Five months ago I warned Krugman this would happen

In a post written on June 14th, I warned Krugman that it was foolish to play politics; he should just advocate the policy that is most effective:

As I read Krugman, his attitude seems to be something like the following (which is my interpretation, not his words):

“Ah, what a pity it is that these conservative central banks aren’t willing to commit to a modest amount of inflation.  That would be the easiest way to boost AD, and the least costly.  But as they aren’t willing to adopt effective policies, we can assume that monetary policy is ineffective.  Now let’s move right along and look at fiscal policy.”

At this point Krugman directs his moral outrage at the conservative knuckleheads in Congress who won’t accept anything bigger than a measly $800,000,000,000 stimulus package, which he thinks is woefully inadequate.

In my view Krugman is mixing science and advocacy in a very misleading and inappropriate way.  When he evaluates central banks, he seems to take a deterministic, scientific, and clinical attitude, as if studying a colony of ants.  (I assume that for entomologists there is no “should.” The only question is how ants behave.)  Central banks are assumed to be impervious to public pressure.  On the other hand his stance toward fiscal policy is much more normative.  Now he is an advocate, he’s part of the game, passionately calling for more stimulus.  But I don’t see how this makes any sense.  If we are going to take a deterministic view of things, it seems likely that Congress is also far too conservative to implement the sort of spending that Krugman advocates.  Indeed, hasn’t that already been shown?   Couldn’t one just as reasonably say: “Since Congress clearly won’t do what it takes, we must fall back on the Fed as our only hope for the sort of stimulus that the economy needs.”

I view my own role as that of an advocate; I am trying to change the consensus view of economists about the causes of this crisis, and the most effective solutions.  I want to describe the most effective solutions, not those I think are politically feasible.  We need to change the political climate, if that is the problem.  Indeed if policy is deterministic, then all hope is lost.  I hope that my ideas will eventually filter down to policymakers.

Krugman is 100 times more influential than I am.  With his NYT column, and his ideological allies in the White House, he is arguably the most influential economic pundit in the world.  And he is also known (for better or worse) for his moral outrage over perceived injustices.  In many cases I think he goes a bit over the top.  But here it is just the opposite.  I am outraged over Krugman’s lack of outrage over current monetary policy.

In this new post Krugman concedes that monetary policy is the best way of reducing the high unemployment rate, and fiscal policy is second best.  But he’s no longer working the fiscal policy route.  Instead, he is now advocating the third best option, wage subsidies and job sharing:

In reality, we haven’t even gotten anywhere near (i): the conventional wisdom is still that any rise in expected inflation above 2 percent is a bad thing, when it’s actually good.

So some readers have asked why I’m not making the same arguments for America now that I was making for Japan a decade ago. The answer is that I don’t think I’ll get anywhere, at least not until or unless the slump goes on for a long time.

OK, so what’s next? The second-best answer would be a really big fiscal expansion, sufficient to mostly close the output gap. The economic case for doing that is really clear. But Washington is caught up in deficit phobia, and there doesn’t seem to be any chance of getting a big enough push.

That’s why, at this point, I’m turning to what I understand perfectly well to be a third-best solution: subsidizing jobs and promoting work-sharing.

Call it constrained optimization, where the constraint comes from the power of bad ideas.

This is a foolish game to play.  There is zero chance Congress would spend enough money on these “third-best” options to make a dent in unemployment.  God only knows what his 4th best option is.

Krugman should have been advocating monetary stimulus all along.  The real problem is that his allies in government; Obama, Pelosi, Reid, etc., don’t even know the first best option exists.  And how could they?  How often is monetary stimulus mentioned in columns written by liberal pundits?   If they realized that they were about to get decimated in the 2010 midterm elections because a few nutty right-wingers at the Fed think the economy needs less stimulus, not more, there would be outrage in Congress and the Administration.  They’d be marching down to the Fed (metaphorically of course, to avoid looking heavy-handed) and make it very clear that the Fed needs to produce robust growth in aggregate demand or else there will be big changes in the way the Fed is set up and regulated.  If they don’t seem “receptive,” then quietly tell the FOMC; “Think the Dodd bill is bad?  You can’t even imagine how much worse we can make it.”

Would this work?  Go read the history of 1937.  (Why does that year keep coming up, anyway?)  Google the phrase “a switch in time saved nine,” and you’ll see that unelected third branches of government have a lot less power than you might assume.

