Paul Krugman, John Locke, Emperor Diocletian, and the zero lower bound

Here’s Paul Krugman:

Ah. In this afternoon’s Reddit, I was asked how the Fed can help the Emperor Diocletian escape the zero lower bound. My answer, I realized later, missed a crucial aspect of the situation: the ancient Roman economy could not have trouble with the zero lower bound, because the Romans didn’t have the concept of zero. They had to set the Fed Imperial funds rate at LXXV basis points, or whatever.

It wasn’t until the Arabs invented Arabic numerals that the liquidity trap became a possibility.

I guess I’d have to admit that overall Krugman is a better monetary economist than Diocletian.  But the famous Emperor does have Paul beat in one area—the zero lower bound.  The real reason that Diocletian never got stuck in a liquidity trap is that he wasn’t a Keynesian.  Only Keynesian policymakers get stuck at the zero bound.  Monetarists don’t get stuck, because there’s no upper limit on the money supply.  And decadent Roman Emperors never get stuck because there’s no zero lower bound to the amount of metal in a coin.  That’s because if the amount of metal fell to zero, it would no longer be a coin!  More seriously, there is no plausible lower bound on the amount of precious metal in a high-valued coin.  Does anyone serious dispute that a 99.99% reduction of the amount of gold in a $20 dollar gold piece would have been inflationary in 1933?  After all, even a 40% reduction turned out to be highly inflationary.

Krugman was way ahead of the profession in 1998 when he emphasized that monetary policy wasn’t about the current setting of the policy instrument, but rather the expected future path.  But he didn’t take that far enough.  That implies that the current instrument setting is primarily a signaling device.  And that means you really need an instrument that doesn’t become mute when you most need it to speak loud and clear.  In other words, nominal interest rates are the worst possible instrument.  Even the FDR/Diocletian instrument (coinage debasement) would be far superior.   Krugman’s a great monetary economist, but he has an unhealthy obsession with using interest rates as a policy instrument.

John Locke was already way ahead of Paul Krugman in 1694:

“For I think no body can be so senseless, as to imagine, that 19 Grains or Ounces of Silver can be raised to the Value of 20; or that 19 Grains or Ounces of Silver shall at the same time exchange for, or buy as much Corn, Oyl, or Wine as 20; which is to raise it to the Value of 20.  For if 19 Ounces of Silver can be worth 20 Ounces of Silver, or pay for as much of any other Commodity, then 18, 10, or 1 Ounce may do the same. . . . And so a single Threepence, or a single Penny, being call’d a Crown, will buy as much Spice or Silk, or any other Commodity, as a Crown-piece, which contains 20 or 60 times as much Silver; which is an Absurdity so great, That I think no body will want eyes to see, and Sense to disown.”

No “absurdity so great?”  John Locke never met a Keynesian.

PS.  Actually Locke must have met some Keynesians–as he was pushing back against claims that currency depreciation wouldn’t be inflationary.



24 Responses to “Paul Krugman, John Locke, Emperor Diocletian, and the zero lower bound”

  1. Gravatar of marcus nunes marcus nunes
    2. May 2012 at 17:35

    No “absurdity so great?” John Locke never met a Keynesian.
    Great one-liner (the PS spoiled it somewhat)

  2. Gravatar of ssumner ssumner
    2. May 2012 at 17:46

    Marcus, Yeah, I see that. I should quit while I’m ahead.

  3. Gravatar of Charlie Charlie
    2. May 2012 at 17:52

    Seems like bad timing. Krugman has been endorsing the Fed be more accommodative for awhile now. He did it on the reddit thread as well. He did it in the NY Times magazine article, and he’s doing it in his book. He’s argued (albeit perhaps not consistently) that the main problem with the ZLB is not that the Fed is out of instruments, but that they are incredibly reluctant to use them. That’s a sentiment that Bernanke has raised throughout (some perceived high cost to unconventional policy like level targeting). Granted, he’s not totally positive what would work, and he worries more about commitment than you, but largely he’s on the same page. I’m not sure it’s useful to obscure this agreement.

