Krugman’s blog, 9/19 and 9/20/15

There were three posts on 9/19 and one yesterday.  The first post on 9/19 was “Thriving:”

Just a heads up for people in the New York area: on the 29th I’lllead a discussion with Richard Layard and David M. Clark of their new book Thrive: How Better Mental Health Care Transforms Lives and Saves Money. It’s actually very important stuff.

Saturday’s second post was “The Creativity of the Permahawks:”

Tim Taylor writes about low interest rates. As he notes, many economists see low rates as a natural (in both the colloquial and Wicksellian sense) response to a weak economy; but he respectfully cites the Bank for International Settlements, which argues that low rates are a source of terrible economic distortions. But it seems to me that there’s some context missing.

Taylor writes,

Notice that none of the BIS concerns are about the risk of a rise in inflation–which it does not think of as a substantial risk.

Ah, but it used to think otherwise. It has been calling for higher interest rates for around 5 years, and at first it was indeed warning about inflation. In its 2011 report, in fact, it declared that

Highly accommodative monetary policies are fast becoming a threat to price stability.

That was dead wrong, and the ECB — which believed in the inflation threat and raised rates — clearly made a big mistake. So you might have expected the BIS to ask why it was so wrong, and reconsider its policy recommendations. Instead, however, it continued to demand the same policies, while inventing new justifications.

And I mean inventing. As I’ve written many times, the remarkable thing about policy since 2010 is that outsiders, particularly bearded academics, have based their criticisms of policy on mainstream, textbook economics; whereas serious-sounding bankers in suits have been creating whole new economic doctrines on the fly to justify what they claim are sound policies.

In this case, the BIS not only claims that low interest rates cause financial instability, but goes on to expound a sort of widow’s crusetheory of interest rates, in which low rates today lead to even lower rates tomorrow, because they produce bubbles that weaken the economy further when they burst. That’s pretty wild stuff; you wouldn’t want to take it seriously without a lot of evidence, which the BIS does not provide.

Or put it this way: if, say, Jeremy Corbyn or Bernie Sanders were to invent whole new, dubious economic theories to justify the policies they clearly want for other reasons, everyone would be coming down on them hard for being flaky and irresponsible. Yet when the BIS — which was, once again, dead wrong on inflation — does the same thing, it’s taken very seriously.

One more thing: I was especially annoyed at the BIS’s claim that we now know that pre-crisis estimates of potential output were greatly overstated; they mention the US in the mid-200s as an example. But we know no such thing. Some methods widely used to estimate potential output in effect assume that the economy has a strong tendency to return to full employment, so if we see a prolonged slump those methods rewrite history, concluding that the economy must have been badly overheated before the slump. But why should we believe that conclusion? The US wasn’t experiencing accelerating inflation at an unemployment rate around 5 percent in the mid-2000s; it’s not seeing accelerating inflation now, with unemployment back to the same vicinity. Doesn’t this mean that it wasn’t overheated either time?

Again, if someone from the center-left were to produce an economic analysis this tendentious, this much at odds with decades of mainstream economics, it would be met with incredulity. It’s awesome to see the ultra-respectable BIS go down this path, and be taken seriously along the way.

The third post on Saturday was “Rate Rage:”

OK, I should have seen that one coming, but didn’t: the banking industry has responded to the Fed’s decision not to hike rates with a primal cry of rage. And that, I think, tells us what we need to know about the political economy of permahawkery.

The truth is, I’ve been getting this one wrong. I’ve tried to understand demands that rates go up despite the absence of inflation pressure in terms of broad class interests. And the trouble is that it’s not at all clear where these interests lie. The wealthy get a lot of interest income, which means that they are hurt by low rates; but they also own a lot of assets, whose prices go up when monetary policy is easy. You can try to figure out the net effect, but what matters for the politics is perception, and that’s surely murky.

