Krugman misses R&R’s point

Paul Krugman has a new post criticizing Reinhart and Rogoff’s view that fiscal stimulus in Germany might be counterproductive.  Here is R&R:

We don’t see your attraction to fiscal largesse as a substitute. Periphery Europe cannot afford it and for Germany, which can afford it, fiscal expansion would be procyclical.  Any overheating in Germany would exert pressure on the ECB to maintain a tighter monetary policy, backtracking some of the progress made by Mario Draghi. A better use of Germany’s balance sheet strength would be to agree on faster and bigger haircuts for the periphery, and to support significantly more expansionary monetary policy by the ECB.

Krugman has two and a half objections:

First, the half level: what, exactly, does it mean to call for expansionary monetary policy by the ECB? Like other major central banks, the ECB has near-zero policy rates, so we’re talking about some kind of unconventional monetary policy. Are we supposed to envision the ECB doing huge purchases of unconventional assets (over and above what it’s already doing in the form of lending to banks against sovereign debt and the promise of outright monetary transactions if necessary)? Alternatively, are we supposed to see a European version of Abenomics, with the ECB credibly committing to a higher inflation target? Both are strategies worth trying, but of uncertain effect “” and both would surely be viewed as anathema by the Germans.

Yes, monetary stimulus would be anathema to the Germans, but they have one vote out of 17 (although their power is admittedly greater than that ratio suggests.)  But fiscal stimulus is also anathema to the Germans, and they have one vote out of one for German fiscal stimulus.  Just a few years ago I was told by lots of worldly-wise commenters that the Japanese would never opt for monetary stimulus, because of the power of the elderly lobby in Japan.  OK commenters, where are you now?  I haven’t heard from you recently.

If the ultra-conservative BoJ can change its policy, I don’t see why the ultra-conservative ECB cannot do the same.

Second, and now we get to where I’m really baffled, if we’re against policies that are procyclical for Germany,what on earth do R&R imagine a more expansionary monetary policy (however achieved) does? Europe as a whole is deeply depressed; Germany is not. So any policy that causes overall European expansion is going to be pushing the German economy up against capacity, and pushing up German inflation. There is no difference at all between fiscal and monetary expansion as far as that issue is concerned.

Krugman doesn’t seem to be aware that R&R are arguing for monetary offset.  The argument seemed obvious to me, but perhaps Krugman read their letter so rapidly he missed that point.  If the ECB is targeting inflation at slightly under 2% (and it seems to be, as it raised rates in 2011 to prevent above target inflation), then higher German inflation forces tighter money, and thus lower non-German inflation.  Obviously that problem does not occur with monetary stimulus—so the two policies are very different, once you account for monetary offset.

Finally, aren’t policies that are procyclical for Germany, and raise inflation there, the whole point of the exercise? We have a competitiveness gap between the periphery and the core that must be closed through some combination of falling wages in Portugal, Spain, etc. and rising wages in Germany. The idea is to shift the balance of that adjustment somewhat away from the deflationary countries “” overheating in Germany isn’t a bug, it’s a feature, and indeed the crucial feature.

File this under “never reason from a wage change.”  Yes, for a given Portuguese NGDP, a lower wage level will help restore full employment.  But if German fiscal stimulus led to a tighter ECB policy, it would reduce Portuguese NGDP.  And falling wages caused by falling Portuguese NGDP are not expansionary.

Oh dear . . . now I’m beginning to sound like Keynes.

HT:  J



16 Responses to “Krugman misses R&R’s point”

  1. Gravatar of Matt Waters Matt Waters
    28. May 2013 at 10:45

    I’m not sure monetary offset would mean a lower Portuguese NGDP than without fiscal stimulus. I think it would be the same NGDP.

    If Germany does fiscal stimulus and Germany’s at full employment, the spending goes directly to wage increases in sectors where the fiscal stimulus applies. Since they’re at full employment, other sectors would need to raise wages as well. If wages are flat for Portugal, Portuguese tradeable goods now become more competitive than German tradeable goods and Portuguese NGDP goes up due to German stimulus.

