An open letter to Mr. Krugman

Dear Mr. Krugman,

Since last October I have been worried that nominal GDP growth would fall far short of the level consistent with full employment.  Last fall I forcefully presented this argument to a number of economists (and was fortunate that Greg Mankiw and Robert Barro were willing to spend more than an hour listening to my views.)  I suggested that despite the near-zero interest rates, an unconventional monetary policy could still be highly effective.

Because you are currently the most influential progressive voice on economic issues, and because you are an expert on liquidity traps, and because you have been skeptical about the effectiveness of monetary policy in the current environment, I decided to write you in the hope that you will reconsider your views on monetary policy.  Not reconsider your model of  “expectations traps,” but rather consider whether things have gotten so bad that the risks of a highly unconventional monetary policy are now outweighed by the risks of not adopting such a policy.

Before getting into specifics, I should add that although I have a reputation as a “right wing economist,” I believe my that proposal is very much in the interests of those who favor the broader policy goals of President Obama.  The American public is not as patient as the Japanese public.  If we stagger through 4 years of Japanese-style deflation (or even zero inflation), it is very unlikely that Obama will be re-elected.  And the American electorate today is also very different from the electorate in 1935 (when FDR was concerned with Huey Long), middle class voters with falling 401k balances would not turn to someone to the left of Obama.

I think that we all agree that faster nominal GDP growth would be desirable.  You have argued that the stimulus plan is too small, both private forecasters and the various financial markets now seem pessimistic, and even the Fed expects nominal GDP growth to fall well short of their target for the next several years (and they’ve been notably too optimistic throughout this crisis.)  So the only question now is:  Can monetary policy be effective in an environment with zero interest rates and a damaged financial system?  For several different reasons, I believe it can.

1.  Historical examples: As you know FDR was able to turn deflation into substantial inflation almost immediately after taking office, through his policy of leaving the gold standard and sharply devaluing the dollar.  I would be the first to admit that the specific policy of devaluation is inappropriate in the current environment, as the rest of the world also faces a severe demand shortfall.  But this example shows that rapid inflation can be achieved through unconventional monetary policies in an environment with near zero interest rates and a severely damaged banking system.

2.  Easy Reforms: Eventually I will get to quantitative easing, but there are some even easier steps that could make the problem much more manageable, without incurring the risks of highly unconventional policies.  One easy step would be to stop paying interest on reserves.  These interest payments increase the demand for reserves, and are thus deflationary (as were the reserve requirement increases of 1936-37.)  Of course this would make T-bill yields immediately fall to zero, and banks would still probably hoard substantial amounts of reserves.  But then why not go one step further and charge an interest penalty on excess reserves?  That would end the current problem of banks treating reserves and T-bills as near perfect substitutes.  Yes, it wouldn’t solve that problem with respect to cash held by the public, but so far most of the hoarding of base money has been done by banks.  (This is probably because, unlike during the early 1930s, deposits are now FDIC insured.)  I don’t know if the interest penalty idea would work, but the Fed should certainly consider it.

3.  Quantitative Easing: This is actually not my ideal solution, as I’ve published many papers advocating Nominal GDP (or CPI) futures targeting.  But I also think it is a mistake to adopt an untried scheme in the midst of a crisis.  Quantitative easing (although somewhat risky in budgetary terms) seems less uncertain, as it is merely an extreme version of the open market operations that are normally used to control the base.  I understand the expectations trap argument at a theoretical level, but in another post I argued that this problem may not limit the Fed’s options as much as one might imagine.  The post is here, but the basic idea is that the two famous liquidity traps (the U.S. in the 1930s and Japan more recently) don’t fit the current situation.  The Fed is not constrained by a gold price peg (as in the 1930s) and the Fed does seem to have a sincere desire for roughly 2-3% inflation (unlike the BOJ, which raised rates in both 2000 and 2006, despite continual declines in their GDP deflator.)

I think you have acknowledged that there is some level of quantitative easing that would boost demand.  If I am not mistaken you are concerned that if such a policy boosted inflation expectations sharply, the Fed would have to quickly sell off these assets, suffering massive capital losses.  I understand that argument, but for two reasons I don’t think quantitative easing would be as difficult as many imagine.  First, as James Hamilton pointed out, we could begin with Treasury inflation-indexed bonds which might not depreciate if the Fed succeeded in inflating the U.S. price level.  I wouldn’t even rule out having the Fed consider buying some riskier U.S. assets (or foreign government bonds), which might actually appreciate if the Fed action succeeded in boosting aggregate demand.

4.  Set an explicit NGDP (or CPI) target and engage in “level” targeting: The other reason why I am not so concerned about the possible losses from quantitative easing is that I think that such a policy (especially if combined with my earlier proposal to reduce excess reserves) would not require as much monetary base expansion as one might envision.  It is very misleading to look at the huge increase in excess reserves that has occurred in an environment without a credible anti-deflationary policy (and with interest being paid on bank reserves) and extrapolate to what would be required to actually boost AD.  Indeed a credible policy along the lines I propose might actually require the Fed to immediately reduce the now bloated base.  One key to making the policy credible (as many have already argued) is to set an explicit nominal target, and commit to make up for any shortfall this year with even faster nominal growth in the future (and vice versa.)  I know that your expectations trap argument raises questions about credibility.  But explicit targets tend to be more credible because it is embarrassing for policymakers to go back on their word–they don’t like to lose credibility (for good reasons.)  And Bernanke, et al, already have reputations very different from the members of the BOJ.

I would also point to hints from the financial markets that a bold move might be highly welcome.  The strong stock market response to the only slightly more expansionary than expected rate cut in December 2008 (by which time it was already clear to you that we were in a liquidity trap) suggests to me that markets might respond very positively to an announcement similar to the array of steps proposed here.  (Multifaceted policy initiatives are more likely to be welcomed by markets, as we don’t know exactly which specific step works best.)  I understand that some might argue that the stock market was grasping for straws last December, but as my post here on the earlier December 2007 contractionary policy surprise shows, stock and bond markets often show a very sophisticated understanding of the impact of monetary policy.

5.  What do we have to lose?: We can get rid of interest on bank reserves (and consider a penalty rate), set an explicit nominal target, and engage in quite substantial quantitative easing using indexed bonds (and perhaps a few foreign government bonds) without incurring much risk at all.  And even if we have to eventually move more heavily into assets more exposed to U.S. inflation risk (long term T-bonds) I don’t see how those risks are any worse that what we are now doing at the Fed.  Isn’t a risky policy that has a good chance to boost AD superior to a risky policy that has little chance of achieving that goal?

6.  Confusing causality:  Lots of people tell me that we need to fix the banking system first.  But isn’t that reversing causality?  Yes, the original sub-prime crisis was caused by bad decisions by banks (among other factors), but isn’t the current deterioration in higher quality mortgages, commercial loans, industrial loans, etc, mostly due to the precipitous drop in nominal GDP that began late last summer?  Even if we end up with some capital losses from unconventional monetary policy, isn’t it also possible that monetary stimulus could vastly reduce the cost of bailing out the banks?  And also consider the impact of faster nominal GDP growth on the budget deficit.  So yes, there are some potential capital losses from unconventional monetary policy, but given what we are now going through those losses don’t seem quite so scary anymore.  FDR showed that boldness can be surprisingly effective–I read somewhere that his housing bailout programs in 1933 ended up costing much less than expected because of his effective steps to boost nominal GDP growth.

