Monday, November 17, 2008
Paul Krugman Makes Sure We Understand How Crazy He Is
It is really amazing to see how glib Paul Krugman can be about his insane recommendations. (HT2MR) I can't take this apart right now; it surely deserves its own Mises.org article. For now, let us just read it and "enjoy":
BTW, if you are a supergeek, here is Krugman's more formal exposition on the liquidity trap. I have to read this in preparation for an article on all this stuff. (I can hear Drago saying to Rocky, "I must break you.")
It’s a curious thing that even now, when we are clearly in a liquidity trap, we still have a lot of economists denying that such a thing is possible. The argument seems to go like this: creating inflation is easy — birds do it, bees do it, Zimbabwe does it. So it can’t really be a problem for competent countries like Japan or the United States.
This misses a key point that I and others tried to make for Japan in the 90s and are trying to make again now: creating inflation is easy if you’re an irresponsible country. It may not be easy at all if you aren’t.
A decade ago, when I tried to make sense of Japan’s predicament, I used a simple, unrealistic model to ask what we really know about the relationship between the money supply and the price level. We normally say that an increase in the money supply, other things equal, leads to an equal proportional increase in the price level: double M and you double the CPI. But that’s not actually right. What a model with all the i’s dotted and t’s crossed actually says is that the CPI doubles if you double the current money supply and all future expected money supplies.
And how do you do that? No matter how much Japan increases the monetary base now, expectations of future money supplies won’t move if people believe that the Bank of Japan will move to stabilize the price level as soon as the economy recovers. And once you realize that central banks may not be able to move expectations about future money supplies, it becomes a real possibility that the economy will be in a liquidity trap: if interest rates are near zero, money printed now just gets hoarded, and monetary policy has no traction on the real economy.
Zimbabwe wouldn’t have this problem: people believe that any money it prints will stay in circulation. But the likes of Japan, or the United States, print money for policy purposes, not to pay their bills. And that, perversely, is what makes them vulnerable to a liquidity trap. Back in 1998 I argued that the Bank of Japan needed to find a way to “credibly promise to be irresponsible.” That didn’t go down too well, but it was what sober, careful economic analysis prescribed.
...
The whole subject of the liquidity trap has a sort of Alice-through-the-looking-glass quality. Virtues like saving, or a central bank known to be strongly committed to price stability, become vices; to get out of the trap a country must loosen its belt, persuade its citizens to forget about the future, and convince the private sector that the government and central bank aren’t as serious and austere as they seem.
BTW, if you are a supergeek, here is Krugman's more formal exposition on the liquidity trap. I have to read this in preparation for an article on all this stuff. (I can hear Drago saying to Rocky, "I must break you.")
Comments:
It's funny that a guy can be so married to the idea of using government for policy purposes that advocating absudities doesn't provide it's own check on his worldview.
But that's how flawed the good Lord made us!
But that's how flawed the good Lord made us!
Coincidentally enough,The Onion again comes to the rescue!
I know that if I saw Bernanke come to a press conference covered in shaving cream, I'd think he'd gone nuts. I certainly wouldn't expect him to rigorously sterilize future liquidity injections!
I know that if I saw Bernanke come to a press conference covered in shaving cream, I'd think he'd gone nuts. I certainly wouldn't expect him to rigorously sterilize future liquidity injections!
He seems to imply there are just 2 policy responses: (1) monetary policy and (2) fiscal policy. When (1) fails, he suggests to try (2). But there are costs associated with both (inflation, debt).
I assume that Dr Murphy would say that there is one other option (3) Do nothing.
Right?
I assume that Dr Murphy would say that there is one other option (3) Do nothing.
Right?
# posted by 
: November 18, 2008 at 4:14 AM
: November 18, 2008 at 4:14 AM
Hopefully God will forgive me, but Krugman may be on to something. I don't think there is a liquidity "trap", but could there be such thing as a currency bubble? As an inflationary cycle deflates, the dollar exchange rate falls, security prices fall, prices fall, asset prices fall. Right now, one makes a positive rate of return by holding cash.
I also believe that people extrapolate and speculate which makes the effects of easy money even worse. If the Fed now eases money again, what are they going to extrapolate? Surely not real estate again, or stocks with their recent memories. They will hoard cash.
Will people start selling held wealth to hoard cash? If they do the rate of return on holding cash will accelerate, feeding a cash bubble. I am skeptical of the black-hole nature of the liquidity trap, but it would be similar.
I also believe that people extrapolate and speculate which makes the effects of easy money even worse. If the Fed now eases money again, what are they going to extrapolate? Surely not real estate again, or stocks with their recent memories. They will hoard cash.
Will people start selling held wealth to hoard cash? If they do the rate of return on holding cash will accelerate, feeding a cash bubble. I am skeptical of the black-hole nature of the liquidity trap, but it would be similar.
Krugman made reference to the word "model" in his opinion piece. No doubt, that impressed everyone because they thought he possessed some super-dooper technical skills that allow him to speak with authority on areas outside his expertise (international trade).
# posted by : November 19, 2008 at 8:41 AM
: November 19, 2008 at 8:41 AM
EM, it's more like, I dispute that his "solutions" will work. So I guess you could say that "(3) do nothing" is my solution.
Brian, that's a really interesting point. I'll have to think about what it would mean to have a bubble in cash.
Brian, that's a really interesting point. I'll have to think about what it would mean to have a bubble in cash.
Sorry I didn't see this post until today, but under a free market, a cash bubble would not be a problem and would be self correcting. As hoarding increases, the interest rate for investment, other things being equal would increase, encouraging some hoarders back to investment.
With the FED parking interest rates at 0 or less than 0 in real terms, there is no incentive from the traditional side to leave the hoarding fold. At the same time, if the hoarders begin to guess that the FED will maintain its reckless policy, the hoarders will start to fear the increasing hoards of their fellows, and the disintegration of their own purchasing power, once their peers' hoards are disgorged.
It then becomes a confidence game. Hold until the prices are "optimal," but be out completely before the average hoarder has decided to liquidate. Thus this bubble is also finite in length and size. The biggest downside is that once this bubble begins to deflate, it will blow up bubbles in commodities (where Jim Rogers and Peter Schiff have been suggesting investments currently). It is beginning to seem like a nightmare version of whack-a-mole, but the mole gets bigger and bigger and takes a chunk out of the players every time he pops back up.
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With the FED parking interest rates at 0 or less than 0 in real terms, there is no incentive from the traditional side to leave the hoarding fold. At the same time, if the hoarders begin to guess that the FED will maintain its reckless policy, the hoarders will start to fear the increasing hoards of their fellows, and the disintegration of their own purchasing power, once their peers' hoards are disgorged.
It then becomes a confidence game. Hold until the prices are "optimal," but be out completely before the average hoarder has decided to liquidate. Thus this bubble is also finite in length and size. The biggest downside is that once this bubble begins to deflate, it will blow up bubbles in commodities (where Jim Rogers and Peter Schiff have been suggesting investments currently). It is beginning to seem like a nightmare version of whack-a-mole, but the mole gets bigger and bigger and takes a chunk out of the players every time he pops back up.
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