A crisis Paul Krugman was born to cover

The ironies are piling up so fast, and becoming so surreal, that I’m almost at a loss for words.  Fortunately Paul Krugman isn’t, and makes some very good points. After quoting Mario Draghi on the importance of keeping inflation expectations well anchored, Krugman points out that they are failing:

Unbelievable. Right now, the ECB has too much credibility on the inflation front; the spread between German nominal and real interest rates, which is an implicit forecast of the inflation rate, is pointing to disastrously low medium-term inflation:

You’d think at a time like this if the ECB was going to err, they’d want to err on the side of a bit too much stimulus.  Instead they’ll miss their inflation target on the low side.

The events of the last few years have caused me to radically revise my views of the Great Depression.  Not in terms of the causal factors, those have been amply confirmed.  Falling NGDP does create domestic and international financial turmoil—no doubt about that.  But I used to think people were stupid back in the 1930s.  Remember Hawtrey’s famous “Crying fire, fire, in Noah’s flood”?  I used to wonder how people could have failed to see the real problem.  I thought that progress in macroeconomic analysis made similar policy errors unlikely today.  I couldn’t have been more wrong.  We’re just as stupid as they are.

Sometimes I get commenters saying that the Germans are inflation-phobic because of their experience with hyperinflation.  I doubt that’s the reason; when countries make mistakes they tend to repeat them again and again.  I don’t see much fear of inflation in Argentina.  And the Swiss are just as inflation-phobic as Germans, but they never had a hyperinflation.  The lesson that should be taught to German children is that the deflation of 1929-32 caused much more harm than the hyperinflation.  Here’s Krugman:

Dylan Grice of SocGen points out that it was the deflationary policies of 1930-32, not the inflation of 1923, that brought you-know-who to power.

Indeed. When we hear assertions that Germans are deeply hostile to loose money because of their historical memories, I always wonder why those memories are so selective. Why is 1923 seared into collective memory, while the Brüning disaster has apparently gone down the memory hole?

This is important “” and there’s not much time to get the record straight.

That’s right; it was deflation, not hyperinflation, which brought the Nazis to power.  As late as mid-1929 (six years after the hyperinflation) the Nazis had only a trivial share of seats in the Reichstag.  By early 1933 they were in power.

Here’s Krugman’s policy analysis:

There are strong self-fulfilling aspects to this crisis of confidence “” which is why Europe desperately needs the ECB to act as lender of last resort, and short-circuit the vicious circles.

But no, the ECB will defend its credibility. And it will end up as the highly credible defender of the value of a currency that no longer exists.

I’m not sure if the lender of last resort is needed.  It’s possible that a dramatic shift toward monetary stimulus could rescue the euro.  But we’ll never know for sure, as the ECH will definitely not undertake my moderate proposal.  Instead it’s all or nothing.  They will either do nothing, or they’ll start buying up lots of bad debt.  But there’ll be no conventional stimulus.

This reminds me of the US during the Great Depression.  Richard Timberlake pointed out that one of the most damning facts of the interwar period is that when the US left the gold standard in April 1933 it had the largest gold reserves in the world.  Just think about what that means.  Those reserves are there for a reason, and it’s not to prevent the NY Fed building from blowing away in a hurricane.  They are held in case of an emergency.  Why weren’t they used in 1929-33 to massively boost the money supply?  Because they were there for emergencies.  Are you stupid!  I’m sure Fed officials were quite proud of the fact that they maintained those reserves all through the financial hurricane of 1931-33.

Similarly, as Trichet left office he proudly stated that under his leadership the ECB had driven inflation to even lower levels than achieved by the Bundesbank.  The irony of 1933 is that the refusal to do more aggressive monetary stimulus prior to 1933, led to the eventually collapse of the international gold standard, a much more radical move.  And the irony of the ECB circa 2011 is that they’d prefer the collapse of the euro system, or the monetization of potentially worthless debt, to a more moderate program of targeting modestly higher NGDP growth.

Again, I’m not saying my proposal would definitely work, but surely there’s no excuse for undershooting your inflation target at a time like this.  The ECB seems determined to hold on to its credibility just as tightly as the Fed held on to its gold reserves.  And by doing so it may end up losing everything.