Of course there is some risk of overshooting toward high inflation, but I believe those risks are minimal.  The Fed can closely monitor yield spreads for signs of a change in inflation expectations.  Admittedly (as Bernanke and Woodford pointed out in a 1997 paper on the circularity problem in targeting market expectations) such monitoring does not provide useful information about the proper stance of monetary policy when it is 100% credible–but we are currently far from that situation.

To conclude, I ask you to reconsider your position on monetary policy.  If you did change your view, some people might accuse you of inconsistency. But remember what your hero once said:

“When the facts change, I change my mind — what
do you do, sir?”

The Obama administration is obviously struggling in coming up with an effective solution to the banking crisis.  The stimulus package seems inadequate, either because (as you believe) it is too small, or (as I believe) the multiplier may be less than we think.  The economic data seems to be consistently worse than expected.  The facts have changed.

Scott Sumner



74 Responses to “An open letter to Mr. Krugman”

  1. Gravatar of Aaron Jackson Aaron Jackson
    1. March 2009 at 08:31

    Excellent argument… my thoughts exactly! If you can get Krugman to change his mind with this note, then I think you should be considered for next year’s Nobel prize. After all, if he does change his mind and is influential in enacting the policy changes you describe above, I think you are right in suggesting that it would greatly speed up the adjustment process, and markets would finally get some good news (which would help right expectations and consumer confidence). Averting further economic malaise on a global scale is definitely Nobel-worthy!

  2. Gravatar of Sprizouse Sprizouse
    1. March 2009 at 12:07

    In response to #2… the treasury still issues debt (mostly) to its own citizens. Long run, interest-paying debt payments to our own citizenry is a good thing and better in the long-term than in the short by issuing non-interest paying bonds.

    The larger concern is, of course, the amount of treasuries being bought by foreign countries. Lowering or completely cutting rates on treasuries might push foreigners away but again, because more than 60% of government treasuries are still bought and retained by US citizens, it would probably hurt us more.

  3. Gravatar of Podunk Podunk
    1. March 2009 at 12:28

    I’m not an economist, so I’ve been trying to catch up a bit reading you, DeLong, Cowen, Krugman, et al. In my layman’s mind, it seems you’re saying that targeting a nominal GDP growth rate rather than the real inflation rate would be automatically counter-cyclical. In boom years when the real GDP was growing at a greater than 3% rate, it would put the breaks on automatically, whereas when real GDP growth was slow or negative, it would basically shift to higher inflation. Both work out about the same for banks and other borrowers, who are making decisions with the implicit assumption that a dollar borrowed now will only cost .x dollars to pay back later. When nominal deflation happens, the dollars now cost 1.x to pay back, and insolvency ensues.

    With the debt load of the American public and government what it is, a bit of extra inflation during a deflationary downturn might not be such a bad thing. I’m not certain the same could be said of Japan in the 90’s, where I believe the savings rate was much higher. In that case, the inflation would devalue the savings and might have been politically impossible.

    Is this understanding anywhere close to the mark? Is the suggestion instead that real GDP would be prevented from contracting with business cycles? Am I completely off the mark here?

  4. Gravatar of Mercure Mercure
    1. March 2009 at 13:21

    Why are you assuming that Krugman is against unconventional monetary policy? Do you have any quote?
    I am a regular reader of Krugman and I think that is opinion is that unconventional monetary policy have to be tried. But he thinks that there is a very low probability that it will be effective so we need a fiscal stimulus in the same time. We can’t wait for the results of this unproven experiment before using the fiscal policy.

    Are you asking him too support ONLY a monetary policy solution to the crisis?
    Here’s a quote:
    “Nonetheless, I guess the Fed had to try the “Bernanke twist.” And it did”

  5. Gravatar of Qingdao Qingdao
    1. March 2009 at 13:22

    Shouldn’t this letter be addressed to that other Princeton econ professor, Dr. Bernanke?

  6. Gravatar of Bill Woolsey Bill Woolsey
    1. March 2009 at 14:05

    Perhaps we could get together some kind of petition
    advocating the end interest on reserve balances at the Fed and
    considering penality rates on excess reserves.

    Everyday I hear politicians and the press claim that banks are lending enough money. Do they realize that the Fed is paying banks not to make loans?

  7. Gravatar of Jim Pinney Jim Pinney
    1. March 2009 at 14:38

    Exactly right. Get a good solid inflation going. Bernanke knows he should do this – with a price level target not an inflation rate target. Greg Mankiw has advised that as well.

    I think the administration is well advised to be very worried about bank nationalization or reorganization. The issue is not the stock holders but rather the debt holders. Bust them with a haircut and all hell might just break out – making Lehman look like a Sunday school picnic. I don’t understand why people who advise nationalization treat this threat so lightly. It would be just terrible. I read one saying that “there is some threat of a Lehman”. Indeed – some threat of the end of the world. To ignore that is just nutty. Again, an inflation would make this unnecessary, or much cheaper – because a lot of those bum loans would turn much better with larger amounts of cash running all over the place.

    Do something REALLY DRAMATIC. Decisively change expectations. Mr. Rich Guy and Mr. Banker – all that cash you are currently sitting on will soon be worth a lot less (in real terms) than it is now. Get out then and spend it. Buy assets – or buy a car or take a vacation. But don’t sit on it.

    And the Fed could do this – with explicit support from the Treasury. A joint announcement – that the administration supports an explicitly higher price level target – and aggressive action to get there. Stop paying interest on reserves. Do the interest penalty on reserves. Those excess reserves would charge out of the Fed zoom zoom zoom. That is what we need. And we need it soon. Do it !

  8. Gravatar of ssumner ssumner
    1. March 2009 at 14:58

    Thanks, you guys have both been a big help to me. I appreciate the support. You’ll find my next post a change of pace, although I plan to return to money topics because I think this issue is paramount right now.

  9. Gravatar of ssumner ssumner
    1. March 2009 at 15:02

    Bill, I forgot to respond to your petition idea. A few weeks ago I was thinking of asking James Hamilton ( if he’d be willing to start such a petition, as he has somewhat similar views to me on the need for a more expansionary monetary policy. And he is much better known. We just need to keep trying to popularize this idea, and eventually we will generate interest in a petition.

  10. Gravatar of Jim Pinney Jim Pinney
    1. March 2009 at 15:10

    the ft is on board

  11. Gravatar of Jon Jon
    1. March 2009 at 16:17

    “Perhaps we could get together some kind of petition
    advocating the end interest on reserve balances at the Fed and
    considering penality rates on excess reserves.”

    The daily effective rate is running between 0.18-.24 and the reserves are paying 0.25, making the spread free-money. But reserves are at least 10x higher than necessary to support a doubling in bank credit–given that the reserve ratio is close to zero in the US, I doubt this has much to do with anything. The January loan officer survey supported the same: lending is flat because demand for new credit is flaccid.

