Never reason from a higher risk premium

First ask why the risk premium rose.

A number of bloggers including Paul Krugman, Tyler Cowen and Nick Rowe have recently weighed in on the question of whether a higher risk premium would be expansionary.  Before criticizing this analysis, let me emphasize that I do understand the concept of ceteris paribus.  However I think it’s very dangerous to engage in this sort of speculation, because higher risk premia almost never happen, ceteris paribus.  They happen for a reason, or multiple reasons.  And any conclusions drawn from the certeris paribus case are often (mistakenly) applied to a real world increase in the risk premium, which is triggered by some sort of actual shock.

Let’s start by trying to understand why so many commenters found Krugman’s argument (that a higher risk premium on government debt can be expansionary) to be a bit too clever, a bit too counterintuitive.  My hunch is that it was because their instincts tell them this is unlikely to happen, mostly because they don’t ever recall seeing anything like an expansionary rise in a risk premium, whereas they have often seen something closer to the opposite.  (Closer, but not exactly the opposite, as rising risk premia are often associated with countries without their own currency, or with debts in foreign currency.)

And in fact we should not be surprised that we don’t see expansionary increases in the risk premium.  The growth rate of NGDP is far and away the biggest determinant of the budget deficit.  A major expansion in NGDP would sharply reduce the budget deficit, and also reduce the ratio of debt to GDP.  So it’s almost impossible to imagine a rational expectations solution where you get an expansionary rise in the risk premium.  Not because there is anything wrong with Krugman’s ceteris paribus reasoning, but rather because it’s almost impossible to imagine a shock that would be expected to promote both a higher risk premium and a faster recovery.

Another way of putting this point is that any assumed shock that boosts both the risk premium and the recovery, is unlikely to do so in a world of rational expectations.  Now of course one could argue that the ratex assumption is wrong, but once we do so we are out of the world of science and into the world of pure conjecture.  In that case proponents of the expansionary risk premium increase can no longer refer to scientific models in support of their assertions.  Without ratex EVERYTHING changes, and virtually anything is possible.  I could argue that the bond vigilante news frightens consumers, and the MPC falls sharply.  Literally ANYTHING is possible, once you dump the ratex solution.  As the old mapmakers used to indicate; “Here be monsters.”

What sort of actual shock would be most likely to cause a rise in the risk premium on US government debt?  I have trouble visualizing any plausible scenario that would do this (in that sense I agree with Krugman, who is also skeptical.)  But I’ll do my best.  Here’s the sort of triple whammy that might do the trick:

1.  Congress engages in a massive fiscal stimulus project, with no credible plan for the long run deficit problem.

2.  The Fed views the plan as highly irresponsible, and sharply tightens policy—driving NGDP lower.

3.  The Fed warns Congress that they will not bail out a failed fiscal policy with inflation, and that Congress will have to clean up its own mess.

That sort of shock might create a higher risk premium on Treasury debt.  And that sort of shock would not be expansionary, just the opposite.  But of course those arguing that a higher risk premium is expansionary are going to object that my conjecture violates ceteris paribus.  True, but nothing ever happens to prices or risk premia, ceteris paribus.  So the ceteris paribus case is not very interesting.

HT:  Saturos, Mike Moffatt


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42 Responses to “Never reason from a higher risk premium”

  1. Gravatar of Bill Woolsey Bill Woolsey
    13. November 2012 at 06:51

    Obama is converted to Modern Monetary Theory and says that budget deficits are no problem, we can just create money and pay it all off.

    The risk of inflationary default increases.

    Why isn’t that expansionary?

    Or, suppose people accept the radical libertarian argument taht we should immediately abolish the income tax and just pay government creditors pennies on the dollar, because explicit default is better than tax hikes.

    Why isn’t that expansionary?

    It seems to me that an increased probability of either inflationary or explicit default in the future is immediately expansionary.

    It is only if the Fed responds by defending the exchange rate or else preventing CPI inflation (well, any measure that includes imported prices) do we get contractionary effects. And these effects are due to central bank policy. (A foolish one.)

    Now, real per capita incomes are almost certainly going to suffer from a capital flight.

    To the degree that government tries to cover greater interest burdens by raising taxes, there are efficiency losses.

    I don’t see much disadvantage of government spending cuts, though there will be sectoral shifts, which are always painful.

