Update:  I see Matt Yglesias beat me to it.

Before criticizing a Paul Krugman post let me praise his recent post on the Chinese yuan.  I completely agree that the press is overplaying the IMF’s decision to make it a reserve currency.  I did see one report that this might push the Chinese to do more financial reforms, which would be fine.  But countries don’t benefit from reserve currency status anywhere near as much as the media would lead you to believe.

In an earlier post Krugman unintentionally insults Dean Baker:

It’s true that Greenspan and others were busy denying the very possibility of a housing bubble. And it’s also true that anyone suggesting that such a bubble existed was attacked furiously — “You’re only saying that because you hate Bush!” Still, there were a number of economic analysts making the case for a massive bubble. Here’s Dean Baker in 2002. Bill McBride (Calculated Risk) was on the case early and very effectively. I keyed off Baker and McBride, arguing for a bubble in 2004 and making my big statement about the analytics in 2005, that is, if anything a bit earlier than most of the events in the film. I’m still fairly proud of that piece, by the way, because I think I got it very right by emphasizing the importance of breaking apart regional trends.

So the bubble itself was something number crunchers could see without delving into the details of MBS, traveling around Florida, or any of the other drama shown in the film. In fact, I’d say that the housing bubble of the mid-2000s was the most obvious thing I’ve ever seen, and that the refusal of so many people to acknowledge the possibility was a dramatic illustration of motivated reasoning at work.

I hear this claim over and over again, and just don’t understand it.  First let’s consider the Baker claim that 2002 was a bubble.  As the following graph shows, US housing prices are higher than in 2002, even adjusted for inflation.  In nominal terms they are much higher.  So the 2002 bubble claim turned out to be completely incorrect. Krugman needs to stop mentioning Baker’s 2002 prediction, which I’m sure Baker would just as soon forget.

Of course prices then rose much higher, and are still somewhat lower that the 2006 peak, especially when adjusting for inflation. So I can see how someone might claim that 2006 was a bubble (although I don’t agree, because I don’t think bubbles exist.)

But here’s what I don’t get.  Krugman says it was one of the “most obvious” things he’d ever seen.  That’s really odd.  I looked at the other developed countries that had similar price run-ups, and found 11.  Of those 6 stayed up at “bubble” levels and 5 came back down.  If they still reported New Zealand it would have been 7 to 5 against Krugman. How can you claim something is completely obvious, when there is less than a 50-50 chance you will be correct?  If Krugman were British or Canadian he would have been wrong.

But it gets worse.  Almost no one, not even Krugman, thought we’d have a Great Recession. That makes the bubble claim even more dubious.  Does anyone seriously believe that the utter collapse of the Greek economy has nothing to do with the decline in Greek house prices?  That it’s all about bubbles bursting, with no fundamental factors at all?  That seems to be the claim of the bubble mongers. Even in the US, at least a part of the decline was due to the weak economy.  No, I’m not claiming all of it, but at least a portion.  Look at France, which held up pretty well despite a double-dip recession.  You can clearly see the double dip in the French house prices, so no one can tell me that macroeconomic shocks like bad recessions don’t affect house prices.

In conclusion, even ignoring the elephant in the room–the Great Recession–Krugman’s claim that a bubble was obvious makes no sense.  Most housing markets didn’t collapse after similar run ups.  Most are still up near the peak levels of 2006, even adjusted for inflation (and significantly higher in nominal terms.)  But add in the Great Recession, and the bubble claim becomes far weaker.

Of all the cognitive illusions in economics, bubbles are one of the most seductive. But I expect more from an economist who usually sees through these cognitive illusions, and did a good job showing the fallacy of the claim that reserve currencies status has great benefits to an economy.

PS.  In case you have trouble reading the graphs, the 5 countries with big drops are the US, Greece, Italy, Spain and Ireland.  The US drop is even more surprising when you consider that our post-2006 macro performance is more like the 6 winners.  So I could have claimed it was 6 to 1 against Krugman, if I’d put in a dummy variable for “PIIGS” status.  Does any bubble-monger know why Australian, British, Belgian, Canadian, French, New Zealand, and Swedish house prices are still close to the same lofty levels as 2006, or even higher?  What’s different about the US that made a collapse “inevitable”?

(Paging Kevin Erdmann.)

PS.  I also have a post on Krugman over at Econlog, in case you haven’t gotten your fill here.

The FT has a couple good comments on today’s action, or should I say inaction:

Here’s the take from Aberdeen Asset Management investment manager Patrick O’Donnell, with our highlights:

Draghi has over promised and under delivered. Markets won’t be particularly impressed.Everyone was expecting Draghi to be the white knight for Europe once again and he hasn’t really showed up.

Today’s measures amount to tinkering around the edges. They may help the European economy a bit, particularly signalling that excess liquidity and therefore accommodative monetary policy for even longer.

But if the ECB isn’t going to do more pre-emptive measures then it is even more important that European politicians get on with reforming their economies. Europe’s economy relies on trade and the global outlook for that is pretty dire. Today measures buy European politicians a bit of time but are no panacea. Unfortunately very few European leaders have the stomach to fight for the reforms their countries need.

Says BBH’s Marc Chandler:

Ultimately, and profoundly the ECB disappointed, and this has rarely been seen in Draghi’s tenure, and hit a market that had amassed a significant short euro position over the past several weeks. As it became clear that the ECB was simply going to deliver the smaller than expected rate cut and extend the program for six months (at least), the shorts ran for what must have felt like a small exit, lifting the euro to almost $1.09.

The ECB announced the inclusion of regional bonds, but the telling disappointment was in not increasing the size of the monthly purchases.