  12. Gravatar of Chris Wood Chris Wood
    1. March 2009 at 16:24

    A few responses, I just want to say I am biased to Krugman, but like a good discussion:

    2. The real reason that is not going to happen is the treasury uses the reserve amounts as a off book funding source. If you stopped paying interest, the banks would just buy bonds instead with the same amount they over fund the reserve with. Thus, crowding out private sector even more. Not to mention the public image problem with an even bigger deficit.

    3. Based off of “he basic idea is that the two famous liquidity traps (the U.S. in the 1930s and Japan more recently) don’t fit the current situation”.

    Yes, the real problem both of these problems were fixed by external exports of some kind. Depression by exporting bombs to blow people up, and Japan by exporting goods to countries not having the problem.

    The real risk is quantitative easing might and I stress might help short term, the real problem is it is very risky. Right now the US is a safe haven right now, and its bonds are being funded. If you spook the foreign capital with inflation worries, they will just go elsewhere. Then the US is Zimbabwe, removing 9 zeros from its currency every 6 months. That is a very big risk for a relatively small gain.

    4. “But explicit targets tend to be more credible because it is embarrassing for policymakers to go back on their word-they don’t like to lose credibility (for good reasons.) And Bernanke, et al, already have reputations very different from the members of the BOJ.”

    Bernie Madoff had a reputation too.

    5. What do we have to loose? Zimbabwe anyone??

    6. Right now, we are going through losses, but they are slow monthly losses. These the government can do something about. Adding more risk, might make things break faster. Those are like atomic bombs going off down the street. All you can do is duck and cover.


    Personally, I think nationalization is the only real fix. It would reduce the cost of the bailouts, and provide equity in the long run. People would get to keep their jobs, excluding the management that should not be there anyways. Salary caps and bonuses removed will eliminate any unnecessary fat. Sell the parts when we are in a boom again. “If you screw up, sometimes you have to pay the piper.”

  13. Gravatar of Peter Peter
    1. March 2009 at 16:25

    I think Paul would agree with almost everything that you said about monetary policy. I am only an undergrad economics major so my views are pretty naive, but I think his argument is that conventional monetary policy is useless in a liquidity trap which is why both unconventional monetary policy and fiscal policy should be applied. In a blog post he links to a 1998 paper where he suggested that Japan should employ price level targeting in order to bring down real interest rates when the nominal interest rate is already zero. If I remember correctly, he is fond of telling the story of Princeton economists (himself included i guess) who recognized that the US could easily become another Japan, so they decided to study and develop proposals for a situation just like the one we’re in today. This may be why he has said he was relieved that Bernanke is Fed chairman.

  14. Gravatar of KJR KJR
    1. March 2009 at 16:44


    Another great post. It is both refreshing and enlightening to read about your policy views (especially as someone who shares your skepticism in regards to the effectiveness of the fiscal policy being employed through the current stimulus package). As an aside, maybe you should forward this letter to some of the folks in our nation’s capital as well. Keep up the great work.

  15. Gravatar of Jon Jon
    1. March 2009 at 17:01


    I agree with your goal (monetary expansion) but not with your diagnosis. In particular, take a look at the decline in high-powered money shown here:

    This reflects adjustments to Fed total credit to account for Treasury deposits at the Fed and the swap-lines. The economy is rolling from a 30% decline in money not a failure of monetary policy at the ‘zero bound’.

  16. Gravatar of smokedgoldeye smokedgoldeye
    1. March 2009 at 17:44

    Why is “fiat money forever” your premise?

    In 1967, Alan Greenspan wrote:
    “An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense–perhaps more clearly and subtly than many consistent defenders of laissez-faire–that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. . . . This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.”

    Forget QE and the risks of horrific hyperinflation. Let’s have a petition to get the government completely out of the money supply business. Sea shells or gold. I’m easy. As long as the government can’t ever quantitatively ease it.

  17. Gravatar of ssumner ssumner
    1. March 2009 at 17:48

    Sprizouse, I know this seems odd, but the goal is not to reduce long rates, but to raise them. Any policy that is truly expansionary will raise long rates through the “income and expected inflation effects.” See my rational expectations post.

    Podunk, Yes, it is intended to be countercyclical, and yet still hold down long term inflation.

    Mercure, I don’t have the same impression, but perhaps I need to look more closely at his recent posts. The ones I read seemed to suggest that nothing more could be done with monetary policy, that not only was the view that more money could help now discredited, but that Friedman and Schwartz’s view that more money could have helped prevent the Depression was also discredited. I admit that I don’t read all his posts, so I will check out whether I have misinterpreted his views.

    Qingdao, There is only a small chance that Krugman reads my blog, but no chance that Bernanke does. One step at a time. If some more important economists can be sold on this idea, they will have the influence to talk to Bernanke. In addition, I think it is very possible that Bernanke partly agrees with me, but there is also the FOMC. BTW: I once visited Qingdao.

    Jim, Yes I recall when Mankiw advocated price level targeting on his blog. (It was a month after I met with him for an hour and suggested that we needed price level or NGDP targeting. Although in fairness, I think he was already leaning that way.) The FT piece is interesting. The UK could also devalue, but I don’t think it is a plausible policy for us. On banking, you probably know more than me.

    Jon and Chris, What about a negative rate on reserves, if we are in a liquidity trap. Would that work?

    Second Jon question, I agree the fall in the monetary base is puzzling and worrisome, but wasn’t the economy in trouble even before the base started falling a couple weeks ago? I wish I knew what the Fed was thinking, right now I just don’t know what to make of their policy. Are they trying hard to be more expnasionary? Or not?

  18. Gravatar of Ken Ken
    1. March 2009 at 18:41

    Hey Scott,

    How well do you think you understand the balance sheets, risks, and operations of the large US financial institutions, e.g. C and BAC?

    Is it possible that macro-economists are confused because they don’t have sufficient understanding of the financial institutions through which monetary policy is supposed to travel?


  19. Gravatar of Jake Jake
    1. March 2009 at 18:46

    Typo note: “Lot’s of people tell” should read “Lots of people tell…”

  20. Gravatar of Jon Jon
    1. March 2009 at 18:59

    “Jon and Chris, What about a negative rate on reserves, if we are in a liquidity trap. Would that work?”

    Most of the excess reserves are coming from the TAF and PDCF. I think its plausible that the banks would return their excess funds to the Fed in that scenario.

    If we’re in a liquidity trap now, its surely a different sort. Evidence of cash hoarding–except by the Treasury–is very weak. If you look back at the TAF auctions, most auctions in the last four months were under-subscribed and all were correspondingly sold at the minimum rate. This minimum tended to be set below the interest-rate on excess reserves. (compare: and AFAIK, this was a big contributor to the Fed Funds rate consistently running below the target. So the increase in bank-reserves is not in itself proof of a liquidity trap.

    “I agree the fall in the monetary base is puzzling and worrisome, but wasn’t the economy in trouble even before the base started falling a couple weeks ago? I wish I knew what the Fed was thinking, right now I just don’t know what to make of their policy. Are they trying hard to be more expnasionary? Or not?”

    Falling a couple weeks ago? I’m confused. The big sterilizations started in late September. This was preceded by a gradual drop in the monetary base less reserves from 2007 on. But yes, I don’t understand their thinking. There is so much sterilization going on once you factor in the Treasury that the policy is not particularly expansionary.

