Yesterday I posted that the ECB just doesn’t “get it,” secure in the knowledge that Paul Krugman totally agrees with me on at least that one point. And then look at what commenter Vaidas Urba sends me:
Paul Krugman from a week ago:
The good news is that the ECB does, I think, understand the problem. The bad news is that it has limited options. Europe needs something like Abenomics as badly as Japan does; but the political and institutional setting is not favorable.
And then more recently:
The thing is, I don’t believe that current management at the ECB is that different in its understanding of what policy should be doing from leadership at the Fed. But it has to struggle against an economy that is weaker in its underlying fundamentals, bad history, and a much more powerful contingent of monetary hawks.
It really is quite scary.
Over the years Krugman and I have both bashed the ECB for their almost unbelievable incompetence. The ECB that has repeatedly raised interest rates in the midst of the biggest recession since the 1930s. The ECB that says inflation should be targeted at 2% and we should forget about unemployment, and then later says don’t worry about the 2% target, deflation is actually healthy because it restores competitiveness.
So why is Krugman suddenly so forgiving? Yes, the “underlying fundamentals” are weaker, due to “bad history.” But the bad history is a tight money ECB policy that created 0.8% annual NGDP growth over 6 years. Those are the “underlying fundamentals” that led to a negative Wicksellian equilibrium rate. Remember that guy who killed both his parents, and then asked the judge for leniency because he was an orphan?
Krugman’s usually not so forgiving in this situation, so let’s consider some alternative explanations. This is from his recent Vox article:
And now we are talking seriously about secular stagnation in Europe and the US as well, which means that it could be a very long time before ‘normal’ monetary policy resumes. Now, even in this case you can get traction if you can credibly promise higher inflation, which reduces real interest rates. But what does it take to credibly promise inflation? It has to involve a strong element of self-fulfilling prophecy: people have to believe in higher inflation, which produces an economic boom, which yields the promised inflation. A necessary (though not sufficient) condition for this to work is that the promised inflation be high enough that it will indeed produce an economic boom if people believe the promise will be kept. If it is not high enough, then the actual rate of inflation will fall short of the promise even if people do believe in the promise, which means that they will stop believing after a while, and the whole effort will fail.
If you are confused don’t feel bad. He’s saying that under certain liquidity trap assumptions there is no rational expectations equilibrium at 2% inflation rate. Now that’s clearly wrong, you could peg CPI futures contracts at 2% inflation. So what’s he really saying? He’s saying that you can’t get 2% inflation in his particular Keynesian model. If you got it in the real world it would be for some other reason, perhaps they ran out of government securities to buy while pegging CPI futures, and then had to buy other assets. Viola, redefine that as “fiscal policy.” QED. I’ve never found those arguments at all persuasive for reasons I’ve discussed ad nauseum. In any case, it has no bearing on what’s going on the real world, where the ECB has been doing “normal” monetary policy for most of the past 6 years, raising and lowering interest rates, and has refrained from QE. The ECB doesn’t have to buy stocks and corporate bonds. They need a more expansionary monetary policy.
And I’m completely confused by his comparison of US and eurozone fiscal policies in the August 13 post. Whenever people point to the fact that Britain has run huge deficits, Keynesians like Krugman say they’ve got it all wrong; it’s the change in the deficit that matters. And the Cameron government reduced the deficit somewhat. But the data he presents shows the US deficit shrinking faster than the eurozone deficit since 2010. And yet it was the eurozone that had the horrible growth performance after 2010, not the US. (Both regions did about the same in the initial downturn.) How does Krugman react? Now he’s back to comparing levels–the eurozone has a smaller deficit than the US. Either deficits matter, or changes in deficits matter; I wish Keynesians would make up their minds.
Of course market monetarists aren’t at all confused by the fact that the US has done much better than the eurozone since 2010.
PS. Perhaps he’s soft on the ECB because they are sophisticated city people, like him. He’s only just arrived in NYC and is already ridiculing the foolish life choices of small town Americans who don’t share his love of strolling though Manhattan:
People should get enough exercise — they will, in general, be happier if they do — but they tend not to get exercise if they live in an environment where it’s easy to drive everywhere and not as easy to walk. People should limit their caloric intake — again, they’ll be happier if they do — but have a hard time resisting those giant tubs of popcorn.
I can personally attest to the importance of these environmental effects. These days, I walk around with a pedometer on my wrist — hey, I’m 61, and it’s now or never — and it’s obvious just how much more natural it is to get exercise when I’m in New York than when I’m in Princeton; just a few choices to walk rather than take the subway fairly easily gets me to 15,000 steps in the city, while even with a morning run it can be hard to break 10,000 in the suburbs. Also, the Bloomberg nanny-state legacy, with calories displayed on practically everything, does help curb my vices (greasy breakfast sandwiches!).
The interesting and difficult question is how, and whether, these kinds of behavioral issues should be reflected in policy. There are some conventional externality arguments for promoting walkable development — less pollution, etc.. But can we, should we, also favor walkability and density because it promotes good habits? How far should regulation of fast food go? Etc., etc.
Also, isn’t it kind of interesting that these days big-city residents on average lead more “natural” lives, being outside and getting around on their own two feet, than “real Americans” who live in small cities and towns?
Yup, small town Americans sure are stupid. They’d be much happier if only they’d listen to Paul Krugman’s advice.