    I think the implicit assumption that results in “contractionary” intuition is inflation targeting. The lower real per capita incomes are going to come through lower nominal incomes, which requires contraction. But it is all about the monetary regime.

    By the way, the only advantage to the bond viligantes is getting off the zero nominal bound so the Fed is in its comfort zone–manipulating demand through interest rate changes. But then, with inflation targeting, including CEP targeting, the result will surely be contractionary. Inflation expecations are going to become unanchored, so we must tighten monetary policy. (So domestic consumer prices rise more slowly or even fall to offset the inflation of the prices of imported consumer goods.) The higher interest rates, of course, reduce the depreciation of the dollar and so the inflation of imported consumer goods to.

  2. Gravatar of Kenneth Duda Kenneth Duda
    13. November 2012 at 07:11

    Scott, I think you’re missing the point of Krugman’s argument.

    The political context is that the right is arguing for cutting taxes for high earners, because as we all know, cutting taxes on high earners creates jobs, expands the economy, and increases tax revenue. But we must balance the budget in the short run, because borrowing is bad, borrowing “got us in to this mess in the first place,” and borrowing more is no option because the US is on the brink of bond vigilante assault, which would be really bad for everyone. (I hope you noticed the sarcasm font I used there.) Therefore, we need deep cuts to social programs.

    Krugman has been systematically shooting down this nutty argument piece by piece.

    In this case, he is going ahead, making the same ridiculous assumptions as the right, and then demonstrating that *even if you accept their assumptions*, there is *still* no credible path from bond vigilante assault to collapse of the US economy. That is, he is (for the sake of argument) accepting everything above except one piece: the link from “bond vigilante assault” to “bad for everyone”.

    So it is really rather unfair of you to fault Krugman’s assumptions. They weren’t his. He simply adopted them to make his point.

    To recast into the terms of your post, the hypothetical “trigger” for higher risk premia is that global bond traders read enough WSJ editorials that they suddenly start believing, all at once, that US government debt deserves junk-bond ratings. Other than that hypothesis, there is no ratex rejection and it is all ceteris paribus.

    I would be very curious how you would analyze the situation assuming that particular (impossible) trigger, suspending disbelief that bond traders could be a collective herd of idiots, setting aside that one ratex violation, and assuming that an inexplicable change in expectations was the sole trigger of a jump in US federal borrowing costs — and run from there. Do you get to the same place as Krugman?

    Kenneth Duda

  3. Gravatar of Alex Godofsky Alex Godofsky
    13. November 2012 at 07:45

    Bill, “inflationary default” is just another term for monetary stimulus.

  4. Gravatar of Kenneth Duda Kenneth Duda
    13. November 2012 at 08:10

    One side comment here. It is discouraging how the economics profession has not stepped up in guiding sensible public policy. I’d say this exchange is illustrative:

    Krugman: “The right is wrong. Even if the bond vigilantes were to strike, it wouldn’t be bad for the overall economy, and might even help. So let’s stop worrying about federal deficits and focus on aggregate demand.”

    Sumner: “Krugman’s analysis doesn’t make sense because the vigilantes won’t strike unprovoked. If risk premia do rise, it will be for some other reason, and the total picture will probably be bad.”

    Media: “Krugman and Sumner disagree about the possible impact of further federal deficits.”

    What can the rest of us do? We shake our heads sadly.

    It appears the vast majority of economists support basically sensible policies, yet as a profession fail to provide any sort of unified guidance for policy makers. I wish you could somehow all get together and provide Bernanke the support he needs to pursue truly expansionary policy in the face of the most dramatic AD shortfall in 80 years.

    Kenneth Duda

  5. Gravatar of Jason Jason
    13. November 2012 at 08:24

    I don’t like the use of the term “risk premia” here because a risk premium is that extra return given to investors above EV as a compensation for risk. You are really talking about an increase in default probabilities. An increase in the quantity or price of risk decreases real interest rates (or decreases the natural rate of interest). This is a precautionary savings effect you would find in any finance model.

    Anyway, I think the Krugman logic is just textbook Mundell-Fleming increase in country risk with a floating exchange rate. You would find this in Mankiw’s intermediate Macro text and probably many others. We usually teach this and then suggest it is a puzzle and try to resolve the puzzle. My favorite way to resolve the puzzle is the same as your logic here, an increase in country risk happens when a country is already experiencing a big recession.