PS.  My unusual policy views puts me in the odd position of agreeing with both Krugman and Tyler Cowen.  Too much debt or too much disinflation?  Maybe both guys are right.

PPS.  I’m very grateful for the nice compliment from Tyler, but in all honesty I think both he and Krugman are much better at euro-analysis.  I’m like the hedgehog who knows one big thing—falling NGDP is very dangerous during a debt crisis.  Yes, it’s a rather important thing, but the euro crisis is very complex, and when I read others I am constantly reminded how much of it is beyond my comprehension.  That’s why I’m sticking to the “more NGDP” mantra, it’s the only advice I feel confident about offering.



26 Responses to “A crisis Paul Krugman was born to cover”

  1. Gravatar of Morgan Warstler Morgan Warstler
    20. November 2011 at 16:19

    Look, get over it, this IS about the losers have to LOSE.

    The ECB (and the Fed) have more respect for the game than you do, because you are basically a non-participant.

    And the RULES of the game are the losers have to LOSE THEIR STUFF…. their houses, their women, their social status, the must ADMIT DEFEAT.

    You don’t like the game. You refuse to consider that the game is bigger than your goals.

    Look, I like your level target NGDP at 4% because it limits the power of the Fed, decreases the size of government, and ENSURES we don’t get 2008 ever again.

    So it is possible for you to appeal to the folks who care about the game, but you DON”T WANT THE GAME TO BE BIGGER THAN YOU.

    I think this is very very hard for you to grasp, but entrepreneurs get it, all gamblers get it, all sports fans get it… the LOSERS HAVE TO DESPAIR, not riot at injustice, they have to ADMIT DEFEAT, there HAVE to be spoils for the victors.

    You are arguing around the deeply held belief of your opponents, and since they won’t say it all out loud in black and white, you also get to pretend that not what they really demand, think, want.

    This is about the Greeks living with less, this is about public employees getting less, this is about the children of the winners having an easier go of it than the children of the losers.


    Which BTW, leads me to one more thing that just isn’t spoken about in all this ethical talk about the inequality of rich kids vs. poor kids.

    KIDS ARE PROPERTY for the first years of their life, they are the crown jewels of the players in the game, and the PRIZE of the game, is that your kids have advantages over other kids.

    You can’t complain about inequality of opportunity without directly confronting the fact the people who are winning WANT their kids to get chances others don’t, they want their kids to be forgiven errors other aren’t forgiven for, they are COMPETING for that exact prize.

    The losers have to

  2. Gravatar of david david
    20. November 2011 at 16:32

    The mind of Morgan Warstler is a depressing place.

  3. Gravatar of Becky Hargrove Becky Hargrove
    20. November 2011 at 16:40


  4. Gravatar of Tyler Cowen Tyler Cowen
    20. November 2011 at 16:45

    Blah, blah, blah, but you never say you wish to take the other side of that bet. You don’t!

  5. Gravatar of Benjamin Cole Benjamin Cole
    20. November 2011 at 16:57

    “You’d think at a time like this if the ECB was going to err, they’d want to err on the side of a bit too much stimulus. Instead they’ll miss their inflation target on the low side.”–Scott Sumner.

    You know, Sumner is right, and it also right to consider taking a job as a bartender on Fiji or some other locale that will benefit from Chinese tourism. Better to have lots of alcohol at ready to contemplate what the Fed and ECB are doing.

  6. Gravatar of ssumner ssumner
    20. November 2011 at 18:19

    Morgan, You talk a tough game, but we both know you favor subsidies for the working poor. So you can’t compete with the heartlessness of the true right-wingers.

    Becky, Yes, it seems pretty worrisome.

    Tyler, Is my false modesty that transparent?

    There is a monetary value high enough where I’d take the losing side of the bet–as long as the money outweighed any pride I might have in my blogging ability.

    BTW, I thought only people like Bryan Caplan talked about bets–I thought you were above all that.

    Ben, I’m about ready to head there right now.

  7. Gravatar of Richard A. Richard A.
    20. November 2011 at 18:35

    “We’re just as stupid as they are.”

    Unlike they (of the 30s), we (of today) have ready access to economic data. We have no excuse.

  8. Gravatar of Carl Carl
    20. November 2011 at 18:47

    scott sumner for dictator!

