I learned an important lesson by reading newspapers from 1933 showing Wall Street’s reactions to FDR’s New Deal policies. They were sort of OK with his outrageously statist NIRA, which had the government herd companies into cartels in order to raise prices (although interestingly they weren’t too crazy about the later high wage add-on.) But Wall Street was absolutely apoplectic about the one FDR policy that actually worked–dollar depreciation. Tinkering with the value of the dollar–which had been fixed to gold for 54 years–was considered an outrage. But then I noticed something interesting; every time the dollar fell a bit more after some sort of action and/or signal from the Administration, stock prices soared. Wall Street was like some sort of masochist. Ow! . . . hmmm, I like that, hit me again.
This all made me think of some recent Krugman posts (and no, not for the reasons you are thinking.) If you read Brad DeLong, you probably notice that he is a bit in awe of Krugman’s ability to be right about everything. Actually, Krugman isn’t right about everything, but he tends to be wrong about exactly the same things that DeLong is wrong about, and so DeLong wouldn’t notice those things. But to give the devil his due, he is right about an awful lot of things. Why is that? My conservative readers may assume that Krugman sold his soul to the devil, but I have a more plausible explanation.
Think about all his recent posts mocking the conservative fear that big deficits will lead to higher interest rates. What evidence does Krugman use? He cites the low and falling 10 year bond yields. In other posts he has used TIPS spreads to explain why inflation is the last thing we should be worried about. Now flash back to March 2009, when Krugman warned that $780 billion in stimulus would not be enough to get the job done. Did he know this from his models, as he claimed? Or did he cheat, did he peek at the equity, commodity and bond markets, and notice that all were predicting a severe recession with lots of disinflation, if not outright deflation? I think he peeked.
My theory is there are two kinds of economists:
1. Those who look smarter than they really are, because they rely on the EMH to predict
2. Those who look dumber than they really are because they rely on their own models to predict:
Conservatives predicting inflation based on Quantity Theory models or Fiscal Theory models.
I bet you never thought you see a list that had Paul Krugman in the pro-EMH camp. But just as with Wall Street in 1933, look at what people do, not what they say. Just as I am a pro-EMH guy who occasional tries market timing in my personal investments, Krugman is an anti-EMH guy who forecasts as if he believes in the EMH. And that makes him a very good forecaster, and very dangerous to us right-wingers. We underestimate him at our peril.
Here is an example of a conservative who wasn’t careful. The passage is a Greenspan quotation, cited by Krugman:
Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.
And here is Krugman’s reply:
You know, some people might take the fact that what’s actually happening is exactly what people like me were saying would happen — namely, that deficits in the face of a liquidity trap don’t drive up interest rates and don’t cause inflation — lends credence to the Keynesian view. But no: Greenspan KNOWS that deficits do these terrible things, and finds it “regrettable” that they aren’t actually happening.
Ouch! Actually, deficits are bad because they lead to higher future taxes, not higher inflation. Inflation is determined by monetary policy, but perhaps Mr. Greenspan forgot that.
BTW, it seems like half the time Krugman is pushing fiscal stimulus, and the other half of the time he is showing how countries with more stimulative policies (such as Iceland and Britain) are doing slightly less bad. But has anyone noticed that the successful policy examples that he cites relate to monetary policy, not fiscal policy. Just saying.