    My guess: many of the Feds actions are tailored to saving the European banking system, but that’s a complex supposition.

  21. Gravatar of travis travis
    1. March 2009 at 19:00

    From the graph of the monetary base, it looks like reserves are decreasing (Federal Reserve Credit) and circulating credit is increasing. That is exactly what we want. Reserves are being put to work in the real economy.

  22. Gravatar of Leigh Caldwell Leigh Caldwell
    1. March 2009 at 19:27

    Good article – I am particularly interested in the idea of a penalty rate on central bank reserves. However it instinctively feels like there might be too many ways around it for the banks. I mentioned this idea in my own blog a few weeks ago at but still have some doubts about it.

    Even though I still like the idea, I have two questions in particular (Jon’s point is interesting too):

    1. If banks keep their reserves at the Fed, can’t they still lend new money into the private sector backed by those reserves? Clearly the banks are well above the required reserve ratio for new loans.

    2. Presumably banks want these reserves (and the funds from TAF) in order to maintain extra liquidity, fearing a repeat of the interbank lending freeze of last year. Would a small penalty rate be enough to overcome this liquidity preference? Maybe what’s needed is instead for the Fed to provide a liquidity guarantee directly against issuance of new long-term private debt.

    Looking forward to your future posts on this subject, as there is a definite need for creative ideas in the field.

  23. Gravatar of Scott Wimer Scott Wimer
    1. March 2009 at 19:31

    I guess it’s really naive to wonder why we need to use the taxpayer as ablative shielding to defend the debtors of the various mis-managed banks and financials.

    The bondholders charge interest to offset the risk of default.

    Apparently they also charge me. And my kids. And my kids’ kids.

  24. Gravatar of kaioh kaioh
    1. March 2009 at 19:38

    Perhaps I am missing something, but in my opinion the ideas in this letter are not addressing the root of the problem. Your ideas to increase AD, or to encourage people to spend by charging a penalty if they save does not sit well with me. In my view, the root of the problem is unsustainable economic activities, i.e. deficit spending, historically low lending rates, and a lack of oversight that allowed historically high increases in home asset values.

    Whenever experiencing changes in the norms, the question should be “What has changed in the picture, that such historic highs are now the norm?”, “What changed to make sub 8% interest rates the norm?”, “What changed to make 20-30% annual increases in home prices the norm?” If there are no good answers (Which for the last few years there was not a good answer) then it means we are/were experiencing an anomaly and eventually there will be a correction so that the average will return to equilibrium.

    I believe we are experiencing deflationary pressure because money has become so abnormally cheap that the market is trying to correct itself. People have reached their credit limit, so they are saving in order to pay down debt. How will giving people more money make them want to spend more, if they are already over extended? What will happen once people reach their next limit?

    In your scenario, AD increases, people do not have money in banks because of the penalty eventually, you presume they will start to buy things again, but how many plasma TVs do people need? At some point people will still stop spending. They will want to pay off their debt, only now savings are even lower and debt is higher. Companies will have layoffs, people will be unable to pay their bills, and we are in the same situation except that now the national debt is trillions of dollars higher. (Is this not the road to hyperinflation?)

    I believe that the proper action is to raise interest rates, and have the government invest in in infrastructure to produce goods and increase export them(instead of dollars). We need to increase the demand of American goods, but cheap money only increases the demand of foreign goods.

    This may cause short term deflation, and short term pain but that is only due to our high inflationary policies of the past years. Eventually it will equal out. (By letting the market work)

    For some reason we are hung up on deflation because of the great depression. The world is so different now (as well as the circumstances of the great depression) that deflation spiraling out of control is not likely; There are too many amazing goods that people want to purchase (tv’s, ipods, computers, cell phones). Nobody is going to hoard dollars as these new life changing devices are produced.

    On the other hand nobody is talking seriously about hyperinflation. We worry about another great depression but not about becoming the next Weimar Republic.

    So I am just an armchair economist. I would like to know where my thinking goes wrong. How are the ideas in your letter a solution for the long term? It seems only to cover up the real problems in the short-term; and seems to be in the same category of precursors to hyperinflation.

  25. Gravatar of Chris Wood Chris Wood
    1. March 2009 at 19:43

    Jon and Chris, What about a negative rate on reserves, if we are in a liquidity trap. Would that work?


    Federal reserve legislation requires 3% I do believe of a banks money to be with the Feds. Since we give them interest on those funds, that is really essentially a negative rate from the governments side. Other countries like Canada, that have had no problem with their banking system do not have such a requirement.

  26. Gravatar of Darrin Olsen Darrin Olsen
    1. March 2009 at 19:46

    That last post just reminded me of that that classic joke about Scott Sumner, Alan Meltzer, and a rabbi flying in a helicopter when suddenly they came across 1 trillion in greenbacks, errrr, how’d that one go again?

  27. Gravatar of Garett Jones Garett Jones
    1. March 2009 at 20:13

    Professor Sumner: Huzzah! Huzzah!

  28. Gravatar of Jon Jon
    1. March 2009 at 20:27

    “Federal reserve legislation requires 3% I do believe of a banks money to be with the Feds.”

    This is incorrect. First the Fed sets the reserve ratio, not legislation, its part of the Federal Register not the USC. Second, the reserve requirement is applied to checkable accounts and other forms of transaction accounts. Nonpersonal time deposits have no reserve requirement. The effective reserve requirement is consequently <1% (based on data from the H3 and H8 statistical releases).

    One reason the ECB started to offer interest on reserves was to compensate for the higher reserve-ratio in the EU.

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  31. Gravatar of Jeffrey Yasskin Jeffrey Yasskin
    1. March 2009 at 21:58

    Well written, and congratulations on the link from Tyler Cowen. Like Mercure, I also expect that Krugman will largely agree with your suggestions. For example, in (1999), he wrote, “My personal view is that a country deep in a liquidity trap should try everything”, and (roughly your point #4, I think) “A credible commitment to expand not only the current but also future money supplies, which therefore raises expected future prices – or, equivalently, a credible commitment to future inflation – will still succeed in raising the equilibrium current price level and hence current output.”

    So good luck to you!

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  33. Gravatar of
    2. March 2009 at 00:38

    TheMoneyIllusion points out the flaws of the US monetary policy…

    Scott Sumner’s open letter to Mr. Krugman on the monetary policy…

  34. Gravatar of rhhardin rhhardin
    2. March 2009 at 01:49

    Buying up inflation indexed bonds and also running the tbill rate to zero ought to produce an unpredictable result pretty quickly.

    Normally the tbill rate would track inflation, but I don’t think inflation would track the tbill rate.

    I’d guess the result would be nobody buys tbills. Supply and demand do not meet.

  35. Gravatar of Bill Woolsey Bill Woolsey
    2. March 2009 at 03:24

    The reserve requirement is 10% of checkable deposits.

    Last I checked the actual reserve ratio was greater than 100% of checkable deposits.

    Checkable deposits make up about 10% of total bank deposits.