Here’s what I find so bizarre.  Almost the entire political establishment thinks we need much more AD.  Even Republicans that argue against the fiscal stimulus don’t say the problem is that it will boost AD; rather they make the opposite argument, they claim it will “fail” where failure is defined as a lack of AD, a continuation of the recession.  Meanwhile the people at the Fed are perfectly aware of Woodford’s argument that I discussed in a recent post.  They know that they could boost AD by setting a higher inflation target.  They simply don’t want to.  And yet almost the entire political establishment thinks Bernanke is doing all he can from the monetary end.

How can we get the people in power to understand what is going on?  There is one person who understands what monetary policy can do, who understands Woodford’s views, who understands Svensson’s views, and who also has a news column read by every single influential person in government.  Do I even need to tell you who I am talking about?

HT:  rob and JimP



15 Responses to “Five months ago I warned Krugman this would happen”

  1. Gravatar of JimP JimP
    14. November 2009 at 14:29

    Yes – would that Krugman would. He simply cannot deny what Woodford wrote in that paper.

    The paper is entirely clear – in a canonical New Keynesian model at the zero bound a price level target is the best way to come out of a crisis. The best way. It is what the Obama administration is looking for. It is what we all are looking for – except the truly insane deflationists. We can give ourselves another Japan, but we do not need to.

    Bernanke is fully fully aware of this. Why doesn’t he act? I believe it is because he needs Obama’s political support to do so – and he apparently doesn’t have it. The way to get it is, as you said in your previous post, to point out what the people of this country will do the Democratic party, and to the Fed. if they don’t act.

  2. Gravatar of JKH JKH
    14. November 2009 at 15:56

    He’s still non-specific about how he would do it if he could. He mentions something in the Japan article about making the monetary base increase “permanent”. What does that mean in the US context? How would he do it? Exactly what would he prescribe to get inflation expectations up? How much would he do it? I’d like to understand specifically what he would expect by way of central bank action, and banking system response, and compare it with your implied model. I’d like to know how he thinks banks work.

  3. Gravatar of JimP JimP
    14. November 2009 at 16:52

    All good questions. But at least the theory is clearly stated. As the paper says:

    begin quote
    The problem with the forward-looking inflation targeting policy is that because the central bank simply targets zero inflation from the time that it again becomes possible to do so, all of the deflation that occurs while the zero bound binds is fully accommodated by the subsequent policy: the
    central bank continues to maintain the price level at whatever level it has fallen to. This results in expected deflation during the entire period of the financial disturbance, for deflation will continue as long as the financial disruption continues, while no inflation will be allowed even if the disturbance dissipates; this expected deflation makes the zero bound on nominal interest
    rates a higher lower bound on the real policy rate, making the contraction and deflation worse, giving people reason to expect more deflation as long as the disruption continues, and so on in a vicious circle.
    end quote

    And this strike me as where we are now. Barron’s, Taylor, Kudlow, et al are calling for a reduction in non-existent inflation – which increases deflationary expectations and traps us. Of course the people who already own the dollars are going to want deflation – it lowers the price of household help. But who else does it help? No one I know.

  4. Gravatar of rob rob
    14. November 2009 at 17:45

    Now Yglesias has commented on Krugman’s ’98 paper:

    He doesn’t even mention the recent post — but clearly Krugman has let the cat out of the bag about monetary policy options — and another liberal now knows about it…

  5. Gravatar of Doc Merlin Doc Merlin
    14. November 2009 at 20:02

    “Instead, he is now advocating the third best option, wage subsidies and job sharing”

    This isn’t a “third best option” unless you consider firebombing second best.

  6. Gravatar of rob rob
    14. November 2009 at 21:42

    BTW, im going to take credit as the “reader” who constantly asked Krugman why he didnt explain his recent inconsistency with his 98 paper. of course i referenced you in the context. but us commenters do what we can.

  7. Gravatar of Doc Merlin Doc Merlin
    14. November 2009 at 22:26

    Um, why would krugman do that? Krugman used to be an economist… now he is a political writer, why would he do what you suggest he should?

  8. Gravatar of rob rob
    15. November 2009 at 01:18

    Doc, my theory is that Krug is a political genius. What better way to make a convincing argument for the “first best” solution than to play hard-to-get for so long and then finally say “this is best but everyone is too stupid to get it so I won’t bother recommending it.” I work in sales and often the joke/tactic is “No, you don’t really want that! That isn’t even for sale!” You do this for what you are trying to sell at the highest price.

