There were two posts yesterday. The first was “Nobody Could Have Predicted, Bill Gross Edition:”
Gillian Tett feels sorry for BIll Gross, who was caught unaware by the sudden shift in bond market behavior. Who could have predicted that interest rates would stay low despite large budget deficits?
Um, how about Pimco’s own chief economist, Paul McCulley?
The truth is that the quiescence of interest and inflation rates was predicted by everyone who understood the obvious — that we had entered a liquidity trap — and thought through the implications. I explained it more than five years ago. When central banks have pushed policy rates as low as they can, and the economy is still depressed, what that tells you is that the economy is awash in excess desired savings that have nowhere to go. And as I wrote:
So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap.
So no crowding out, no reason interest rates should rise.
And Paul McCulley understood all this really well (pdf):
[I]n the topsy-turvy world of liquidity traps, these textbook orthodoxies do not apply, and acting irresponsibly relative to orthodoxy by increasing borrowing will do more good than harm.
Crowding out, overheating and rising interest rates are also not likely to be a problem as there is no competition for funds from the private sector. For evidence, look no further than the impact of government borrowing on long-term interest rates in the U.S. during the Great Depression, or more recently, Japan.
Really, this wasn’t and isn’t hard.
Or maybe it is. Strikingly, Tett’s version of what went wrong with Gross’s predictions makes no mention of deleveraging and the zero lower bound; it’s all a power play by central banks, which have been “intimidating” bond investors with unconventional monetary policy. This is utterly wrong, and in fact Gross’s own mistakes show that it’s wrong: one of his big failures was betting that rates would spike when the Fed ended QE2, which they predictably didn’t.
As an aside, whenever I hear people explaining away the failure of interest rates to spike as the result of those evil central bankers artificially keeping them down, I want to ask how they think that’s possible. Surely the same people, if you had asked them a few years ago about what would happen if the Fed tried to suppress interest rates by massively expanding its balance sheet, would have predicted runaway inflation. That didn’t happen, which should make you wonder what exactly they mean by saying that rates are artificially low.
Oh, and Tett ends the piece by citing the Bank for International Settlements as a voice of wisdom. That’s pretty amazing, too; the sadomonetarists of Basel have a remarkable track record of being wrong about everything since 2008, but always finding some reason to call for higher rates.
The thing is, Tett is a smart observer who talks to a lot of people in finance; seeing her present a discredited theory as obviously true, without so much as mentioning the kind of analysis that has been worked all along, says bad things about the extent to which anyone who matters has learned anything.
Yesterday’s second post was “Mr. Krugman and the Classics (Trivial and Self-Indulgent):”
Joe Gagnon, traveling in Asia Minor, sends me a picture from a museum:
I know I’m an old-time Keynesian, but maybe even older-time than I knew …