimulus, it is Paul Krugman. Indeed, if Paul Krugman cannot credibly commit to be irresponsible, no one can.

Markets will smoke if he is shortlisted. If he is nominated, they will all but go on fire. So if you are interested in disproving Paul Krugman’s many calls for fiscal policy in a liquidity trap, you best champion for his nomination as Fed Chair.

(P.S. I did promise you “notes” plural. Your next best shot is to abdicate the scientific method, and choose to believe in hyperinflation, hard money, and short run superneutrality. This has been the option of choice for most.)

P.P.S Comon, is there a better “expectations channel” than

Brad DeLong has a long and thoughtful discussion on the confusing process of updating his priors in the past decade. The macronarrative is the tension between his prior and posterior of his confidence. At a 2006 lecture on NAFTA, DeLong starts by noting “Usually whenever I standup and talk in lecture, I am talking about something I’m sure I know what I think, and I’m also arrogant enough that when I’m sure I know what I think, I’m also sure I know I’m right”. This post does not exude that same confidence. But the micronarrative is the tension between his prior and posterior on the state of neoliberalism: have we solved the business cycle, are we at the end of economic history?

It’s a long post, and I won’t comment on it all. It’s definitely worth reading and, if you keep up with his blog, not all the sentiments or slides are brand new. I will respond to Paul Krugman’s pithier post disagreeing (for once) with some of DeLong’s comments.

Brad DeLong has a long meditation on policy that, surprisingly, includes some things I strongly disagree with. I guess I should start by saying that when he describes his fairly complacent view of macroeconomics on the eve of the crisis, he’s describing a view that many economists shared — but I wasn’t one of them. Japan’s troubles and the Asian financial crisis destroyed my faith that we had the business cycle under control; I wrote a whole book about the return of depression economics back in 1999.

Paul Krugman first detailed this argument, a year before his book, in 1998 at BPEA, for which Kenneth Rogoff’s opening response was “this is a truly inspired paper on Japan’s ongoing ‘Great Recession,’ although I have to keep pinching myself to ask if the main thesis can really be true”. I hope Rogoff is no longer pinching himself. (Note, one year later, in March 1999 the Bank of Japan became the first central bank in history to engage in quantitative easing policies).

However, Paul Krugman’s general prior with regard to fiscal dominance at the turn of the 21st century – which is the primary object of DeLong’s introspection – could not have been far from DeLong’s, and other “complacent” neoliberals. Indeed I wonder who, in 2003, wrote:

[L]ast week I switched to a fixed-rate mortgage. It means higher monthly payments, but I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits…my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.And as that temptation becomes obvious, interest rates will soar. It won’t happen right away… But unless we slide into Japanese-style deflation, there are much higher interest rates in our future.

Like any intellectually honest man, he recognizes his flaw and notes:

My thinking has evolved. If you haven’t updated your views in the face of new experiences, you’re not doing your job.

At least insofar as the blight of fiscal dominance, which was the import of the discussion, both Paul Krugman and Brad DeLong have evolved substantially. Krugman indeed was definitely more vocal about the return of depression economics as a phenomenon. However, if I sat with Krugman and DeLong, each, a decade ago and asked “what are the odds America will fall into a liquidity trap”, I expect both would find the chance negligible.

That Krugman believed disinflationary expectations challenged the end of business cycles does not mean he thought America would fall victim. There is an intellectual difference, granted, in accepting it could fall victim and rate the probability as negligible and rating the existence of such a probability itself as negligible. However, I have greater concern with Krugman’s take on confidence “imps”:

First, our expectations argument is a hope; theirs is a plan


Which brings us to the second point: those of us hoping to summon the expectations imp want to do so with policies that are at worst harmless, such as expanding the monetary base under conditions where this has no direct inflationary impact. The austerians, on the other hand, have pushed directly destructive policies — fiscal contraction in depressed economies — in order to achieve their hoped-for shift in expectations.

So this is the difference between “Let’s try this possibly ineffective remedy, it might work and in any case won’t do any harm” and “Let’s do the opposite of what standard analysis says we should be doing, just trust me”.