  6. Gravatar of Evan Soltas Evan Soltas
    13. November 2012 at 08:27

    Scott,

    I think, even while accepting the terms of the argument, one could argue that an increase in the risk premium would be contractionary. Following up on what I had written you earlier, there are some very doubtful assumptions in this as to the stability of i* (the risk-free interest rate) when the risk premium of American debt increases and the willingness of the central bank to accept large increases in the price level.

    My post is here: http://bit.ly/RVnba0.

  7. Gravatar of Major_Freedom Major_Freedom
    13. November 2012 at 08:30

    Kenneth,

    Krugman made it clear in his article that he actually believes what he wrote.

    —————-

    ssumner:

    The growth rate of NGDP is far and away the biggest determinant of the budget deficit. A major expansion in NGDP would sharply reduce the budget deficit, and also reduce the ratio of debt to GDP.

    A major expansion in NGDP would encourage the government to borrow and spend more. And why not? Taxation would go up. You’re holding too many things constant.

    I hope you’re not reasoning from an NGDP change, and saying that because the deficit went up post 2008, that it “proves” NGDP is far and away the biggest component of NGDP. I mean, an alien invasion would probably increase the deficit, but I don’t think that would “prove” threats of aliens are the biggest regulator of deficits during “normal” times.

    Deficits are a function of two variables, spending and receipts. If deficits go up, then it’s because the difference between spending and receipts went up.

    A decline in NGDP is not associated with increased deficits unless there is an increase in the difference between government spending and receipts, which of course means NGDP isn’t the reason. Deficits are (obviously) caused by a refusal of government to decrease the difference between spending and receipts. Spending isn’t sacred. All of it is discretionary, even if they call some of the spending “non-discretionary.”

  8. Gravatar of Saturos Saturos
    13. November 2012 at 08:33

    Man, I totally should have called that title…

  9. Gravatar of Saturos Saturos
    13. November 2012 at 08:37

    What about a minor expansion in NGDP, which isn’t enough to offset the shock to fiscal credibility? Wouldn’t that raise the risk premium and AD without violating ratex?

  10. Gravatar of Saturos Saturos
    13. November 2012 at 08:41

    Kenneth, that’s not quite what Scott’s saying. I’m pretty sure he’s arguing that regardless of the supply-side reason for the bond-vigilante attack, any positive effect of this on AD gets factored into the original net change in risk-premiuim via ratex. So if genuinely expansionary then the bond vigilante strike will lower risk premia, not raise it.

    Of course if really expansionary then interest rates should rise anyway, again via ratex. So Krugman is right for the wrong reasons…

    Flicking through old WCI posts – Livio Di Matteo had one about Bond Villains as fiscal stimulus, I clicked on it thinking it was a response to Krugman…

  11. Gravatar of Saturos Saturos
    13. November 2012 at 09:03

    Jason, interestingly a perusal of that textbook reveals that Mankiw himself makes a “Sumner critique” of expansionary rises in the risk premium. He notes that the central bank is likely to react by reducing the money supply to hold up the exchange rate, and also that, not withstanding the rise in interest rates people may demand more money as a safe asset, pushing down aggregate demand.

  12. Gravatar of mpowell mpowell
    13. November 2012 at 09:23

    This is a great point and true of a lot of economic arguments. Some friends of mine wondered recently whether it was risky to buy a house based on low interest rates. What if rates go up later? Will that cause your house to go down in value? The problem with this type of reasoning is that you need a theory of why rates will go up. You have to be very careful with ceteris paribus based reasoning if you are going to try to use your conclusions in the real world.

  13. Gravatar of Doug M Doug M
    13. November 2012 at 09:29

    Currently the fed is working hard to drive down the risk premium of government debt — opperation twist. Is this counterproductive?

    “What sort of actual shock would be most likely to cause a rise in the risk premium on US government debt?”

    This is easy! And increase in expectations of NGDP growth. The risk premium of Govenment debt is the spread between the risk free rate and Treasury rates. And, rational expectations of future Fed actions is the major driver of this spread. So, expectations of faster growth or faster inflation would drive up the the risk premium.