    Checkable deposits are important, becaue they are used as money. Because of sweep accounts, some poorly measured fraction of savings deposits are used as money too. Much of this is in checkable deposits during the day, but it is measured at night when it is held in savings accounts. The total of savings deposits is the biggest part of total deposits. And then, there are CDs, which while much larger than checkable deposits (more than twice) are much smaller than savings deposits (about half). None of the CD’s are used as money.

    Banks also fund assets (like loans) with long term bonds and equity, neither of which is anything like money.

    Anyway, paying interest on reserves while complaining that banks aren’t lending enough is insane. Everyone knows what the interest rate the Fed is paying–.25%. Yes, it is low. But it is too high for sure. It should be zero. Or negative.

    And yes, banks would buy T-bills (and perhaps aaa commercial paper and other low risk assets.) Good.

    The interest rates on these things would be driven even lower. Good.

    “Crowding out” the private sector? A rather unusual usage of language. There is _NO REASON_ to provide the private sector with low risk assets for them to hold. Gee, there won’t be any T-bills, or low risk commercial paper for people to hold because it is all owned by banks. They will be forced to.. what? Consume? Purchase higher risk securities? Good! That is the point.

    In reality, of course, they will tend to hold insured bank deposits. But the point is to drive the yields on those down as well. Negative if possible.

    The demand for money rose and velocity fell as a side effect of a rush to short term, low risk assets. At least part of insured bank deposits are money. And, of course, deposits at the Fed are money from the banks point of view.

    Once the yeilds on these sorts of assets are driven so low that storing zero interest currency is attractive, then, there is nothing left but to have the Fed purchase longer term and higher risk assets. Fine. But first drive the low risk, short interest rates as low as they will go. Paying interet on reserves proves that the Fed is not powerless. It is allowing nominal income to fall.

    There is just one argument on the other side. That is that the supply and demand conditions for money created last fall are already adquate to get nominal income back to target next fall. Further expansion now will do nothing to help things now, next summer, or next fall, and will result in nominal income rising too much next year. In other words, it is all about lags.

    If, like the Fed says, nominal income will not be back on target next year. Then they should expand more now. And the notion that they cannot expand any more is crazy. If they are doing things to prevent expansion, like paying interest on reserves. They have not bought up all the T-bills even yet.

    The claim that monetary policy is ineffective would be that after they have bought up all the T-bills and certainly stopped paying banks to hold reserves, and still the supply and demand conditions for money (not credit) are inconsistent with nominal income rising, then, something unusual must be done. Charging interest to hold reserves and accumulating long term, higher risk assets would be such actions. And they should.

  36. Gravatar of A quick response to Scott Sumner – Paul Krugman Blog – A quick response to Scott Sumner - Paul Krugman Blog -
    2. March 2009 at 05:03

    […] I see that Scott Sumner has written an open letter to me. But I’m puzzled. He writes: I think you have acknowledged that there is some level of […]

  37. Gravatar of babar babar
    2. March 2009 at 06:07

    thanks for keeping the debate on this going.

    the problem i have with krugman at this point is that he knows a bit too strongly that he is correct. there is no certainty in economics. what if there is a 10% chance that he is misreading the signs and that he is incorrect that we are in a liquidity trap? what if there is a way to use the expectations game to beat the liquidity trap rather than using hard cash to do it? it’s not as if the concept of “liquidity trap” is a “hard cash” concept — it’s based on “forwards” ie expectations of future money. well, the game changer, i think he would agree, is something that would change expectations, which is part of what you are saying..

  38. Gravatar of Rob Anthony Rob Anthony
    2. March 2009 at 06:20

    The current environment is certainly nerve wracking for a layman such as myself. The gap between the current reality of cautious policy (exemplified by paying interest on reserves) and a desirable end state (modest, controlled inflation) is frustrating. It’s also frustrating that we may have drifted into a situation where monetary policy shifts are all too visible, which may have its own problems…..

    It does seem to me that what needs to be taken on by the quantitative easing argument is Mr. Bernanke’s apparent view that the economy will recover this year without it. If that is correct, then we might be less willing to take on the risks of very aggressive monetary policy (e.g. over-shooting, moral hazard), no? On the other hand, if, for example, Warren Buffett is right, or even worse, then it’s time right now to short circuit the bad credit cycle. Isn’t the forecast a big part of the money supply debate?

  39. Gravatar of Alex Alex
    2. March 2009 at 06:28

    I’ve suggested importing Machinea and Sourrouille from Argentina to replace Bernanke and Geithner. You actually don’t have to bring them, just buy two tickets for them and that should be enough to bring an increase in inflationary expectations in the US.

  40. Gravatar of Chris Wood Chris Wood
    2. March 2009 at 07:57

    The last thing that changed expectations was the Lehman Brothers collapse. It turned it was a bad turn of expectations.

  41. Gravatar of jimh jimh
    2. March 2009 at 08:48


    Just an FYI, but it is important as you use the fact to buttress your argument. FDR did NOT leave the gold standard. Repeat, FDR did NOT leave the gold standard. He stopped the right to turn in dollars in return for gold. That is not leaving the gold standard. He did deflate the dollar by changing the rate of implied exchange, but he did not leave the gold standard. That was Nixon.

  42. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    2. March 2009 at 09:31

    Krugman’s response is classic Krugman. He tried it on William Isaac last week on the Jim Lehrer Newshour,

    but Isaac didn’t let him get away with it:

    PAUL KRUGMAN: ….If you want to believe that the banks are in fine shape and they just need a little bit of help, well, you know, there’s not much I can do to argue with that, if that’s your point of view.


    WILLIAM ISAAC: Well, let me deal with that in a second, but, first, I want to address — Paul really misquoted me. I didn’t say these banks are in fine shape. I said they’re in better shape than the major banks in this country were in the 1980s. And I’ll guarantee you they are.

    Every one of the major banks, if they had had to follow mark-to-market accounting in the 1980s, would have been insolvent, and clearly insolvent. So what I’m saying is that these banks are doing relatively well in a very difficult environment.

    Of course they need help. And mark-to-market accounting has destroyed $600 billion of capital in the banking industry, which is $6 trillion of lending capacity. And it’s been a major, major cause of the crisis we’re in.

    Now, as far as a short-term takeover, there’s no such thing. You take these things over, you’re stuck with them for a long time. Mexico had to stay with them for 17 years. They nationalized 80 percent of their banking system, and it was a total mess after 17 years of government ownership.

  43. Gravatar of Concerned Globalist Concerned Globalist
    2. March 2009 at 09:50

    “Because you are currently the most influential progressive voice on economic issues”

    Is this just my “” non-scientific “” “feeling” that people, media and politicians listen to Nouriel Roubini more?

  44. Gravatar of Scott Sumner on Monetary Policy « The Sphere of Choice Scott Sumner on Monetary Policy « The Sphere of Choice
    2. March 2009 at 10:26

    […] 2009 March 1 tags: Monetary Policy, Scott Sumner by Mario This is just a pointer to an excellent article by Scott Sumner on the possibility that there might be monetary policy tools that have yet to be […]

  45. Gravatar of DanC DanC
    2. March 2009 at 10:28

    I suppose if you inflate the economy, the nominal increases in housing prices could fool some people into thinking their wealth is increasing. And debt holders would see the burden of their debts decline. This could stimulate the economy.

