Vindication is Sweet, Recovery would be Even Sweeter

My first claim to fame (at least among my colleagues) was when I wrote an open letter to Krugman in March, and he actually responded.  Of course his response was a quick dismissal of my plea for more monetary ease.  He did so by denying my claim that he had several times acknowledged that massive unconventional QE might work.  At the time, he favored fiscal policy, partly because he thought monetary policy had run out of ammunition, and partly because he felt that central banks were too conservative to do the really unconventional things necessary, like promising to inflate.  Here’s how I described his views in June:

At a certain level Krugman would agree with much of what I have said.  He also thinks the conservative attitude of the BOJ is a big factor limiting the effectiveness of base expansion.  But the way he interprets these facts is very different.  As I read Krugman, his attitude seems to be something like the following (which is my interpretation, not his words):

“Ah, what a pity it is that these conservative central banks aren’t willing to commit to a modest amount of inflation.  That would be the easiest way to boost AD, and the least costly.  But as they aren’t willing to adopt effective policies, we can assume that monetary policy is ineffective.  Now let’s move right along and look at fiscal policy.”

At this point Krugmandirects his moral outrage at the conservative knuckleheads in Congress who won’t accept anything bigger than a measly $800,000,000,000 stimulus package, which he thinks is woefully inadequate.

In my view Krugmanis mixing science and advocacy in a very misleading and inappropriate way.  When he evaluates central banks, he seems to take a deterministic, scientific, and clinical attitude, as if studying a colony of ants.  (I assume that for entomologists there is no “should.” The only question is how ants behave.)  Central banks are assumed to be impervious to public pressure.  On the other hand his stance toward fiscal policy is much more normative.  Now he is an advocate, he’s part of the game, passionately calling for more stimulus.  But I don’t see how this makes any sense.  If we are going to take a deterministic view of things, it seems likely that Congress is also far too conservative to implement the sort of spending that Krugman advocates.  Indeed, hasn’t that already been shown?   Couldn’t one just as reasonably say: “Since Congress clearly won’t do what it takes, we must fall back on the Fed as our only hope for the sort of stimulus that the economy needs.”

And here is how Krugman described our only hope today:

So if we’re going to have any real good news, someone has to take responsibility for creating a lot of additional jobs. And at this point, that someone almost has to be the Federal Reserve.

Krugman is very influential—imagine if he had said this in March.  Would people like DeLong have been writing posts saying that monetary policy was ineffective because rates are at zero?  I don’t think so.

I thought this was the most amusing line in Krugman’s article in today’s NYT:

But while economic analysis says that we should have a large second stimulus, the political reality is that the president — faced with total obstruction from Republicans, while receiving only lukewarm support from some in his own party — probably can’t get enough votes in Congress to do more than tinker at the edges of the employment problem.

The Fed, however, can do more.

Question:  In all of world history, who are the two economists most famous for denigrating the Fed’s ability to “do more” once rates hit zero?  (Hint, both names start with K.)  Who gave me this reply when I suggested that massive QE might be effective?

OK, I see that Scott Sumner has written an open letter to me. But I’m puzzled. He writes:

“I think you have acknowledged that there is some level of quantitative easing that would boost demand. If I am not mistaken you are concerned that if such a policy boosted inflation expectations sharply, the Fed would have to quickly sell off these assets, suffering massive capital losses.”

Um, you are mistaken. I’ve never said such a thing. Did you mean to address this letter to someone else?

My view, which I thought was pretty clear, is that the liquidity trap is real: no matter how much the Fed increases the monetary base, it has no effect, because it just substitutes one zero-interest asset for another.

I won’t rehash all the evidence that his misrepresented his own views.  And before Krugman fan’s write in saying; “There is no contradiction, he’s always said inflation targeting can work, he doesn’t think that merely increasing the money supply can help once rates hit zero”  you might want to check out the next paragraph in the new Krugman piece:

The most specific, persuasive case I’ve seen for more Fed action comes from Joseph Gagnon, a former Fed staffer now at the Peterson Institute for International Economics. Basing his analysis on the prior work of none other than Mr. Bernanke himself, in his previous incarnation as an economic researcher, Mr. Gagnon urges the Fed to expand credit by buying a further $2 trillion in assets. Such a program could do a lot to promote faster growth, while having hardly any downside.