    You should have spent this post criticizing Jim Hamilton:

  4. Gravatar of Peter N Peter N
    2. May 2012 at 18:38

    And you debase a federal reserve note by using thinner paper and less ink?

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    2. May 2012 at 18:40

    I’ll bet steam was coming out of Krugman’s ears when he realized the joke was on him.

    I’ll also bet the guy featured here has the same effect;

    ‘…Conard rejects the notion that America has “some monopoly on hard work or entrepreneurship.” “I think it’s simple economics,” he said. “If the payoff for risk-taking is better, people will take more risks.” Conard sees the success of the U.S. economy as, in part, the result of a series of historic accidents. Most recently, the coincidence of Roe v. Wade and the late 1970s economic malaise allowed Ronald Reagan to unify social conservatives and free-market advocates and set the country on a pro-investment path for decades. Europeans, he says, made all the wrong decisions. Concern about promoting equality and protecting favored industries have led to onerous work rules, higher taxes and all sorts of social programs that keep them poorer than Americans.’

  6. Gravatar of Steve Steve
    2. May 2012 at 20:08

    @ Peter N

    “And you debase a federal reserve note by using thinner paper and less ink?”

    No, extra zeros!

  7. Gravatar of Steve Steve
    2. May 2012 at 20:12

    @ ssumner

    I agree with Charlie.

    The Keynesians need to be trained like Pavlov’s dogs. When Brad DeLong has an Al Gore moment and claims he invented NGDP targeting, pat him on the head and feed him a meat flavored biscuit. When Krugman goes after the FOMC hawks, give him a squeaky toy. But when they revert to Keynesianism, put them on a short leash in a cold shed.

  8. Gravatar of ChargerCarl ChargerCarl
    2. May 2012 at 20:15

    when did brad ever claim he invented NGDP targeting?

  9. Gravatar of Steve Steve
    2. May 2012 at 20:35


    Brad DeLong as quoted by our friend Marcus:

    “I thought three-and-a-half years ago that the Federal Reserve would announce that its mission was primarily to keep economy-wide nominal spending on its pre-2008 growth path”

  10. Gravatar of Major_Freedom Major_Freedom
    2. May 2012 at 21:19

    I’m just laughing at the fact that this is the 4th post that Krugman has devoted to the “debate” he had with Ron Paul.

    The lady doth protest too much.

  11. Gravatar of Dan S Dan S
    2. May 2012 at 22:34

    Maybe this is not a useful distinction, but I think the Keynesians think there is a big difference between printing or coining money and going out and spending it on goods and services (what the ancient Roman emperors did) and printing money and using it to purchase government debt when the interest rate is zero. Perhaps the latter would not work?

  12. Gravatar of Saturos Saturos
    3. May 2012 at 01:02

    Sorry, where exactly is that quote from? Can I find it online?

  13. Gravatar of W. Peden W. Peden
    3. May 2012 at 01:22

    Dan S,

    Some Keynesians may think that, but Krugman has argued persuasively that a central bank that commits to expansion at the zero lower bound can still stimulate expansion up to full employment and I agree with him.

  14. Gravatar of Saturos Saturos
    3. May 2012 at 01:34

    Dan S, yes it would. What do the people selling bonds want to do with the money? Buy more bonds? What about those sellers? Eventually the yield falls to zero. What then? Buy other assets? What about the people selling those assets? Buy more assets? Eventually the prices of assets rise tremendously relative to wages and the cost of capital, stimulating hiring and production. More simply, money that circulates must eventually buy real goods and services, otherwise it would return in a circle to a previous owner without everyone having made real gains from their transactions.

    As for the notion that money and bonds are perfect substitutes when rates are zero, this is false. As Scott says, “When I go shopping at Walmart I don’t take T-bills with me”. Scott has a couple of reductio ad absurdums (absurdae? absurdii? reductii?) against this. In one he points out that interest rates must rise eventually, and then people will want to switch to bonds. Otherwise the government debt could be financed at zero cost.