    But lenders would see a drop in the value of their loan portfolio. On balance I am unsure that a possible increase in GNP, and a greater ability of some to pay debts, will be greater then the decline in the value of the portfolio of loans that banks own. What should lead me to think think that it would be a positive gain?

    Do we have a liquidity crisis? Yes. i.e. people are so uncertain of the future that they withdrawing from the game. I would argue that the radical shift in the political economy ( higher energy costs, increased control of health care, higher taxes, promises to provide greater government benefits while sending the bills to others,etc.) have all made forward looking investors nervous – some terrified.

    Most politicians make big speeches and then rule from about the center. Currently, we have the most left leaning government in the history of the country. Why should we be surprised that this would contribute to a liquidity trap? What happens to private investment in South American countries when left leaning governments take control?

    Many thing are going wrong at the same time. The stimulus plan was a mistake. And this is hardly the time to have a collection of left leaning academics (which is what President Obama really is) trying to remake the economy the old fashioned way – through political spoils to interest groups.

    Can monetary policy correct, encourage growth and investment, while the ruling political party is following policies that are in opposition to long term growth?

  46. Gravatar of smokedgoldeye smokedgoldeye
    2. March 2009 at 10:48


    You couldn’t be more correct. I’m a businessman and I’m terrified. If Obama’s objective was to terrify capitalists like me and get us to scrap ALL of our plans for investing in risky (but possibly lucrative) projects that could employ in aggregate MILLIONS of Americans…he has succeeded brilliantly. Interest rates are a sideline. Even if interest rates were NEGATIVE 5%, I’d say to myself, “Will I be able to keep even half of the profits from this project with Obama’s proposed confiscatory tax policy?” And my answer right now is “No”. The bottom line is Obama’s message has been delivered and clearly understood by all the aspiring entrepreneurs of this country. “It’s not OK to get rich anymore.” Every action has a reaction. Welcome to the first Great Depression of the third millenium.

  47. Gravatar of cucaracha cucaracha
    2. March 2009 at 10:53

    You are the best one I have ever seen on this subject.

    Technical, objective, courageous.


  48. Gravatar of R.M. ‘Auros’ Harman R.M. 'Auros' Harman
    2. March 2009 at 11:34

    @ smokedgoldeye: Oh, what utter nonsense. Anti-tax zealots said the same thing about Clinton’s tax increases, and what ensued was the greatest investment boom in decades. I’m an MBA student graduating in May, and there are still plenty of us with business plans who plan on trying to get rich. A team of my fellow students recently won the regional round of a business plan competition sponsored by Wal-Mart, and are off to Bentonville soon, to try to win seed money. (And even if they don’t get it, the VCs on Sand Hill Road are still making deals.)

  49. Gravatar of Missourman Missourman
    2. March 2009 at 11:50

    Obama’s confiscatory tax policy which will raise long term captital gains tax rate from 15% to 20% is going to leave you with less than half the profits? Right.

    It’s a miracle the U.S. economy grew at all from 1932 until 1982 when the highest marginal income rates were over 50%, reaching highs of 91%. I long for good old conservatives who believed you had to raise taxes to pay for wars instead of running up debts?

  50. Gravatar of Al Al
    2. March 2009 at 12:02

    DanC, if you think an administration that has Tim Geithner and Larry Summers as its main economic policy guys is a radical left-wing regime that would institute confiscatory taxes then you are needlessly scaring yourself. Obama will not put in “confiscatory” taxes. Confiscatory to me would mean something in the 50%+ range. That will never ever happen. What he has done is raised the marginal tax rate for high income earners to a level that in the past proved to be sustainable.

    Yes, it’s a policy that now tilts towards the middle classes instead of the very wealthy but boohoo, the past president had granted millionaires’ and billionaires’ every wish and now that’s over. Our turn.

    Furthermore, you talk of plans to invest in risky but possibly lucrative projects that could employ millions in America. Pray, tell me what those projects are that are viable in an environment of a worldwide collapse in economic demand? Are you willing to invest in such an environment?

  51. Gravatar of ssumner ssumner
    2. March 2009 at 13:38

    Ken, I don’t know much about bank balance sheets, but I don’t think M-policy “works through” banking. It works through the excess cash balance mechanism plus expectations.

    Jake, Thanks

    Jon, If reserves are returned to the Fed, then do open market purchases. The banks can’t return those reserves.
    And why the MB less reserves? Is that cash?

    Travis, I think the entire MB is falling, not just cash.

    Leigh 1. Yes 2. If a small penalty rate is not big enough, make it bigger.

    Kaioh, 5% nominal GDP growth is sustainable forever. Let’s address overconsumption with changes in our tax system.

    Chris, See Jon and Bill below.

    Jeffrey, Seems like Krugman is gradually moving from being a New Keynesian to being an old Keynesian.

    Bill, Nice explanation of the whole point of quantitative easing. Regarding the recovery later in the year, I probably focus too much on the stock market, but I’m not very optimistic right now.

    Baber, Thanks, Expectations are the key, as you say.

    Rob, see response to Bill above

    Alex, I wonder how the markets would react if the Fed adopted my entire plan?

    JIMH, You are basically right. I usually say they went off in 1933 and went back on in 1934. Technically they were probably on all along, but de facto they were off for a year. One of the main points of my Depression manuscript is that we were back on the GS in 1934-68, and that had a big impact on the pace of recovery.

    Patrick, Yeah, I heard about that debate–it does sound like Krugman didn’t know as much as Isaac.

    DanC, History shows that deflation leads to leftist policies.

    Thanks also to those I didn’t respond to.

  52. Gravatar of Existentialed Existentialed
    2. March 2009 at 15:01

    I find it interesting, as some have noted, that with the interest rate spread, credit is still flat. Doesn’t his indicate a factor that warrants deeper consoderation? Could it be that that ‘demand’ for credit, considerinig that its linked to the ‘demand’ to buy or invest in something, if applied to mortagages, that maybe we’ve scared off the next generation of buyers into the American dream. Speaking for myself, between the hits that the investments have taken, the loss in position on the house, at 51 years old, well educated with a lot left to enjoy, I wouldn’t advise my children to buy a house. If I wasn’t stuck in my presnet position, my wife and I would certainly be enjoying our 50’s somewhere other than wehere we got stuck when this thing caved in.
    I’m not convinced that home mortgage ownership is the way to go over the long term. It may be that the younger generation agrees and they don’t want the credit anchor at any price.

  53. Gravatar of Gabe Gabe
    2. March 2009 at 16:00

    You seemed to have forgotten the plan.

    1)create “crisis” by freezing up lines of credit.
    2) elite banks take advantage of crisis by sucking up competitors for pennies on dollar.
    3) blame crisis on “free-markets”.
    4) extend crisis by using the old crisis to grab more power.
    5) civil unrests starts.
    6) “Serious Thinkers” demand “order”.
    6) After years of planning, police state comes to fruition.
    5) destroy the will of Americans to maintain sovereignty.
    6) put in place world wide central bank with carbon taxes paid by all humans to the new super bank.

    “Give me control of a nation’s money
    and I care not who makes the laws.”