    Run away infaltion would (with Real GDP contacting so NGDP stayed low) would cause the risk premium to increase.

    An increase in non-government borrowing — corporate or MBS — would compete with government bonds, and drive up the rates / spreads.

    1,2 and 3 above would likely drive down the risk premium of government debt.

  14. Gravatar of Suvy Suvy
    13. November 2012 at 09:41

    I agree completely. Trying to increase the risk premium is extremely dangerous. Especially because a small increase in interest rates creates a much larger cost to service the government debt. With government debt already at such high levels and the unfunded liabilities of Social Security and Medicare; trying to increase the risk premium of government debt is extremely risky and not even a good idea. I also agree that setting an NGDP target would be ideal because it would help reduce the budget deficit by quite a bit.

  15. Gravatar of GMC GMC
    13. November 2012 at 10:14

    Krugman is, as usual, deploying ordinary economic tools in service of intentionally dishonest models in order to attack some element of an assumed conservative economic program that will not be enacted because politicians who have economic programs never get elected.

    If the bond vigilantes attack, the result will be contractionary in the short run, and irrelevant in the long run. The United States simply has too much wealth, and too much debt, too much of which is held by people not looking for a speculative attack opportunity, for a “run” to be successful.

    Krugman’s usual mistake – assuming that fiscal changes have an effect on aggregate demand – is relevant here. If the monetary authority does what it is supposed to do, the bond vigilantes will have no more effect on aggregate demand than Congress does.

    “If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.”

    -Paul Krugman, February 6, 1997.

    The 1997 version of PK is still right. And we’re still wondering what the Hell happened to him.

  16. Gravatar of JL JL
    13. November 2012 at 10:18

    Scott,

    I agree with Kenneth Duda. You have totally missed Krugman’s argument.

    Back in March 2009, I thought it was unfair that Krugman misrepresented your views. I gues it’s 1-1 on the misrepresentation front now, isn’t it?

    If you want to fault someone for speculating, fault the right, not Krugman.

    Krugman has always maintained that this threat of the risk premium rising ceteris paribus is imaginary. He calls them the INVISIBLE bond vigilantes, remember?

    But since the right wing keeps claiming that it’s a real threat, he worked out the scenario to prove that EVEN IF this imaginary scenario would materialize, it would actually be good.

    And now you and Tyler are arguing that the imaginary scenario will never materialize, therefore Krugman is dangerous and wrong for analyzing an imaginary right-wing scenario.

    Sigh…

  17. Gravatar of ssumner ssumner
    13. November 2012 at 10:34

    Kenneth, This post didn’t single out Krugman. I was interested in the broader question of whether a higher risk premium is expansionary, not the politics of the current debate. I claim you can’t answer the question without more information. That’s all.

    I’ll look at the other comments later.

  18. Gravatar of David Beckworth David Beckworth
    13. November 2012 at 11:39

    Scott,

    I think the premise of the Krugman-Cowen conversation is wrong. Rising yields or the appearance of “bond vigilantes” would be a sign of recovery and a drop in the risk premium.

    http://macromarketmusings.blogspot.com/2012/11/bond-vigilantes-to-rescue.html

  19. Gravatar of Lover Of Chicken Tenders Lover Of Chicken Tenders
    13. November 2012 at 14:45

    Agreed on the commentators regarding the misunderstanding. While this discussion between bloggers has been illuminating in some ways, the notion of bond vigilantes seems to imply at least a “soft” ratex rejection. They are vigilantes because they act in the absence of shocks. Perhaps they are the shock. Look at Krugman’s relentless castigating of “zombie” notions:
    http://krugman.blogs.nytimes.com/2012/11/10/more-on-invisible-bond-vigilantes/

    It seems like the IBV is seen as a set of wrong ideas that mysteriously gather critical mass, rather than a rational response to new information.

  20. Gravatar of JSeydl JSeydl
    13. November 2012 at 14:51

    “Now of course one could argue that the ratex assumption is wrong, but once we do so we are out of the world of science and into the world of pure conjecture.”

    Right. So Krugman’s call on rates and inflation in 2011 was pure conjecture. Got it.