    The monetary offset that happens next then pushes up the Euro’s value, which keeps general German inflation from happening. Portuguese NGDP goes back down because their tradeable goods are no longer more competitive than German tradeable goods without German inflation. It seems like Portuguese NGDP would end up in the same spot as before, not lower.

  2. Gravatar of Vivian Darkbloom Vivian Darkbloom
    28. May 2013 at 10:54

    Not to get too hung up on nomenclature, but where exactly does giving the periphery a bigger and quicker haircut fit? Economists tend to divide stimulus into fiscal and monetary worlds. To the extent the German and other non-periphery governments take the haircut hit, doesn’t this debt forgiveness fall into the fiscal basket, more or less? Even to the extent private banks take the hit, the German government is financing part of that through lower tax revenues as a resuIt of home country banks taking losses for tax purposes (I’m assuming this has not been done already through marking the debt to market, which some countries allow). This strikes me as a means to inject a sort of fiscal stimulus directly into the “periphery’ (where it is needed most) and would likely not entail as large an inflation risk as direct spending or tax cuts in Germany. Thus, would there be the need for ECB offset? I doubt it.

    The moral hazard issue can probably be dealt with. The R&R proposal of monetary lathering followed by a quick head shave seems to be a rational proposal. Perhaps even Krugman would buy it if they were to call the proposed haircut “fiscal stimulus”.

  3. Gravatar of J J
    28. May 2013 at 11:05

    Matt Waters,

    Consider eurozone inflation, which is some sort of average of inflation between let’s just say Germany and Portugal. Germany has fiscal stimulus which pushes German inflation up by 1 percentage point and Portuguese inflation up by 0.2 percentage points. Then, eurozone inflation goes up by 0.6 percentage points, so the ECB tightens until that 0.6 falls to 0. Where will Portuguese inflation be after this exercise? Probably lower than where it started and German inflation will be above where it started. The German fiscal stimulus essentially steals NGDP from other countries in Europe because the ECB prevents overall NGDP from rising.

  4. Gravatar of Fearghal Fearghal
    28. May 2013 at 11:08

    But, if German inflation would cause the ECB to tighten monetary policy because we’re pretty much at its target for Eurozone inflation, then how can it loosen policy without overshooting its target? Surely it’s either targeting close to, but less than, two percent inflation, or it isn’t?

    Or do you mean that the ECB would be willing to overshoot its target in order to offset austerity policies across all of the Eurozone, but not if they are only being pursued in part of the Eurozone?

    Sorry for speaking completely in questions (and also for asking pretty much the same question as on another thread) but I can’t quite get my head around your argument.

  5. Gravatar of Steve Steve
    28. May 2013 at 11:14


    If I put my Krugman hat on, I’d say that tax losses for German investors would be “corporate welfare” or “crony capitalism” not fiscal stimulus. In order to be true “fiscal stimulus” you’d need to hire more Portuguese government workers and increase health and social security benefits for retirees.

    Not my beliefs, just saying…

  6. Gravatar of JJriverrun JJriverrun
    28. May 2013 at 11:50

    I love arguments about which never going to happen policy option is going to happen first!
    I buy neither the assertation that German fiscal stimulus would be offset in such a manner as to make the periphery worse off than before, nor the argument that unconventional monetary policy is so far fetched as to not be worth mentioning.

    PS. Reading R&R’s response letter, it’s kind of hard to figure out if they are actually suggesting monetary offset as the mechanism for the procyclical nature of German Stimulus.

  7. Gravatar of ChargerCarl ChargerCarl
    28. May 2013 at 13:28

    Scott, whats your opinion on the Avent/Klein debate?

  8. Gravatar of StatsGuy StatsGuy
    28. May 2013 at 13:49

    “Just a few years ago I was told by lots of worldly-wise commenters that the Japanese would never opt for monetary stimulus, because of the power of the elderly lobby in Japan.”

    I don’t think I took that position (not sure if you’re referring to me). My concern was whether the large banks holding all the JGBs would go along with it, because of fears their bonds would get crushed in NPV terms (and they would lose solvency if their funding costs rose).