    The one I like better, though, is legalizing counterfeiting. The idea is that if an infinite number of new dollars flooded in, this would most certainly raise spending. Even in an economy without credit, money loses value as its quantity rises. As money is injected, the supply of money on the market will eventually rise, as people hold money for the purpose of (eventually) exchanging it.

  15. Gravatar of Mike Sax Mike Sax
    3. May 2012 at 03:12

    Locke actually sounds to me like Major Freedom. MF Ron Paul is a crank with no asnwers and he proved it in that interview. Krugman though should have told him to stop interrupting him.

    I guess Paul has the advantage of being a Congressman where the art of the filibuster is his bread and butter.

  16. Gravatar of JP Koning JP Koning
    3. May 2012 at 06:01

    While I agree with the spirit of this post – that monetary policy is about signaling – I don’t think the choice of interest rates has to be thrown out the window at the zero-lower bound.

    The Fed simply has to set a negative federal funds rate or IOR, and to prevent everyone from holding their savings in 0% interest cash, impose a compensating burden on cash holders by issuing only $20 bills and lower. This will impose significant inconveniences on cash holders, mainly storage costs, and let the fed funds rate remain below 0.

  17. Gravatar of 123 123
    3. May 2012 at 06:32

    There is no al gore moment:
    “Brad DeLong was right”

  18. Gravatar of ssumner ssumner
    3. May 2012 at 08:18

    Charlie, I have a new post on Hamilton. As far as this post, it was clearly meant to be humorous–he does many along the same lines, so I’m sure he’s not offended.

    Peter N. No, by adding zeros. 🙂

    Patrick, That was a good article. Our financial system has flaws (mostly government created moral hazard) but it’s nice to be reminded of the useful role played by finance.

    Steve, You read my mind.

    ChargerCarl, I don’t think he claims to have invented the idea, which has been around for decades.

    DanS, FDR showed you can reflate merely by debasing coins–it doesn’t matter what you buy.

    Saturos, It’s from a book on John Locke’s views on economics. Don’t know if it’s online. The book’s in my office, so I don’t know the exact title.

    JP Koning, In a recent post I argued that the Fed should set negative Fed funds targets. But most people seemed to think the idea was silly. So I’m partly basing this on the fact that negative rates aren’t widely accepted. If not, let’s use a different language.

  19. Gravatar of JP Koning JP Koning
    3. May 2012 at 08:41

    Scott, fair enough. But if negative interest rates were part of the accepted language, would you agree that my scheme would be a relatively easy way to solve the zero-lower bound problem? Easier than abolishing cash, or imposing a stamp tax?

  20. Gravatar of ssumner ssumner
    3. May 2012 at 18:17

    JP, Yes, but targeting NGDP forecasts would be far more effective.

  21. Gravatar of JP Koning JP Koning
    3. May 2012 at 18:28

    Ok, thanks for the response.

  22. Gravatar of Lorenzo from Oz Lorenzo from Oz
    25. February 2014 at 14:02

    Just for the record, the Indians invented/discovered the concept of zero and Arabic numerals are really Indian (i.e. Sanskrit) numerals, we just got them from the Arabs. Arabic is written from right to left and Arabic-Sanskrit numerals go from left to right (as does Sanskrit).

  23. Gravatar of c8to c8to
    26. February 2014 at 06:27

    Peter N,

    Yes, but only relative to the overall stack 🙂

  24. Gravatar of When should the Fed raise its federal funds rate target? | Sound Money ProjectSound Money Project When should the Fed raise its federal funds rate target? | Sound Money ProjectSound Money Project
    27. October 2015 at 08:55

    […] its sustainable potential. Personally, I don’t put much stock in the zero-lower bound argument. (I’m in good company.) And I tend to think the optimal rate of inflation is negative. If I am wrong, though, and […]

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