    C’mon, Scott. This post has so much Krugman envy in it that it’s actually hard to read. Deep down, you know that Krugman has been right on just about everything in recent years — that his ceteris paribus assumptions have held up better than anything coming out of the ratex world. Yet you’re criticizing him for being too simplistic — for “conjecturing” too much. I suggest you reread Friedman’s The Methodology of Positive Economics one more time. For the truth is that Friedman, if he were alive today, would be on Krugman’s side, praising things like IS-LM.

  21. Gravatar of ssumner ssumner
    13. November 2012 at 17:41

    Kenneth, You said;

    “It appears the vast majority of economists support basically sensible policies, yet as a profession fail to provide any sort of unified guidance for policy makers.”

    Most economists do NOT support sensible policies, they support the tight money policies that caused the Great Recession. Economists are the problem, not the solution.

    Evan, Good point. I agree that an increase in the risk premium is likely to be contractionary if the central bank is targeting inflation or NGDP.

    Saturos, It depends what causes the increase in the risk premium,

    JL, I fully understand exactly what Krugmasn was saying, and did not misrepresent his views. But I see you misrepresented my views as badly as you claim I did his.

    Let me quote from my post:

    “What sort of actual shock would be most likely to cause a rise in the risk premium on US government debt? I have trouble visualizing any plausible scenario that would do this (in that sense I agree with Krugman, who is also skeptical.) ”

    Next time read my post before making a fool of yourself.

    BTW, Krugman frequently misinterprets my posts, so it wouldn’t be 1 to 1.

    David, That’s also true of course.

    JSeydl, It’s rare that a post is so completely wrong about EVERYTHING. You don’t seem to understand that from the very beginning I’ve argued that the bond vigilante argument was wrong. So why would I be envious of someone who made exactly the same arguments as I did? I’d love to hear your explanation.

    And do you not realize that Krugman uses ratex models when he makes his arguments? Don’t you know ANYTHING about New Keynesian economics? His famous 1998 article on liquidity traps was a 100% ratex model. He’s made the same ratex arguments against the bond vigilante theory as I have.

    As far as being “right about everything” I’ve been right about the things Krugman was right about, and also right about some of the things Krugman was wrong about.

    Friedman would be praising IS-LM? You must be completely insane.

    As a general rule I find the more insulting the post, the more moronic the commenter. And you are a perfect example of both. You are in so far over your head that you don’t even understand how silly your arguments sound.

  22. Gravatar of Major_Freedom Major_Freedom
    13. November 2012 at 18:45

    As a general rule I find the more insulting the post, the more moronic the commenter. And you are a perfect example of both. You are in so far over your head that you don’t even understand how silly your arguments sound.

    Daaaaaamn.

    You have some pretty good smackdowns.

  23. Gravatar of gofx gofx
    13. November 2012 at 18:50

    JSeydl

    I am not sure I even accept the AD-deficiency framework of monetarist and NKs, but within that framework, Krugman(and Delong) were wrong about monetary policy at the ZLB, and the Sumner Critique. He’s been twisting around ever since trying to make fiscal policy (specifically spending)matter more. That’s in addition to his usual contradictions and inconsistencies.

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    13. November 2012 at 19:44

    Janet Yellen endorsed “oscillatory” convergence for inflation and unemployment in her speech today. This is in sharp contrast to the “monotonic” convergence that Bullard proposed in September, and which you parodied to great effect at the time. I commented on it here (too many links to put it here):

    http://economistsview.typepad.com/economistsview/2012/11/-fed-watch-yellen-supports-explicit-guideposts.html#comment-6a00d83451b33869e2017c337224be970b

  25. Gravatar of Saturos Saturos
    13. November 2012 at 20:38

    Actually Mundell-Fleming says that the boost in income comes from falling demand for money as yields rise. But would demand for money really fall during a sovereign risk crisis?

  26. Gravatar of Hugh Hugh
    14. November 2012 at 00:17

    Dear Professor Sumner,

    You list three reasons for an increased risk premium in your blog entry:

    1. Congress engages in a massive fiscal stimulus project, with no credible plan for the long run deficit problem.
    2. The Fed views the plan as highly irresponsible, and sharply tightens policy—driving NGDP lower.
    3. The Fed warns Congress that they will not bail out a failed fiscal policy with inflation, and that Congress will have to clean up its own mess.

    However, I believe that there is a fourth more compelling reason: Interest rates are now at historic lows, let’s say 2% on perpetuities to make the math easier. An investor with $100,000 earns US$ 2,000 per year – not very exciting, but that’s what the market is paying.