Yes, it could do a lot indeed.  Last March it would have been even more helpful.  On March 1st I asked Krugman to endorse this sort of plan.  I am glad that he has finally done so.  Now let’s consider why the Fed has refused to do more.  Here is Krugman’s explanation:

So why isn’t the Fed doing it? Part of the answer may be political: Ideological opponents of government activism tend to be as critical of the Fed’s credit expansion as they are of the Obama administration’s fiscal stimulus. And this has probably made the Fed reluctant to use its powers to their fullest extent. Meanwhile, a significant number of Fed officials, especially at the regional banks, are obsessed with the fear of 1970s-style inflation, which they see lurking just around the bend even though there’s not a hint of it in the actual data.

There’s a bit of truth in what Krugman is saying.  But let’s not lose sight of the fact that the Democrats recently won a big electoral victory.  They control the Presidency.  They have 60 Senate seats.  They have an overwhelming majority in the House.  They have the non-Fox, non-WSJ press.  Most leading economists are Democrats.  Sure there are a lot of loudmouths opposing more monetary stimulus.  But where were the voices on the other side back in March?  A time when the conservatives were even more discredited than today?  Last March, how many liberals even understood that monetary stimulus could play a major role in reducing joblessness?  And who is their intellectual leader on economic questions?   How can anyone be surprised that the voices of inflation hawks have drowned out the other side, when the other side never made an effort to engage the debate.  Until now.

Rather than look back in anger, I’d like to end on a positive note.  Despite my many disagreements with Krugman, I’ve always considered him to be a very persuasive writer.  It’s great seeing him write editorials like the one I have taken these excerpts from.  Here’s how the op-ed piece ends:

But there’s also, I believe, a question of priorities. The Fed sprang into action when faced with the prospect of wrecked banks; it doesn’t seem equally concerned about the prospect of wrecked lives.

And that is what we’re talking about here. The kind of sustained high unemployment envisaged in the Fed’s own forecasts is a recipe for immense human suffering — millions of families losing their savings and their homes, millions of young Americans never getting their working lives properly started because there are no jobs available when they graduate. If we don’t get unemployment down soon, we’ll be paying the price for a generation.

So it’s time for the Fed to lose that complacency, shrug off that fatalism and start lending a hand to job creation.

I couldn’t have said it better.  And that is precisely why this is such a big deal.  We need the rhetorical skills of people like Paul Krugman (and Brad DeLong, and Matthew Yglesias, and many others who have been saying similar things recently.)

HT:  Marcus Nunes

◊◊◊◊◊◊

PS.  After I wrote this I realized that I should have acknowledged Joseph Gagnon’s paper more explicitly.  It is his work not mine that is having an impact on the blogosphere.  It is Gagnon who has worked out an explicit proposal that includes a lot of data analysis.  My point is that I did call for unconventional QE and either inflation or NGDP targeting last March, and it seems to me that Krugman now thinks those policies are our best hope today.  So I take some satisfaction from that.  But I should have emphasized that it is Gagnon who is actually having a major impact on the blogosphere.  And of course our views differ in some respects—so he shouldn’t be blamed if you don’t like NGDP targeting, that’s my idea not his.

PPS.  I just reread DeLong’s post where he endorses Gagnon for chair of the Fed.  I agree.  I noticed that at the end he suggested that QE with long term bonds isn’t really monetary policy, as it works by changing risk and maturity, not simply by changing the monetary base.  I think that’s an overly narrow definition of ‘monetary policy,’ but there is no point in quibbling.  But here is what I do claim.  If you go back through the blogosphere and look at Krugman, Delong or indeed most bloggers from six months to a year ago, there were very few echoing my argument that a highly aggressive Fed policy was our best hope.  They weren’t just saying that nothing more can be done within some narrow definition of monetary policy, there were widespread comments that the Federal Reserve System could do no more.  And thus we had to rely on fiscal policy.  So I still say something has changed.  Maybe it is just a change of tone or rhetoric, not deep theoretical beliefs.  But words matter.  And this change makes me a bit more optimistic.

• Become A Funded Futures Trader