Relative to market expectations, and to what was discounted, the ECB tightened policy. It spurred a sharp backing up of European interest rates, and substantial narrowing of the 2-year interest rate differential that had been widening with the dollar’s rise.

Today is the official launch date of my book on the Great Depression, entitled . . . well . . . do you want the official title (The Midas Paradox) or my preferred title (The Midas Curse)?  The publisher thought the latter title sounded too depressing, and wouldn’t sell.  But in my own mind it will always be The Midas Curse.  The metaphor reflects the fact that attempts to hoard lots of gold ended up impoverishing the countries that got too greedy.  And I’d add that the second theme of the book is that attempts to artificially drive up wages ended up impoverishing workers through high unemployment.

A few observations about the book:

I began research on this subject in 1986.  I was interested in McCloskey and Zecher’s critique of Friedman and Schwartz, and tried to reconcile the two studies on my own terms, by developing a model of discretionary monetary policy under a gold standard.

Then I tried to get empirical estimates of both national and global monetary policy. At that time I defined monetary policy not as expected NGDP growth, but rather changes in the gold currency ratio.  Even today, I would defend that seeming inconsistency as follows: Under a fiat money regime there are no significant constraints on monetary policy, hence it makes sense to think of the stance of policy in terms of the goal variable (NGDP, or something similar).  Under a gold standard, policy is sharply constrained; hence it makes sense to think about the stance of policy in terms of deviations from the rules of the game, i.e. changes in the gold reserve ratio.  That’s what central banks actually controlled, not the money supply or interest rates.

Then I started noticing that private gold hoarding was also an issue.  And finally, I added changes in the price of gold (1933-34) to complete the demand-side model. I noticed that real wages seemed highly (negatively) correlated with output, and thus added New Deal policies aimed at boosting wages as the supply-side of the model. (Based on research with Steve Silver.)  Obviously other factors matter, but I still think these are the key drivers of high frequency fluctuations in output from 1929-39.

I had a lot of frustrations along the way.  Most of my empirical data (on “Minitab”) was eventually lost when Bentley changed it’s computer system. I once lost a notebook with almost a year’s worth of notes on the New York Times I had read from the 1930s.  I read virtually the entire NYT from that decade, on microfilm.  I also read many old dusty volumes at Bentley, Brandeis and Harvard Baker Libraries.

I think I worked far too carefully, trying too hard to be accurate.  At the time I was working on my own (I did not use research assistants) and didn’t know how other economists did research.  I was very careful collecting all sorts of obscure data like the stock of Estonian kroons (monthly) in the 1930s, to make data sets as complete as possible.  (To give you an idea how old this research is, Estonia didn’t exist at the time.) Later I learned that most researchers cut lots of corners, and I doubt that any tiny improvement in accuracy from my painstaking approach was worth all the time I spent.  (I wasn’t thinking like an economist.)  If I had known how difficult the project would be, I probably never would have done it.  And even with all that effort, the book undoubtedly has some mistakes.

By around 2005 the book was done.  After a long period at Cambridge University Press it was rejected.  The reviewer was not at all helpful.  Then I set it aside, before sending it to Princeton after I started blogging in 2009.  Another rejection (at least the reviewer was acceptable—just wasn’t their cup of tea.)  Then Independent Institute, and again more delays.  Unfortunately that means the book is somewhat out of date in terms of the literature review.  Once I started blogging I had no time to keep up with my research.  But the good news is that my work is so out of the mainstream that I doubt anyone else was doing the same sort of thing. It’s a throwback to the approach taken by Friedman and Schwartz.  The differences from F&S include:

1.  Defining monetary policy in terms of the global gold/currency ratio, not the domestic money supply.

2.  Focusing on both supply and demand shocks, instead of mostly demand shocks as F&S did.

3.  Looking at market reactions to policy shocks, which led me to abandon the F&S “long and variable lags” approach.  I noticed that policy shocks, the market reaction, changes in the WPI, and changes in industrial production all tended to occur at roughly the same time, or perhaps a month lag, which is impossible if there are long and variable lags.  If there actually are long and variable monetary policy lags then my entire book is utterly worthless, and should be thrown in the trash.

Ideally, my book should have been done using NGDP instead of the price level.  But I had better price level data at the monthly frequency, and it turns out that during the 1930s you get roughly the same results either way, both the WPI and NGDP fell roughly in half during 1929-33.  (Both the WPI and NGDP were also highly correlated, as output was highly correlated with prices during this period.)  But if I were doing a similar study with postwar data I’d definitely use NGDP.

I sort of regret having to be so critical of the Fed’s performance during the Great Recession.  This material was added after the book was finished, and I would still defend everything I say.  But when I wrote the book I always envisioned Bernanke as the “ideal reader.”  I think he might have liked the book when it was finished in 2005, but would now hate it, due to just a half dozen pages out of 500.

I looked briefly at the 1920-21 recession, and it seems to have had the same cause—central bank gold hoarding.  I seem to recall that the Fed alone hoarded enough gold in 1920-21 to reduce the entire world price level by about 17%.  I did not study the 1893 depression, but I suspect that gold hoarding (perhaps private) associated with devaluation fears explain some of that depression too.  I also suspect there were a few other factors as well.  Someone could do the same sort of study of 1893-96 as I did for 1929-33, and it would be interesting to compare results.

For better or worse this is my life’s work.

PS.  Scott Alexander (who I had the good fortune of meeting last week in Boston) said the new title sounds like an airport thriller.  (I’ll bet Robert Ludlum could have made it into a real page-turner.)  Speaking of Alexander, I hope everyone saw his list of suggested hardball questions for the next debate. Funniest post of the year.

PPS.  I also have some comments over at Econlog.