    If interest rates now rise to 3%, an historically unexceptional rate, our investor loses 33 % of his capital, or $33,000 and sells his bonds to avoid more pain. The extra $1,000 of interest available on new bonds is completely insufficient to compensate the capital losses. A run on bonds ensues as other investors (not necessarily vigilantes) follow suit.

    Now yes, it is true that capital losses are attenuated for shorter maturity bonds, but I do not find this scenario far-fetched, and can imagine any number of ways in which it might come to fruition.

    Yours Sincerely,

    Hugh

  27. Gravatar of JSeydl JSeydl
    14. November 2012 at 00:43

    ssumner,

    “You don’t seem to understand that from the very beginning I’ve argued that the bond vigilante argument was wrong.”

    I never said that you didn’t. But for what it’s worth, I just skimmed through your Jan. 2011 to July 2011 archive and didn’t find one post countering all of the nonsense about how rates and inflation were about to go through the roof. During that period, Krugman dedicated at least two to three posts a week to the topic.

    “And do you not realize that Krugman uses ratex models when he makes his arguments? Don’t you know ANYTHING about New Keynesian economics?”

    Of course Krugman uses NK models. But he has also been very critical of them. In his own words:

    “There has been an ongoing discussion in the econoblogosphere about the usefulness or lack thereof of “microfoundations” in macroeconomics, which in practice means trying to write down models in which aggregate behavior is justified in terms of the actions of utility-maximizing individuals with rational expectations. I upset even New Keynesians, such as Simon Wren-Lewis, with my observation that the crusade for microfoundations has had only one success, the prediction of stagflation after an extended period of high inflation, and that this success is 35 years old.

    Yet I stand by that statement.”

    The point I was making is that simple ceteris paribus models, like IS-LM, have had much better predictive power in recent years. Which brings me to the final point.

    “Friedman would be praising IS-LM? You must be completely insane.”

    Of course Friedman would be praising IS-LM. Have you even read MofPE? Here’s Friedman:

    “The ultimate goal of a positive science is the development of a theory or hypothesis that yields valid and meaningful predictions about phenomena not yet observed … Truly important and significant hypotheses will be found to have assumptions that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions … To be important, therefore, a hypothesis must be descriptively false in its assumptions.”

    He is describing exactly what IS-LM is: A barebones model with assumptions that are wildly inaccurate descriptive representations of reality, but yet with predictions that have been valid and meaningful.

    Look, this point is really not debatable. You can ask any economic philosopher who studies methodology, and the response that you’re going to get is that much of what Friedman stood for has been coming out of Krugman’s mouth in recent years. Again, if you see this differently, then the chances are that you haven’t read enough of Friedman’s work on methodology.

    “And you are a perfect example of both. You are in so far over your head that you don’t even understand how silly your arguments sound.”

    This is just a baseless attack. It’s kinda cute, but it warrants no response.

    Cheers!

  28. Gravatar of Rien Huizer Rien Huizer
    14. November 2012 at 02:59

    Scott,

    Gvt debt risk premia are easily observable in Euroland and clearly not associated with short term growth (to put it conservatively). Also, differences in risk premie occur between countries with different levels of activity (most clearly in employment). A good theory should be able to explain those phenomena as anomalies which may be challenging.

    As to ratex: invented to make economics more than a beautiful cultural artefact and a branch of applied mathematics, largely useless in designing policy but highly useful in developing policy rhetoric. A good metaphor would be the usefulness of particle physics for a pinball player. It may be useful, but mainly to impress rivals with similar motor skills. But that does nit make particle physics less interesting.

    All in all, I would not mind to live in a world where rates and the efm would apply consistently, because that would make lots of predatory charlatans unemployed…But that is not reality.

  29. Gravatar of Saturos Saturos
    14. November 2012 at 06:32

    Scott, I found this John Cochrane post interesting, any thoughts?

    http://johnhcochrane.blogspot.com.au/2012/11/diversity-in-academia.html

  30. Gravatar of Saturos Saturos
    14. November 2012 at 06:36

    MF sounds like someone with the time to think up comments to put on this post: http://johnhcochrane.blogspot.com.au/2012/11/gas-price-contest.html#more

  31. Gravatar of Kenneth Duda Kenneth Duda
    14. November 2012 at 06:37

    Scott: thanks for the reply !! I don’t know where you find the time for it, but thanks.