    This appears to be getting some play today:

    Since I doubt the BoJ will throw the banks under the bus, I would look for some sort of accommodation plan (the BoJ taking the JGBs off of the banks’ hands at above market rates), in exchange for the banks increasing lending and re-balancing into other assets.

    But I’m just guessing, really. I have no clue what’s going on behind the scenes in Japan, though i’m quite certain deals have been worked out, and are being updated frequently.

  9. Gravatar of Geoff Geoff
    28. May 2013 at 14:00

    Never reason from a price change.

    Never reason from an interest rate change.

    Never reason from a wage change.

    Never reason from the change to 427,865,234 concepts.

    Reason from an NGDP change.

    Never worship Zeus.

    Never worship Allah.

    Never worship Yahweh.

    Never worship 1,590,560 Gods.

    Worship Mithra.


    “Oh dear . . . now I’m beginning to sound like Keynes.”

    You always did. The main difference is that instead of the Treasury being God, the Fed is God.

  10. Gravatar of 123 123
    28. May 2013 at 16:33

    The question is, would a German fiscal stimulus help with the Eurozone-wide supply side problems? Guess you could build such a model, but does it have anything to do with reality? Still, I think I will spend some time pondering it, before dismissing Krugman completely.

  11. Gravatar of 123 123
    29. May 2013 at 05:15

    Of course, under NGDPLT it would be very unlikely that German fiscal stimulus could improve Portuguese supply side enough. But under quasi price level targeting, it is a scenario that could sometimes occur. But of course it is better to actually focus the German fiscal capacity on the supply-side PIGS debt problem, as Rogoff is proposing.

  12. Gravatar of ssumner ssumner
    29. May 2013 at 05:44

    Matt, See J’s reply.

    Vivian. I’m not sure how the Keynesians treat debt forgiveness. I presume it has something to do with the relative MPCs in Germany and Greece.

    Fearghal, That’s a very difficult question and I honestly don’t have the answer. There is only one way to do good monetary policy, but there are a million different ways to fail.

    JJriverrun, They are pretty clearly referring to monetary offset.

    Chargercarl. Haven’t followed that closely, but my general view is that malinvestment does harm to an economy, but not business cycle levels of harm.

    Statsguy, I have a horrible memory for names, and thus no idea as to the many commenters who made that claim. Interesting that you’d think it might be you . . .

    I doubt rates will rise significantly.

    123. I agree with your second comment.

  13. Gravatar of J J
    29. May 2013 at 07:50


    The issue is that inflation will be what the ECB allows it to be, and so fiscal stimulus is not relevant to the overall level of inflation in the eurozone. The ECB will not overshoot its target, but maybe it can be pressured to raise its target. If it raises its target, then it can engage in policy to hit its new target. No matter what, fiscal stimulus will not help.

    The argument for fiscal stimulus is that we are in a liquidity trap. This doesn’t mean that central banks are targeting too low inflation/NGDP, but means that they want higher inflation/NGDP and are unable to hit the target. If a central bank will respond to more fiscal stimulus by cutting back on monetary stimulus, conventional or unconventional, then the argument for fiscal stimulus disappears.

  14. Gravatar of Mikio Kumada Mikio Kumada
    30. May 2013 at 00:48

    Well, as far as the lobby of the elderly is concerned: it is courtesy of Abe’s clear political campaigning before that he received such a clear mandate. He convinced the elderly that we have to do and move on or be overun and left be behind by China and everyone else. I think he made the case to do this for the “next generations” – appealing to the elders, and won. They have effectivelly agreed to be tax (via inflation and negative real rates) to fund Japan’s recovery. Not sure the Germans would respond to appears to “save future generations of Greeks and Italians”…

  15. Gravatar of ssumner ssumner
    30. May 2013 at 05:40

    Mikio, But you can’t have it both ways. If the eurozone is truly a club, then they should all cooperate. If it’s dog-eat-dog world, then the Germans get outvoted but the debtors. Either way you need more stimulus.

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