On the one hand, I’m bound to agree because I think confidence vigilantes are hardly a problem with the massive demand for safe assets and the American dollar. On the other hand, it misses the ideological Turing Test in its sweeping indictment. We must always consider the priors of those who advance a certain theory. This is like Krugman saying “bond vigilantes are wrong because, well they’re wrong”. DeLong is not unlikely to agree with Krugman on this point, but notes the structural and mechanistic similarity between the confidence fairy and expectations imp (god damned “animal” spirits!). One advancing the confidence fairy argument:

  • May take a Treasury view prior, or believe in monetary offset and hence disregard austerity as bad for growth.
  • May believe inflation is a serious risk.

Neither of these views lend themselves to Krugman or DeLong, but do not divorce the mechanistic similarities between the two spirits. So it’s really not “the difference between “Let’s try this possibly ineffective remedy, it might work and in any case won’t do any harm” and “Let’s do the opposite of what standard analysis says we should be doing, just trust me”.” Because that would be like (logically) begging the question.

The distinction between “hope” and “plan” is even more confusing. And it also really depends if you talk to New or Old Keynesian Krugman (or Krugman the academic vs. Krugman the blogger). He has as much a plan – via a standard IS-LM – as do the austerian types. It’s just a better plan, but that makes it a plan nonetheless. But his word choice is even more confusing. Krugman says that “we have a hope”, “they have a plan”, and yet uses this language to describe their “plan”:

I want the Fed, the Bank of Japan, etc. to target higher inflation, in the hope that it might help, but it’s a hope, and meanwhile we need to fight demands for fiscal austerity and even push for stimulus. The expansionary austerity types, on the other hand, are (or were) actually counting on the supposed rise in confidence to avoid what would otherwise be nasty recessions, which have in fact materialized.

Replace “counting on” with “hope” and tell me if the semantics change? Am I equivocating something? Have I misunderstood? Perhaps. But also, Krugman’s hope is as much predicated on a plan for something else. Furthermore, insofar as we’re only talking about one country, it’s entirely possible to kickstart inflation. As he himself brilliantly put it, the Bank of Japan must “credibly commit to be irresponsible”. That sounds like a plan. A hopeful one, but a plane nonetheless.

To me the similarity between confidence fairies and expectations imps ends at the mechanistic level. But I didn’t even think about it until Brad DeLong pointed it out, so I feel the smarter for it. I wrote this post because after reading Krugman’s post I was quite confident I didn’t feel stupid for feeling smart earlier. So I wrote this post; and maybe I haven’t updated my confidence levels as much as DeLong has, but that’s a sign of ignorance more than anything!

By the way, I think Paul Krugman has been the most astute academic through this crisis. Economic history textbooks will note his prescience and forceful blogging. That doesn’t mean he’s always right, and I think this post is a good example.

Edit: Dean Baker has some thoughts that echo my thoughts, perhaps in better words!

After the heated debate between Joe Scarborough and Paul Krugman, Jeffery Sachs and Scarborough co-authored an op-ed in the Washington Post, contending that “Deficits do Matter“. Paul Krugman replied with some good points and asks Sachs, what exactly he considers “crude Keynesianism”. To this, Sachs wrote a well-thought editorial in the HuffingtonPost.

I don’t think the attack on Krugman is fair – I’ll get to that later – but I also think Sachs’ argument fails to grasp the extent of cyclical (rather than structural) downturn, the extent to which ‘infrastructure’ can create immediate jobs, and external factors, like the European crisis. Ultimately, I think Sachs misrepresents his own (good) ideas under the guise of ‘debts are bad’. Infrastructure spending is smart, necessary and, yet, increases our structural deficit. Sachs is absolutely right that stimulus won’t solve long-term unemployment. Sweeping AS reforms, however, won’t be as quick to solve short-term unemployment. Skill atrophy will force long-term unemployment, in some measure, to be a function of short-term unemployment (though, WWII is a pretty good example to the contrary). There is no reason the US can’t both stimulate the economy with spending while at the same time overseeing broad, long-term, structural reforms.

So what is crude Keynesianism? According to Sachs:

(1) The belief in large, stable, and predictable multipliers on taxes and transfers;
(2) The belief that our problems are due overwhelmingly to a deficiency of aggregate demand, rather than to structural problems that need a long-term approach;
(3) The belief that a rapidly rising debt-GDP ratio is largely benign because interest rates are low today and will stay so indefinitely;
(4) The belief that “to a large effect, spending is spending,” thereby catering to waste and vested interests while ignoring America’s urgent investment needs.

I believe that all of these positions are misguided.