But what we should be doing, I now realize, is focusing not on broad classes but on very specific business interests. In particular, commercial bankers really dislike a very low interest rate environment, because it’s hard for them to make profits: there’s a lower bound on the interest rates they can offer, and if lending rates are low that compresses their spread. So bankers keep demanding higher rates, and inventing stories about why that would make sense despite low inflation.

Now, you can argue, as Brad DeLong does, that easy money is in the long-run interest of commercial banks — that in the end the nominal interest rate depends on the rate of inflation, and that locking us into a lowflation or deflation world would be very bad for the banks. But nobody has ever accused bankers of being especially clear about macroeconomics, and in any case what matters for today’s bank executives is not the long run but the next few years, during which they either will or won’t be getting big bonuses; in the long run they are all full-time golfers.

So the demand for higher rates is coming from a narrow business interest group, not the one percent in general. But it’s an interest group that has a lot of clout among central bankers, because these are people they see every day — and in many cases are people they will become once they go through the revolving door. I doubt there’s much crude corruption going on at this level (or am I naive?), but officials at public monetary institutions — certainly the BIS, but also the Fed — are constantly holding meetings with, having lunch with, commercial bankers who have a personal stake in seeing rates go up no matter what the macro situation.

Like everyone, the bankers no doubt are able to persuade themselves that what’s good for them is good for America and the world; more alarmingly, they may be able to persuade officials who should know better. Does this explain the puzzling divergence between the views of Fed officials and those of outsiders like Larry Summers (and yours truly) who have a similar model of how the world works, but are horrified by the eagerness to raise rates while inflation is still below target?

I don’t know about you, but I feel that I’m having an Aha! moment here. Oh, and raising rates is still a terrible idea.

Yesterday’s post was “More on the Political Economy of Permahawkery:”

To be honest, I’m feeling rather stupid about not understanding until now how to make sense of the ever-changing rationales for the ever-changing demand for higher interest rates. As someone who started in international trade, I more than anyone should have known that specific factors, not Stolper-Samuelson, is usually the way to go.

For the 99.9 percent of readers who have no idea what I’m talking about: One of the landmark papers in international trade theory was the demonstration by Wolfgang Stolper and Paul Samuelson, way back in 1941, that the income distribution effects of protectionism typically swamp any efficiency considerations. If you said something judicious along the lines of “Well, protectionism might increase labor’s share, but workers will still end up losing because the economy will become less efficiency”, you were just wrong in terms of the standard model: if an economy imports labor-intensive goods, protectionism will raise real wages — end of story.

So trade policy should have big effects on the distribution of income between broad classes of players — labor versus capital, highly educated versus less-educated labor, and so on. But if you try to understand the political economy of trade policy, what you see is much narrower interests at play — not capital in general but the owners of textile factories or sugar plantations. Blessed are the cheesemakers, not any manufacturers of dairy products. And the right model to think about this is the specific factors model of trade, in which capital is temporarily stuck in a particular industry; in the long run it may be fungible, but lobbyists don’t worry about that.

So we’ve had a long discussion of the distributional effects of QE and all that, which are ambiguous but also, I now realize, irrelevant. Is QE good or bad for capital, for rentiers, whatever? No matter — it’s bad for bankers, because it leads to a compression of the net interest margin, the spread between deposit rates and lending rates. And that is why there’s so much agitation for rate hikes on the part of finance. Furthermore, while I don’t think institutions like the BIS are corrupt in any direct sense, they probably pick up by osmosis from all the bankers they meet the general prejudice against easy money, leading to increasingly baroque attempts to justify rate hikes despite low inflation.

Incidentally, this also means that the common claim that QE is a giveaway to bankers is the opposite of the truth; to the extent that journalists with close ties to bankers spread this story, it’s Orwellian. Remember, the Fed isn’t lending money at low interest to banks — banks, with their $2.5 trillion (!) of excess reserves, are lending vast sums at low interest to the Fed.

It’s all falling into place.



One Response to “Krugman’s blog, 9/19 and 9/20/15”

  1. Ustanof Says:

    I doubt if bankers are against lower rates since they have don’t have a ceiling as opposed to the lower bounds rate.

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