    Mayer Amschel Rothschild

  54. Gravatar of GlobalPatriot GlobalPatriot
    2. March 2009 at 16:30

    I going to create a new derivatives product that packages Cap and Trade CO2 credits ‘assets’ with commercial bank equities. I plan to package these across risk levels and industries so that I ‘spread the risk evenly’. Then I think I’ll market these as equity products, (I’ll establish a hedge fund to handle that part of my business), and I also think I’ll re-package another product of the same fundamental instruments but offer them as futures, (there’s bound to be an options market for CO2 credits arise, that’s the fundamental logic behind the cap and trade proposal), there should be some really interesting ways to price this, configure margins, should be an interesting options product.
    Now my hedge fund in these Cap and Trade CO2/commercial equity derivative product will draw in all kinds of investment dollars to my hedge fund, (the Gaussian Copula Function makes it easy for me to convince investors – “look here, one number measures all your exposure, sign here please everybody’s doing it – don’t miss out!”); the hedge fund will provide my steady income stream while I play the futures market. Now that I think about it, I have a hedge fund with basically the same products, (just repackaged), as my commodity product, I might be able to play both to their benefit with some creative marketing and press releases from time to time. This is going to be great. Just in case, think I’ll cover the futures with a short position here and there – in the same product of course.
    Anybody want to invest?

    This is the basic scheme that allowed $billions of dollars to disappear from wall street. This represents the type of scheme that functioned as our investment banking and financial sector since the late 90’s. Don’t be too concerned though, lot’s of people made vast amounts of personal income while they kept the house of cards afloat for a couple of decades – vast sum’s of money, so it wasn’t all lost. It just accrued to fewer people.

    I will guarantee that today an out-of-work financial investment analysts that used to work for one of the big, probably no longer existing, financial investment firms is thinking about how package a product very similar to the one I describe. Cap and Trade CO2 credits markets – be afraid, be very, very afraid….

  55. Gravatar of DanC DanC
    2. March 2009 at 17:30

    Clinton was rather far to the right of Obama. Don’t forget that he was a conservative Democrat in favor of welfare reform, free trade etc and was lucky enough to see oil prices drop significantly (plus a big drop in defense spending) to offset a rise in taxes.

    Obama and a very left Congress want to create radical change in the economy. They want to increase regulations in almost all sectors of the economy. They want radical changes in health care. Much higher energy prices. The indirect taxes from these government interventions will dwarf the increase in marginal tax rates he wants.

    Kevin Murphy has done excellent research on the growing inequality in incomes and it has little to do with government taxes.

    Next I don’t believe in central planning and big projects. I think leaving people free to exchange services and products creates more value and more growth then big government programs. I prefer the millions of voluntary transactions that occur everyday as the way to grow an economy. And governments that make those transactions more difficult reduce the well being of all citizens.

    Lastly even in the middle of the great depression people started businesses. So what?

  56. Gravatar of smokedgoldeye smokedgoldeye
    2. March 2009 at 17:50

    I did say aggregate millions of jobs. Hey, I’m just a small biz (4 employees, medical devices). And, yes DanC, when I talk about my fear of confiscatory tax policy I’m referring to marginal tax, unlimited ss, new surprise universal health care taxes, cap&trade taxes, import duties and new FDA regulations. Some taxes are explicit, some hidden. The annual total of costs due to government to me are “taxes”. And yes, I’m still terrified. I feel like the businessmen in Havana must have felt before Castro. Can you believe folks that a former Democrat prez said “The business of America is business”? Not anymore. If you’re a businessman you’ve got a target on your back. And guess what? We millionaire small businessmen employ middle class workers. Your turn. Congrats.

  57. Gravatar of smokedgoldeye smokedgoldeye
    2. March 2009 at 17:59

    Correction: Calvin Coolidge was a Republican. Oops. Has a democrat ever said anything like that? Surely at some point in our history, one would hope.

  58. Gravatar of Jon Jon
    2. March 2009 at 18:47

    “Jon, If reserves are returned to the Fed, then do open market purchases. The banks can’t return those reserves.
    And why the MB less reserves? Is that cash?”

    I don’t see how you can get the banks to be willing counter-parties unless they can profit from the transaction. If you set the penalty-rate at 1% and the banks expect 10% charge-offs which is more profitable? Can the banks find borrowers willing to pay interest to cover the difference? Only given a credibly large inflation rate.

    I think you’re right that NGDP could do double duty. i.e., it would both reduce the expected charge-off rate and it would create a credible threat of inflation, but what of the effects on savings and hence investment?

    MB less reserves reflects the sterility of what the Fed is currently doing. Sure the monetary base looks dramatic, but it has no traction via-a-vis lending. So the point is that current fed policy is ineffective.

  59. Gravatar of GlobalPatriot GlobalPatriot
    2. March 2009 at 19:11


    Your analysis is sound but only based on an important data point. What is the current charge-off rate; the ratio. I’ll find time inbetween everyting else to find myself as well, but part of my suspicion has been that the media is playing this differently than the facts.

  60. Gravatar of GlobalPatriot GlobalPatriot
    2. March 2009 at 19:18

    Real estate loans Consumer loans Leases C&I loans Agricultural loans Total loans and leases
    All Residential 1 Commercial 2 All Credit cards Other
    2008:4 1.75 1.58 2.04 4.02 6.25 2.69 0.62 1.35 0.24 1.89
    2008:3 1.31 1.46 1.16 3.65 5.64 2.39 0.56 1.02 0.19 1.50
    2008:2 1.00 1.18 0.97 3.36 5.47 2.16 0.54 0.85 0.16 1.27
    2008:1 0.68 0.85 0.49 3.00 4.72 2.01 0.40 0.71 0.12 0.99
    2007:4 0.41 0.44 0.35 2.59 4.10 1.73 0.21 0.61 0.10 0.75
    2007:3 0.25 0.26 0.20 2.58 4.10 1.57 0.29 0.51 0.11 0.63
    2007:2 0.14 0.19 0.14 2.37 3.84 1.49 0.20 0.45 0.11 0.54
    2007:1 0.12 0.15 0.09 2.37 3.94 1.44 0.24 0.40 0.09 0.51
    2006:4 0.12 0.12 0.06 2.22 3.97 1.17 0.15 0.28 0.13 0.42
    2006:3 0.10 0.11 0.07 2.26 3.96 1.12 0.09 0.32 0.10 0.45
    2006:2 0.06 0.10 0.05 1.96 3.49 1.01 0.14 0.30 0.08 0.41
    2006:1 0.07 0.09 0.05 1.78 3.13 0.96 0.28 0.26 0.10 0.38

  61. Gravatar of GlobalPatriot GlobalPatriot
    2. March 2009 at 19:27

    You all are the smart econ guys. I’m an amatuer in this realm, but am to beleive that a charge-off rate of 0.15% of mortgages, and 0.51% of total laons in 1Q/2007 started this whole problem of ‘toxic mortgage backed securities’ that caused this collapse, as is being attributed by the media? Even today the rate is 1.58 and 1.89 for residentail and total charge-off rates. It doesn’t feel right to me. I take risks 20 times that big every day and I’ve made money for a long time.

  62. Gravatar of RareBreed RareBreed
    4. March 2009 at 01:00

    The is purely a credit problem.