He continues:

The belief in stable, predictable, and large multipliers is belied by both theory and evidence. Households and local governments might simply use a temporary tax cut or temporary transfer, for example, to pay down debts rather than to increase spending, especially because the tax cut or transfer is seen to be temporary. Businesses, concerned about the buildup of public debt, might hold back on business investment in the face of large deficits, anticipating higher taxes in the future.

That families might use stimulus checks to pay down debts is incorporated into any calculation of a multiplier which is inversely proportional to the marginal propensity to save. Sachs might argue that the method in which multipliers are calculated is incorrect, which might well be the case, but is not in itself a criticism of Keynesian policy. The rational expectations argument has a lot of appeal, but is ultimately predicated on the idea that much of our deficits are structural. If deficits are primarily cyclical, a government can impose a one-time high tax that would have no effect on future investment (whether this is subgame perfect or not is another story).

Key to Sachs’ argument is that we face a looming structural deficit:

These structural components are not susceptible to a Keynesian diagnosis or to a Keynesian remedy. They require a long-term public investment response that has not been forthcoming.

Second, Krugman seriously and repeatedly downplays these structural changes occurring in the U.S. economy. He repeatedly emphasizes that we suffer a demand shortfall, pure and simple, one easily remedied by more stimulus. Yet it’s increasingly hard to reconcile many features of the U.S. economy with this view.

Unlike the Great Depression, which Krugman repeatedly uses as his reference point, U.S. profits are soaring. Unlike the Great Depression, the world economy is growing rather rapidly (3 to 4 percent per year) so that more rapid U.S. export growth is feasible. Unlike the Great Depression, vacancy rates are recovering even as unemployment is stuck. (Technically, the Beveridge Curve has shifted to the right.)

I completely agree that the US is ripe for vast reinvestment in infrastructure and public works projects (oh, and, Krugman does too). However, that much of our deficit is structural is plain false:


When we consider deficits as a proportion of potential GDP, the deficits are coming down. Sachs and Scarborough don’t acknowledge that CBO estimates a flat debt-GDP ratio over the next decade. We have a long-run spending problem which, again, has nothing to do with a criticism of short-run stimulus. CBO budget projections are pretty accurate in the short-horizon, and at this rate cyclically-adjusted (or structural) deficits will fall below 3% this year. This is eminently feasible, at current growth rates.

This rides in well into his third criticism of of ‘crude Keynesianism’ – that it suggests a rising debt-GDP ratio is somehow okay. Krugman certainly doesn’t think so. And while long-term problems are better solved today, their existence doesn’t somehow void the need for short-run stimulus. For this reason, this sounds like an unfair argument:

Third, crude Keynesians like Krugman believe that we don’t have to worry about the rising public debt for many years to come, perhaps well into the next decade. This is remarkably shortsighted. The public debt has already soared, from around 41 percent of GDP when Obama came into office to around 76 percent of GDP today (and with no lasting benefit to show for it). If Krugman had his way, and deficits were not restrained, the debt-GDP ratio would already be above 80 percent by now and would be rising rapidly towards 90 percent and above (as shown in the recent CBO alternative scenario).

For one, ‘has increased’ is wildly different from ‘is increasing’ – not the least that the former is true while the latter is not. Furthermore, so long as growth projections outpace structural deficits, there isn’t something magical about a 90% debt-GDP ratio. Indeed, growth would have picked up faster, and fewer people would be unemployed, and even fewer permanently unemployable. A self-proclaimed progressive like Sachs should care about this. A lot.

Most of the shortfall this recession has been due to demand-deficiency. While supply-side reforms are crucial, we’re not experiencing any severe cost-push inflation. We have time to implement a well-thought infrastructure plan that would invigorate our power grids in an environmentally and economically sustainable fashion.

Further, Obama has tried to leverage global growth to the greatest extent he can. While Sachs might argue Krugman hasn’t ‘quantified’, the effect of the European crisis is pretty obvious. Sluggish European demand has widened our trade deficit and, for the first time, the greatest trade growth in developing countries has come from other developing countries. China is now the largest trade partner for most countries. It’s not as easy to ‘tap in’ to global recovery as it once was. Obama is pursuing a European free-trade deal that would hopefully spur job growth. Both the United States and Europe are in dire need for homogenized regulations, we have good reason to believe the President can pull this off.