    Seriously though, with all this stupidity and intentional foot shooting it’s not surprising extremism took hold of much of Europe during the depression.

  9. Gravatar of ChrisA ChrisA
    20. November 2011 at 18:59

    Don’t you think it is maybe better that the whole Euro game is ended now? I mean it is clear than Germany is just not suited to be in a currency union with the Southern med countries. If the ECB does adapt a constant NGDP target, it clearly will result in much higher inflation for the Germans. You can say that they shouldn’t worry about this, but they do. And they won’t tolerate it, and of course they had the recent memory of their economy actually thriving during a period of low inflation. So the future if the Euro does stay together would be pretty bleak – basically stagnation and deflation for much of Europe.

    Maybe a big crash breakup now is better – it will be rough for a while but at least it will be over and people can start to rebuild.

    By the way, this is not a prediction, as you know my prediction is that the Germans will allow monetization of the Med Debt by ECB once their technocrats are obviously and fully in control, there are two many people invested (reputation) in the Euro to let it fail.

  10. Gravatar of ChrisA ChrisA
    20. November 2011 at 19:01

    Sorry two=too

  11. Gravatar of B B
    20. November 2011 at 19:16

    “Dylan Grice of SocGen points out that it was the deflationary policies of 1930-32, not the inflation of 1923, that brought you-know-who to power.”


  12. Gravatar of StatsGuy StatsGuy
    20. November 2011 at 19:22

    “We’re just as stupid as they are.”

    Uh, no. We’re more stupid. We have their example to learn from, and choose to ignore it.

    On the Euro:

    Day by day, it’s getting very hard to see alternatives. So much damage has been done to bank balance sheets and confidence in sovereign debt, they would now need NGDP much higher than they needed it before. Just the cost of rolling debt in the next 2 years at the current rates…

  13. Gravatar of StatsGuy StatsGuy
    20. November 2011 at 19:34

    I grow so tired of hearing about the scars of the German hyperinflation, and the threat of out-of-control fiscal spending.

    When foreign war reparations are annually extracting 10%+ of the national income (with threats of more, and increasing debt to fund it), it doesn’t take much of a run on the currency to send this spiraling out of control (a run happily triggered by the French invasion of the Ruhr).

    While the Germans sacrosanctly raise the specter of the collapse of society as the currency disintegrates, they fail to realize that THEY ARE DOING TO SPAIN AND ITALY exactly what the French did to them in 1922.

  14. Gravatar of pct pct
    20. November 2011 at 19:42

    So what exactly is the import of the Hyun Song Shin paper that Krugman and Becky Hargrove point to? European banks as well as US banks act as financial intermediaries in US markets. OK. And?

  15. Gravatar of Rajat Rajat
    20. November 2011 at 20:14

    Krugman’s quote of Draghi’s – taken in isolation does – not imply that Draghi thinks ECB action is required to keep inflation down. It could equally be interpreted to mean he thinks action is required to prevent deflation.

  16. Gravatar of Morgan Warstler Morgan Warstler
    20. November 2011 at 20:27

    Scott, I favor subsidies to the working poor because I’m not heartless, our commitment to EVERYONE is a SOCIAL moral function, it has nothing to do with the private economy, we all agree that everyone in our club / country needs to eat, bathe in warm water, be able to learn, etc.

    But that commitment has nothing to do with altering the game.

    But you don’t confront the conclusion – you admit the first bit, subsidies to the working poor is a good thing… done my way BECAUSE:

    It doesn’t interfere with the game.

    It actually empowers it, since you will ALWAYS have to work but you will ALWAYS be fed, we can disassociate wages from “what it takes to live in a rich country” and instead set wages based on “what it takes to put person X to work at a profit… no matter how shitty X is”

    When you can earn a profit on ANY MANS LABOR, even the weakest, the most incapable, we all truly become our brothers keeper, by not even trying… instead entrepreneurs comb through the reams of low low low skilled workers dreaming up inventions that put EVEN him to work at a profit… since he only costs $1 per hour.

