Krugman’s blog 7/7/13

There was one post yesterday, “That Terrible Taper:”

One of the odd things about the people arguing that we must raise interest rates to head off bubbles — Raghuram Rajan, Martin Feldstein, the BIS, and so on — is the near-universal assertion among this group that just a little rate increase can’t do any real harm. (Just a thin little mint). After all, rates are so low!

As I’ve argued, this is a novel economic principle; where else do we argue that demand curves (in this case the demand for investment) are vertical at low prices? But it has occurred to me that it might be helpful to look at what the partial victory of these people — their implicit success in bullying the Fed into talking about tapering despite a still very weak, low-inflation economy — has wrought. Bear in mind that the interest rates that matter most for the economy are not the rates at which the government can borrow, but the rates facing private investors — and above all, mortgage rates, for housing is the most important transmission mechanism for monetary policy. And here’s what we see for mortgage rates since the talk of tapering began:

Do you really think that this will have no effect? Really, really?

By the way, I see that some readers imagine that the effects of the taper talk somehow refute my earlier assertions that the rate at which the Fed is buying long-term bonds has little effect on interest rates. But you’re misunderstanding both what I said and what is happening now. My point was always that the direct effects of bond purchases were small, so that anticipated changes in the pace of purchases — like the end of QE2 in 2011 — had minimal effects.

What’s happening now, however, is that the taper talk has led to a sharp revision of market expectations about the path of short-term interest rates, which the Fed does control. From Gavyn Davies:

The Fed didn’t mean this to happen; it tried to communicate that it wasn’t changing the path of short-term rates; but this was naive on its part. The Fed can’t really commit to future policy; all it can do is signal its character, and what it ended up doing here was convey the sense that it’s much more inclined to tighten too soon than previously thought.

So it’s a bad story, all around.



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