Sachs’ interpretation of future interest rates is also questionable:

It’s true that we’ve not paid heavily so far for this rising debt burden because interest rates are historically low. Yet interest rates are likely to return to normal levels later this decade, and if and when that happens, debt service would then rise steeply, increasing by around 2 percent of GDP compared with 2012. Many people seem to believe that we can worry about rising interest rates when that happens, not now, but that is unsound advice. The build-up of debt will leave the budget and the economy highly vulnerable to the rise in interest rates when it occurs. The debt will be in place, and it will be too late to do much about it then.

If a vedic astrologer told me that rates would be ‘normal’ later this decade I would be thrilled. It means businesses aren’t hoarding cash, private investment is increasing, unemployment is falling and, as automatic stabilizers start slowing, decreasing deficits. Alas, this is not the case. Markets are forward looking, and any expectation of future growth or rise in interest rates would result in a discounted increase today, which is not the case. Yields capture the macroeconomy. Furthermore, we’ve rolled over a lot of our debt on longer maturities. The effect of increasing yields will be slow to cause rising deficits.

There also seems to be an unfair criticism of Krugman vis-a-vis his former positions:

Krugman, an economist and New York Times columnist, agreed not so long ago with our position that demographic challenges demanded fiscal restraint. In 2001, he wrote that deficits mattered as he inveighed against President George W. Bush’s tax cuts. With the gross federal debt then at a mere $5.6 trillion, Krugman nervously declared that balancing the budget “is mainly a matter of preparing for the fiscal consequences of an aging population.” But these days, Krugman tends to be a bit more dismissive about the dangers of long-term debt despite America’s aging population and the addition of another $10 trillion of debt in the past 12 years.

In fact, Krugman’s argument is highly consistent. If the economy is in the gutter, it’s okay to spend more. It’s a pretty terrible idea to run deficits when it’s expanding. Krugman isn’t arguing for structural deficits that outpace growth, only the need for cyclical stabilizers. This is both economically and morally sound.

However, I completely agree with Sachs on his policy recommendations, as well as his dissatisfaction with Obama’s first-term economic team:

(1) Decade-long public investment programs in renewable energy, upgraded public infrastructure, fast rail, job training and the like;
(2) Adequate fiscal revenues (including tolls on infrastructure) to pay for these investments over the course of a decade, including a downward path of the debt-GDP ratio;
(3) Increased revenues through taxation on high net worth, financial transactions, high incomes, capital gains and carried interest, offshore corporate earnings, and carbon emissions, and a stiff crackdown on tax havens and phony transfer pricing.

All of this would have been much easier if Obama had started down this long-term path in 2009, and had never conceded the permanence of the Bush-era tax cuts for almost all households. Instead, he followed a populist and shortsighted policy of “stimulus” and tax cuts.

Green investment will be a crucial and also empowering driver for not just economic growth, but America’s standing as a hub of real innovation and moral agency. As a recent San Francisco Fed paper argues, infrastructure spending isn’t mutually exclusive with short-run stimulus, as is sometimes thought:


While most of the gains come 6-8 years after increase in investment, there is a not insignificant increase in immediate activity. Indeed, ARRA included just under $30 billion in highway grants.

I found this paragraph to be very important (and apparently Tyler Cowen does too):

This approach is disastrous both politically and economically. Progressives like myself believe strongly in the potential role of public investments to address society’s needs – whether for job skills, infrastructure, climate change, or other needs. Yet to mobilize the public’s tax dollars for these purposes, it is vital for government to be a good steward of those tax dollars. To proclaim that spending is spending, waste notwithstanding, is remarkably destructive of the public’s trust. It suggests that governments are indeed profligate stewards of the public’s funds.

However, as a progressive I ultimately disagree that short-term spending is misguided. Much of the stimulus and cyclical deficit was directed in financing unemployment insurance and transfers for the relatively poor. By virtue of a flat dollar reimbursement and nature of the tax holiday, the largest beneficiaries of this scheme are those who earn the least. While Sachs approaches this spending from a merely artificial economic angle, there is a deeply human element, namely the funds provided by the recovery allowed many Americans to make end’s meet. This is a terrible way of achieving that necessary goal, but an important achievement nonetheless.

Ultimately, all of Sachs’ great ideas will require us to run greater structural deficits. Official estimates suggest the US government can invest about $80 billion a year more on infrastructure and see positive gains. Do I think we should spend that much? Yes. I just don’t think it’s politically feasible without deficit spending.

Unfortunately, Sachs can’t have the luxury of being both an advocate of public infrastructure and investment while simultaneously fearing our short-run deficit.