Krugman’s blog, 8/28 and 8/29/15

There was one post yesterday and two posts on Friday.  He didn’t post to his blog yesterday.  The first post on Friday was “1998 in 2015:”

David Beckworth has a good if possibly over-elaborate discussion of China’s flirtation with crisis. What I find striking is the extent to which China has managed to put itself into something like the situation many of its neighbors faced in the late 1990s. The renminbi “wants” to depreciate, partly because of a slowing economy and monetary easing, partly because of a crisis of confidence and capital flight. But Chinese authorities aren’t willing to let it drop all the way, perhaps because of fears of trade conflict but also perhaps because the private sector and state-owned enterprises now have a lot of foreign-currency debt.

What happened in 1997-1998 was that Asian depreciations turned into balance-sheet disasters, because domestic firms were highly leveraged and had lots of dollar debt. This debt soared as a share of GDP, not because of massive new borrowing, but because the denominator crashed as currencies plunged:


International Monetary Fund

I and others wrote about this at the time; you can see, by the way, why I get annoyed at assertions that economists paid no attention to debt until the 2008 crisis, but also why I’m annoyed at myself for not realizing how a housing crash could produce balance-sheet stress just as currency crashes did in 1998 Asia.

Anyway, it looks like time to dust off the extensive analysis that took place back then. Obviously there are some important differences between China 2015 and Indonesia 1998, including huge foreign exchange reserves but also what looks like a much bigger and more problematic overhang of internal debt. But we do have a lot of material to draw on; no need to reinvent everything from scratch.

Friday’s second post was “Fear of Asymmetry:”

David Roberts has a very nice essay on American politics, framed as an analysis of what nerds don’t get; but it’s not just nerds who seem weirdly blind to the reality here.

One problem with the essay, however, is that Roberts never really explains why people who pride themselves on their ability to think things through slide into lazy cliches when it comes to politics. And that’s important: just lecturing Silicon Valley types on the need to get serious about politics won’t work if there are deeper reasons smart people get stupid when politics enters the picture.

Here’s how I see it: it’s about self-image. Tech types like to imagine themselves above the fray, operating on a higher plane than those grubby political types. But if you get serious about US politics, you realize that this is actually an irresponsible pose. As Roberts says, the parties are not symmetric, and wisdom does not lie somewhere between the extremists on both sides. In fact, policies that the tech elite support, like carbon taxes, are supported only by the left wing of the Democratic Party; the entire Republican Party is controlled by climate denialists, and anti-science types more broadly. And in general the modern GOP is basically anti-rational analysis; it’s at war not just with the welfare state but with the Enlightenment.

But for an ubernerd to acknowledge this reality would be to sound, horrors, partisan. And so they refuse to go there; all their belief in data and careful analysis gets set aside when it comes to politics, because the political data — and there really are a lot of data on all this — tell you what they don’t want to hear.

As readers might guess, I face some personal frustration here. When it comes to economics, I try to base what I say on evidence and on models that have stood the test of confrontation with evidence; but I often encounter people who assume that I’m just a left-wing version of Stephen Moore. Why do they believe that? Have they actually looked at my analysis and track record? No, they just know that I’m much more critical of the right than of the left, and they assume that this means ipso facto that I’m biased. But what if in modern America the right is much more wrong than the left? Not a possibility they’re willing to contemplate.

So are efforts to change this futile? I hope not. Roberts may well have the right approach: keep stressing the evidence of political asymmetry. Maybe, maybe, someone will listen.

Saturday’s post was “Artificial Unintelligence:”

In the early stages of the Lesser Depression, those of us who knew a bit about the macroeconomic debates of the 1930s, and realized how relevant the hard-won insights of Keynes and Hicks were to the post-financial crisis world, often felt a sense of despair. Everywhere you looked, people who imagined themselves sophisticated and possessed of deep understanding were resurrecting 75-year-old fallacies and presenting them as deep insights.

A lot of water has passed under the bridge since then, and I at least no longer feel the same sense of despair. Instead, I feel an even deeper sense of despair — because people are still rolling out those same fallacies, even though in the interim those of us who remembered and understood Keynes/Hicks have been right about most things, and those lecturing us have been wrong about everything.

So here’s William Cohan in the Times, declaring that the Fed should “show some spine” and raise rates even though there is no sign of accelerating inflation. His reasoning:

The case for raising rates is straightforward: Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying.

Oh dear.

Cohan’s theory of interest rates is basically the old notion of loanable funds: the interest rate is determined by the supply of and demand for credit. As Keynes and Hicks explained three generations ago, this is a completely inadequate story — because it misses the reality that the level of income isn’t fixed, and changes in income affect the supply and demand for funds. So loanable funds doesn’t determine the interest rate; all it does is define a relationship between interest rates and income, the IS curve of the IS-LM model:

What determines where we end up on that curve? Monetary policy. The Fed sets interest rates, whether it wants to or not — even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice.

And how would you know if the Fed is setting rates too low? Here’s where Hicks meets Wicksell: rates are too low if the economy is overheating and inflation is accelerating. Not exactly what we’ve seen in the era of zero rates and QE:

OK, there are arguments that the Fed should be willing to abandon its inflation target so as to discourage bubbles. I think those arguments are wrong — but in any case they have nothing to do with the notion that current rates are somehow artificial, that we should let rates be determined by “supply and demand”.

The worrying thing is that, as I’ve suggested, crude misunderstandings along these lines are widespread even among people who imagine themselves well-informed and sophisticated. Eighty years of hard economic thinking, and seven years of overwhelming confirmation of that hard thinking, have made no dent in their worldview. Awesome.

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One Response to “Krugman’s blog, 8/28 and 8/29/15”

  1. Flap Jacks Says:

    The point worth remembering is the inviolable trust we have in the Federal Reserve is diminished by the tone with which people who are against a central bank believe the sole function of the Fed is to print cheap money.

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