  17. Gravatar of “Incredible Europeans” have learned nothing from history « The Market Monetarist “Incredible Europeans” have learned nothing from history « The Market Monetarist
    20. November 2011 at 21:52

    […] large extent a political crisis and policy makers seem unable to learn much from the past. Here is Scott Sumner for […]

  18. Gravatar of Steve Steve
    20. November 2011 at 22:37

    ssumner wrote: >> Richard Timberlake pointed out that one of the most damning facts of the interwar period is that when the US left the gold standard in April 1933 it had the largest gold reserves in the world. Just think about what that means. Those reserves are there for a reason, and it’s not to prevent the NY Fed building from blowing away in a hurricane. They are held in case of an emergency. <<

    Scott, as a finance person rather than a macro person, I keep thinking about Basel III and SIFI surcharges. What's the point of all this extra capital if it will never be used during a downturn; rather, it will be accumulated during a downturn? I'm not sure if you have an opinion on the finance aspects of this crisis, but the regulators seem quite proud of themselves for requiring capital accumulation during the credit down cycles.

  19. Gravatar of Jim Glass Jim Glass
    21. November 2011 at 02:22

    <em<"We’re just as stupid as they are"

    We’re stupider, because we have far more information than they had, including, not least, the object lesson of their experience.

    You’d think at a time like this if the ECB was going to err, they’d want to err on the side of a bit too much stimulus. Instead they’ll miss their inflation target on the low side.

    Not just them, us too:

    “The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.42 percent.”

  20. Gravatar of William J McKibbin William J McKibbin
    21. November 2011 at 03:09

    Central bankers are celebrating near zero inflation — as society is throttled to the grave…

  21. Gravatar of William J McKibbin William J McKibbin
    21. November 2011 at 03:10

    Central bankers are celebrating near zero inflation, while society is throttled to the grave…

  22. Gravatar of krugginator krugginator
    21. November 2011 at 06:00

    You’d think at a time like this if the ECB was going to err, they’d want to err on the side of a bit too much stimulus.

    Right. Because the way to solve a crisis created by easy money is with…easy money.

    Or something. Now can I have my Nobel Prize, please?

  23. Gravatar of Morgan Warstler Morgan Warstler
    21. November 2011 at 07:25

    We’re stupidier ONLY because we don’t admit the guys who want the game won’t be denied. Stop protecting the losers. Be an impartial referee not an interested party and you’ll PROVE we have learned.

  24. Gravatar of ssumner ssumner
    21. November 2011 at 10:19

    Richard. Yes, it’s worse.

    Carl, No surprise.

    ChrisA. Probably better to break it up now, perhaps leaving the Northern euro intact (if those countries are determined to carry on, it might would in a limited region.)

    Statsguy, It’s not quite as bad, Germans are not imposing war reparations. And Spain and Italy volunteered to join a euro that they knew full well would be a hard currency. Having said all that, Germany has been very unhelpful in their attitude toward the ECB.

    pct, I guess there’s a danger that American banks get pulled down as well, but I admit that I’m not expert here, so I have to take his word for it.

    Rajat, Perhaps, but Draghi is also suggesting that the ECB is successful, and I think that’s what exasperates Krugman.

    Morgan, Well I’m certainly not criticizing the policy, but your rhetoric leaves many readers convinced that you are something that you aren’t.

    Steve, That might be a good analogy. I’m not really an expert on the financial side, so I don’t claim to know the optimal capital ratios. Much hunch is that more good would come from banning high risk mortgages, than tinkering with capital ratios.

    Jim Glass, Good point.

    William, Sad but true.

    Krugginator, Inflation and NGDP growth over the past three years has been the lowest since Kennedy was President. Doesn’t seem like an easy money problem to me.

  25. Gravatar of Jason Odegaard Jason Odegaard
    21. November 2011 at 13:25

    And the WSJ seems to keep cheer-leading for the European pain train – though they would argue they’re just advocating responsible policies for today’s woes:


    “Europe’s real problem now, as at the euro’s founding, is that the currency zone lacks a mechanism for enforcing fiscal discipline.”

    Odd, I thought it was deflation and bank runs that are Europe’s real problems now. Wasn’t Spain also running surpluses throughout the 2000’s before the crisis, and cut their debt/GDP ratio in half? Sure sounds like fiscal discipline.

  26. Gravatar of Scott Sumner Scott Sumner
    22. November 2011 at 07:00

    Jason, That’s just sad.

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