    > Most economists do NOT support sensible policies …

    Well that is even more sad. I feel like you, Beckworth, Krugman, Wren-Lewis, DeLong, and Yglesias all have similar sensible things to say about the current situation and are arguing in a similar direction. Please keep it up!!

    -Ken

  32. Gravatar of Saturos Saturos
    14. November 2012 at 07:26

    Kenneth and Scott, they support sensible theories (in theory), but not sensible policies. In fact Scott had a post on that once (good luck finding it now)…

  33. Gravatar of Saturos Saturos
    14. November 2012 at 07:27

    This blog is all about deducing correct unconventional policy conclusions from conventional theories…

  34. Gravatar of Morgan Warstler Morgan Warstler
    14. November 2012 at 09:40

    The Fed is buying what 60%+ of Treasuries currently?

    The options are then:

    1. Bond Vigilantes unloading what they have – and the Fed buys more driving down yields. The money moves to next safest asset. This continues until Fed is buying 100% of Treasury debt.

    2. The Fed isn’t buying more, and the BV are demanding a risk premium increasing yields and money stays where it is, but US has fiscal crunch.

    Neither of these looks expansionary to me.

  35. Gravatar of Julian Janssen Julian Janssen
    14. November 2012 at 13:40

    @Scott,

    I think where Krugman may be coming from are the arguments that risk is not yet priced in. Believe it or not, there are commentators (ie, the great unwashed) who seem to think that suddenly for no new reason, foreign people, countries, governments are going to “sober up” and realize that there is more risk keepin their wealth in dollars than they realize and take their money and run. I have heard a friend of mine say such things (even though he is quite intelligent on some things). So I think his discussion has to do with those types, rather than rational expectations academics. Prof. Krugman has stated before to sometimes listen to the Gentiles (ie, non-economists) and that seems to be what he’s responding to.

  36. Gravatar of ssumner ssumner
    15. November 2012 at 07:40

    Saturos, That’s the problem with Krugman using a model to make his point. Once you throw out ratex, then you can’t make any behavioral assumptions about money demand, or anything else.

    I’m not a huge fan of that Cochrane article. Academics have political views that differ from the average American, but I don’t see why that’s a problem.

    Julian, Maybe so, but my argument still stands.

  37. Gravatar of Saturos Saturos
    15. November 2012 at 07:43

    Scott, he’s accusing Princetonians of being particularly insular, against the spirit of academic openness and integrity. I.e. basically an origin-story for Paul Krugman.

  38. Gravatar of John David Galt John David Galt
    16. November 2012 at 19:59

    If point 3 ever happens, the Fed chairman will be fired that same day.

  39. Gravatar of Frank Restly Frank Restly
    16. November 2012 at 21:54

    Scott,

    “Not because there is anything wrong with Krugman’s ceteris paribus reasoning, but rather because it’s almost impossible to imagine a shock that would be expected to promote both a higher risk premium and a faster recovery.”

    You need to start looking at both risk and reward to make any sense of a risk premium. A change in economic policy that would be increase the risk premium and promote a faster recovery would be for the federal government to sell equity liabilities that have a higher potential rate of return than bonds. Of course markets would try to equalize out any discrepancy unless part of the risk in government equity would be liquidity risk (non-marketable government equity).

    In that way government policy affects economic growth via a balance sheet affect – public sector liabilities become private sector assets. And that affect cannot be traded away via market equalizing forces.

  40. Gravatar of Krugman and the Bond Vigilantes | Who let the dough out? Krugman and the Bond Vigilantes | Who let the dough out?
    17. November 2012 at 16:23

    [...] number of great bloggers have opined on this, including Scott Sumner and Tyler Cowen. Here’s my 2 cents on [...]

  41. Gravatar of Scott Sumner Scott Sumner
    17. November 2012 at 18:20

    Saturos, I’m leery of that sort of explanation of Krugman. Bernanke, Woodford and Svensson all taught in the same department.

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    19. November 2012 at 11:32

    [...] number of great bloggers have opined on this, including Scott Sumner and Tyler Cowen. Here’s my 2 cents on [...]

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