Krugman’s blog, 9/21/15

There were three posts yesterday.  The first was “Milton, Money and Interest Rates:”

Still mulling over the political economy of permahawkery; and, unusually, I have a moderate disagreement with Brad DeLong. Brad has been arguing that demands for tight money are, in fact,contrary to the bankers’ own interests:

It was Milton Friedman who insisted, over and over again, that in any but the shortest of runs high nominal interest rates were not a sign that money was tight–that the central bank had pushed the market interest rate above the Wicksellian natural rate–but rather that money had been and probably was still loose, and that market expectations had adjusted to that.

Friedman did in fact make that claim. But if “the shortest of short runs” means weeks or months, he was wrong.

Consider the Volcker disinflation. The Fed clearly announced its intention to reduce inflation, and temporarily changed its operating procedure by switching to money supply targeting; in short, it did everything one might imagine to make it clear that there was a regime shift that would lead to disinflation. As I and others have pointed out, the fact that this policy change nonetheless led to a severe recession is conclusive evidence against both the Lucas notion that only unanticipated monetary policy has real effects, and the Prescott view that business cycles reflect real shocks.

But the episode also undermines the Friedman claim on interest rates. Yes, short rates ended up lower than before once the disinflation was complete. But they were sharply elevated for three years — and while you might have expected long rates to fall due to reduced expectations of inflation, in fact they rose along with short rates and stayed high for several years.

So put yourself in the (very expensive) shoes of a bank CEO today, who is assured that the Fed’s hold on interest rates now will help avoid deflation and assure higher interest rates and hence higher bank profits in the long run. Even if you understand the macroeconomics and know the history (which you probably don’t), this is a story about a better bottom line four or five years down the pike, by which time you will have foregone a lot of bonuses and may well be retired.

As I see it, interest-rate hawkery on the part of bankers isn’t irrational, just evil.

Yesterday’s second post was “Partisan Divides in Everything:”


The last post yesterday was “Nutcases and Knut Cases:”

Monetary permahawkery takes two forms. One is obviously ridiculous, but nonetheless has a lot of influence on right-wing politicians. The other can sound serious and judicious, which makes it dangerous, because it might gain real traction with policymakers.

Permahawkery of the first kind is exemplified by the likes of Ron Paul, Zero Hedge, and Paul Ryan. Hyperinflation is always just around the corner. And no matter how wrong the scare stories have been in the past, there’s always a willing audience.

But the clear and present danger comes from people like Andrew Sentance, who was until recently a member of the Bank of England’s Monetary Policy Committee – the equivalent of the FOMC. Sentance has a remarkable piece in today’s FT castigating the Fed for not hiking rates. What makes the piece so remarkable is that there isn’t so much as a nod to what you might have thought was the standard approach to monetary policy; not only has Sentance made up his own version of macroeconomics, he’s evidently completely unaware that he has done so.

As I’ve been trying to point out – and as others, notably Ben Bernanke, have also tried to point out – such monetary wisdom as we possess starts with Knut Wicksell’s concept of the natural interest rate. Try to keep rates too low, and inflation accelerates; try to keep them too high, and inflation decelerates and heads toward deflation.

Now comes Sentance, claiming that monetary policy has been consistently too easy, not just in recent months, but for the past generation:

Since the 1990s, the Fed and the Bank of England have pursued policies similar to the ones any well-meaning government official would have chosen. They have cut interest rates very readily, but when they have raised them (in 1994-5 and 2005-7) they have been behind the curve. Independent central banks were established precisely to avoid this “behind the curve” interest rate policy. But it has not worked.

So central banks have been too eager to cut and too slow to hike, presumably meaning that interest rates on average have been much too low. If true, this should imply that policy has had an inflationary bias, right? Except that inflation has trended downward, not upward:

You might have expected at least some effort to explain why this isn’t a problem for Sentance’s claim. But no. (The BIS does offer asort of explanation, claiming that excessively low interest rates now push required rates even lower in the future, which is bizarre but at least coherent.)

Wait, it gets worse. Sentance mocks the decision not to raise rates, suggesting that it has no real justification:

A multitude of reasons have been advanced for delaying the first rate rise: sluggish growth in all the major western economies in 2011-12; the euro crisis in 2013-14; and now the Fed is citing weak economic growth in China and the impact this has on financial markets.

If you look around hard enough, there can always be a reason for not raising interest rates.

Notice something missing? How about the fact that inflation is still below the Fed’s target, and shows no sign of rising? And that doesn’t even get into the argument, which Larry Summers, yours truly, and many others have made, that the risks of getting it wrong are highly asymmetric: a premature hike would do far more damage than waiting too long.

Maybe Sentance is right to toss almost everything economists have said about interest rate policy for the past 117 years out the window. But since he offers no reason for rejecting basic monetary economics, it’s hard to escape the suspicion that he has no idea that this is what he’s doing. And he sat on the committee making British monetary policy!

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