    Good firms are still getting credit. All the talk about unconventional policies to lessen the extent of this recession will only make it a depression.

    We can’t prop up the economy on more debt or we’ll be waiting for Credit Crunch mark 2.

    Asset values are still too high. The credit restriction is showing thier true value and we need to let the market correct this.

    This market correction will show which banks/businesses have a solid reserve basis and the rest can go hang. The whole economy needs to restructure along more conservative lines of credit. Inflation will not do this and any increase in inflationary pressure now will be catastrophic when we hit the bottom.

    The solution is simple but unpalatable for politians:

    Cut Public spending.
    Cut/eliminate the deficit.
    Raise interest rates to INCREASE reserves.
    “Bail-out Banks” sell off all but their main street presence and reduce their exposure to future losses (the tax payer should not be exposed to these risks)
    Build the banking sector from scratch again.

    The alternative is not worth thinking about.

    Your proposal is mumbo jumbo. The more you try to prolong the correction the longer this recession. Short term unemployment is much better thatn longterm unemployment.

    I’m thinking the vested interests in the banks will not let this happen.

  63. Gravatar of Vangel Vangel
    4. March 2009 at 05:26

    What terrible ideas. What got us into the crisis was government and central bank meddling. More meddling will not get us out. If we want to get out of trouble as rapidly as possible we have to be able to take a brief but painful hit to the general economy that will cause malinvestments to be liquidated as rapidly as possible. The best way to do that would be to cut government spending, cut taxes and regulations, and allow bankruptcies to get rid of bad debt and reckless lenders. And while we are at it, get rid of the Fed just as previous presidents got rid of the first two central banks.

  64. Gravatar of Conventional Folly » Your Morning Friedman (Milton) Conventional Folly » Your Morning Friedman (Milton)
    4. March 2009 at 06:36

    […] tax cuts than government spending for [debatable] reasons of efficiency), or coming up with new and heretofore untried monetary measures. According to Milton Friedman, anyway, doing anything less””i.e. arguing that letting the market […]

  65. Gravatar of ssumner ssumner
    5. March 2009 at 12:09

    Missouriman, et al, My take on supply side is that there is more to it than most economists believe, but less to it than supply-siders believe. The 1932-82 argument is a good one, but let’s take a more fine-grained look:

    1. The 1920s were much more prosperous than the 1930s.
    2. The Kennedy tax cuts from 90% to 70% seemed to help the economy.
    3. The Reagan cuts of the top rate didn’t seem to cost much revenue, and seemed to boost growth (relative to other developed economies.)
    4. Clinton is a partial counterexample, but consider that he raised MTRs at the beginning of his first term. Two years later the economy was still sluggish, and the Republicans swept the Congress. In his second term he made two major cuts in MTRs, one obvious (capital gains) the other less so, welfare reform. It was his second term that saw the great Clinton prosperity.
    5. Virtually every country in the world has cut MTRs for the rich in recent decades, even left wing governments. Are they all making the same mistake as Arthur Laffer?
    6. Our tax system is so riddled with double and even triple taxation of capital, that published tax rates are very deceptive.
    7. The European welfare states (which some on the left seem to like), raise their huge tax revenues by hitting consumption hard, not capital. (They differ from us primarily in high VATs, gas taxes, payroll taxes, etc.)

    Existenialed, Housing is an interesting issue, but I’m looking for a solution to a crisis that is hurting all industries.

    Gabe, Maybe I’m naive, but I think most left-liberals are well intentioned.

    Global patriot, I am also skeptical of cap and trade.

    DanC, I agree.

    Smokegoldeye, I agree, but things will swing back the other way before we get close to Cuba.

    Jon, Now I see your point about MB-R = Cash. Yes, that shows that the injection of liquidity has been mostly sterilized, not getting out into the economy–partly due to the interest on reserves, but not entirely.

    I don’t understand the 10% charge-off point. If the yield goes negative, they have the option of holding zero interest T-bills. And if the yield on T-bills goes negative, you have broken out of the liquidity trap.

    RareBreed and Vangel, As I see the things, Hoover’s policymakers were opposed to creating an artificial prosperity by printing money. I think that mistake led to the New Deal.

  66. Gravatar of Sujan Patricia Sujan Patricia
    18. June 2009 at 07:20

    I must admit I’m loving the little catfight between Meltzer and Krugman. Inflation vs. deflation debate between Allan Meltzer and Paul Krugman is a rather interesting and insightful. Allan Meltzer says inflation is our greatest threat and I’m agree with him. Meltzer’s warning remains relevant.

  67. Gravatar of ssumner ssumner
    18. June 2009 at 09:27

    Sujan, I have always wondered if any females read my blog. Many commenters use aliases, so it’s hard to tell. I don’t recall any female names (until yours.)

  68. Gravatar of TheMoneyIllusion » Vindication is sweet, recovery would be even sweeter TheMoneyIllusion » Vindication is sweet, recovery would be even sweeter
    11. December 2009 at 07:10

    […] first claim to fame (at least among my colleagues) was when I wrote an open letter to Krugman in March, and he actually responded.  Of course his response was a quick dismissal of […]

  69. Gravatar of Vindication is Sweet, Recovery would be Even Sweeter Vindication is Sweet, Recovery would be Even Sweeter
    13. December 2009 at 17:10

    […] first claim to fame (at least among my colleagues) was when I wrote an open letter to Krugman in March, and he actually responded.  Of course his response was a quick dismissal of […]

  70. Gravatar of TheMoneyIllusion » The perils of reaching the truth before Krugman TheMoneyIllusion » The perils of reaching the truth before Krugman
    24. July 2010 at 06:39

    […] is ready, while he is still pinning his hopes on fiscal stimulus?  On March 1, 2009, I wrote an open letter to Krugman calling for a three-pronged attack on deflation; elimination of IOR, having the Fed buy Treasury […]

  71. Gravatar of TheMoneyIllusion » Strange new respect from Krugman TheMoneyIllusion » Strange new respect from Krugman
    23. August 2010 at 10:26

    […] that a sufficiently large fiscal stimulus package was politically impossible.  In early March 2009 I called upon Krugman to start pushing the Fed to move more aggressively, arguing that it was our only hope.  He seemed […]

  72. Gravatar of TheMoneyIllusion » A Keynesian grapples with QE TheMoneyIllusion » A Keynesian grapples with QE
    1. November 2010 at 18:38

    […] week Krugman seems to inch a bit closer to adopting the ideas that I asked him to support in my open letter of March 2009.  A few months back he endorsed Joe Gagnon’s call for QE plus eliminating interest on […]

  73. Gravatar of TheMoneyIllusion » Paul Krugman is gaining a better understanding of market monetarism TheMoneyIllusion » Paul Krugman is gaining a better understanding of market monetarism
    13. October 2011 at 06:39

    […] focused on expectations; that’s why we’re called market monetarists.  When I wrote an open letter to Paul Krugman in 2009, I discussed the need for QE, lower IOR, and a NGDP target, level targeting.  That’s […]

  74. Gravatar of Roger Farmer: Someone Has a Very Elevated Idea of Himself | Last Men and OverMen Roger Farmer: Someone Has a Very Elevated Idea of Himself | Last Men and OverMen
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    […] […]

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