    OK – maybe I am being sarcastic, but the result is the same.

    Since it is 3am I will resort to one of my favorite philosophers, Emerson, who says something to the effect of: “No matter how much you try to hide what you really believe, it is the same as if you were preaching it.”

    Krugman has served a good purpose, finally, and he deserves credit for it. Of course, Scott deserves more.

    That Yglesias is running with this leads me to believe that this meme has long and variable legs….

  9. Gravatar of Mike Sandifer Mike Sandifer
    15. November 2009 at 07:08

    Some suggest Nixon put pressure on Burns to stimulate the economy to help him get re-elected. Looking at the data, this seems to be when inflation really took off, rather than the late 60s as even many on the left think.

  10. Gravatar of Scott Sumner Scott Sumner
    15. November 2009 at 08:03

    Thanks JimP,

    JKH, That is a good question, as there is a lot of misunderstanding about that issue. The key point is that you need the increase in the price level to be expected to be permanent. So if the Fed injects money, but then is expected to later pull it back out of circulation, then there won’t be any expected increase in the future price level. To get a permanent increase in the price level you need a permanent increase in M.

    But here’s where things get tricky. Strictly speaking, his comments on the money supply only apply if the QT of Money holds. If not, then what you need is a permanent increase in the money supply RELATIVE TO THE EXPECTED INCREASE IN MONEY DEMAND. Because the base is currently bloated by ERs held for a variety of reasons (low rates on T-bills, interest on reserves, etc.), it is very possible that demand for reserves is expected to fall back closer to its normal level as the economy recovers. In that case, you’d just need the permanent increase in the money supply to be large enough to raise the long run price level, it doesn’t necessarily have to be larger than the current price level.

    JimP, I agree, and some of these conservatives are their own worst enemy, as deflation leads to frustration with the free market system, and government takes a larger role.

    rob, Thanks, that may be worth a post.

    Doc Merlin, I put “third best” in quotation marks the second time I mentioned it, I should have done it both times.

    I was going to make a joke about his 4th best option being communism, but I restrained myself, as I want liberals to take what I say seriously.

    rob, Thanks for your support. I like that Emerson quotation.

    Mike, Yes, Nixon’s policies were the worst. But the decision to ease policy in 1967-68 was the first huge mistake of the Great Inflation. The dollar left gold (internationally) in April 1968.

  11. Gravatar of q q
    16. November 2009 at 06:41

    the best option is still have find other planet threaten to destroy us. we would get our act together real real quick.

  12. Gravatar of Joe Joe
    18. November 2009 at 13:55

    Most republicans do not want an increase in Inflation expectations….it kills the rich bondholders who fill their coffers and “debases the currency”

  13. Gravatar of Scott Sumner Scott Sumner
    18. November 2009 at 19:08

    Joe, Except the rich Wall Street hedge funds generally supported Obama in 2008. And the rich are more likely to be in stocks or corporate bonds (versus T-bonds), and those assets were hurt by the deflationary policies.

  14. Gravatar of Thorstein Veblen Thorstein Veblen
    20. November 2009 at 14:20

    Scott– I share your outrage over Krugman’s (and DeLong’s) lack of outrage over monetary policy, but where the hell has the rest of the Economics profession been? Bernanke has clearly been too cautious, and it’s now been clear for at least six months. What is it that Monetary economists do, anyway?

    Has Woodford published any op-eds pointing out the Feds folly? What has Chris Sims done? Mankiw? I mean, christ, Mankiw blogs about his textbook every day, you’d think he’d get around to posting about the Fed’s folly if he thought it were serious. Fama? Cochrane? The Minnesota people?

    Mostly, I think it’s b/c economists are busy doing algebra, have never been taught to really think, and so just aren’t equipped to analyze real world issues.

  15. Gravatar of Scott Sumner Scott Sumner
    26. November 2009 at 06:39

    Thorstein, I share your outrage over the entire profession. In many posts I have pointed out that at least Krugman understands the need for stimulus, which is more than one can say about most Chicago economists.

    I have seen Mankiw posts recommending inflation targeting, level targeting. I have not seen any Mankiw posts arguing that because monetary policy is now ineffective we need a big fiscal stimulus.

    But you might want to check out my earlier post “Invasion of the New Keynesian mind snatchers.”

    I will try to more forcefully bash Chicago in the future.

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