Good friend Srinivas Varadarajan of Mount Nathan Capital Management sent me the links to Larry Summers’ speech at the IMF Economic Forum on November 8 and two Krugman articles – one written before Summers’ speech and one after. I could not read the articles because I had exhausted my quota of ten free articles in New York Times for November. My friend kindly sent me the text of the articles. I read the Krugman articles and have not listened to the speech. At least not yet.
A quick summary of his articles is this:
Krugman would like to assign the task of containing bubbles in asset prices to regulatory policies and that monetary policy should focus on full employment and price stability. The implicit objection, perhaps, is that monetary policy is too blunt a tool to contain asset price bubbles. It is a different story that the Federal Reserve has neither used its regulatory powers nor monetary policy levers ever to contain bubbles.
As is normal for Krguman, he sets up a strawman to knock it down. He engages in polemics and not well-reasoned arguments. Here is a sample:
There are many economic commentators who take rising leverage, asset bubbles and all that as prima facie evidence that monetary policy was too loose; some argue that the Fed kept rates too low for too long after the 2001 recession, some argue that interest rates were too low over the whole period from 1985 to 2007.
The trouble with this line of argument is that if monetary policy is assigned the task of discouraging people from excessive borrowing, it can’t pursue full employment and price stability, which are also worthy goals (as well as being the Fed’s legally binding mandate). Specifically, since the US economy shows no signs of having been overheated on average from 1985 to 2007, the argument that the Fed should nonetheless have set higher rates is an argument that the Fed should have kept the real economy persistently depressed, and unemployment persistently high – and also run the risk of deflation – in order to keep borrowers and lenders from making bad decisions. That’s quite a demand. [Link]
The problem with this line of argument (aren’t we getting tired of repudiating this obvious non-sense?) is that it is not black or white. The Fed not only did not do anything to contain bubbles forming; it actively encouraged the formation of asset bubbles because it believed (and still does believe) in the transmission from asset prices to the real economy.
Second, by not curbing bubbles, did the Federal Reserve really help the cause of stable and full employment?
He argues for a negative real rate of interest and this is his proposed route to getting there:
One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom – whether it’s a bubble or driven by expansionary fiscal policy – to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations. [Link]
The problem with this line of argument – about creating inflation – is that they do not know what they will get. There is no roadmap; there is no precedence. There is full scope for the law of unintended consequences. Hubristic Krguman should become a more humble Krugman. That might not restore economic growth to America but at least restore sanity to policy debates.
One key point that Krugman writes in his piece is this:
So how can you reconcile repeated bubbles with an economy showing no sign of inflationary pressures? Summers’s answer is that we may be an economy that needs bubbles just to achieve something near full employment – that in the absence of bubbles the economy has a negative natural rate of interest. And this hasn’t just been true since the 2008 financial crisis; it has arguably been true, although perhaps with increasing severity, since the 1980s. [Link]
Unintentionally, Krugman might have stumbled on to something here. The world economy ran out of organic forces of growth by the time it entered the 1980s and since then has sustained itself on debt and debt-fuelled bubbles in different parts of the world with increasingly inequitable consequences. What the world experienced in the twentieth century second half was an aberration and not the norm. It was not seen in the first nineteen centuries and hence it is a mistake to presume that such economic growth – seen at best for half a century if not less – is the world’s birthright.
Even if the source of growth shifted to the East, it would not be feasible to achieve what the West did because that growth model is resource intensive (and that is not just about crude oil) and hence unsustainable when bigger and populous countries embrace it. By its sheer nature, it is prone to result in military conflicts too.
Of course, there is another reason why the West would be unwilling to support economic growth in the East – even if the resource intensive model were sustainable – and that is the loss of geopolitical dominance that comes along with loss of economic growth.
What is the answer? There are no easy answers. Unlike PK and LS, one should not pretend to have answers. Acceptance of lower growth is the answer at least until some technology (resource) frontiers are crossed and growth can resume sustainably.
In an article on slowing global trade, FT cites Paul Krugman stating the reasons for global trade slowdown:
Yes, the relationship between trade and GDP was changing as many of the factors that had driven globalisation over the past three decades were “receding in the rear-view mirror”, he said. But that was not necessarily cause for angst. “Ever-growing trade relative to GDP isn’t a natural law, it’s just something that happened to result from the policies and technologies of the past few generations,” he wrote. [Link]
It is a pity that Krugman is unable to link what he wrote about the factors driving globalisation receding into the rear-view mirror with economic growth itself.
Further, it is the ultimate irony that Krugman should write this:
OK, this is still mostly standard, although a lot of people hate, just hate, this kind of logic – they want economics to be a morality play, and they don’t care how many people have to suffer in the process.
It is the policy of stimulus that appears to be an immoral play, as it benefits the rich and the Wall Street at the expense of Main Street, pensioners and old people who live on savings without, at the same time, giving any hope or jobs to the young.
Krugman should listen to the interview that Stanley Druckenmiller gave CNBC on the day the Federal Reserve chose not to taper in September. He should read Andrew Huszar’s article, ‘Confessions of a quantitative easer’.
Krugman concludes his article referring to the final remarks of Larry Summers in his speech. BTW, by the time I finished this blog post, I had finished listening to Larry Summers’ speech. You can find it here.
LS concludes his speech by saying that we should be concerned about a policy agenda that has monetary policy doing doing less with monetary policy than was done before and doing less with fiscal policy than was done before and taking steps whose purpose is to cause to be less lending and borrowing (and less?) inflated asset prices.
Well, I am not quite sure what policy alternative that LS would approve of and one that has no unpleasant, long-lasting and inequitable side-effects. At the very least, those who propose such never-ending stimulus should ring-fence their policies and the macro-economy from financial market speculation.
Capital controls should be back on the agenda. Short-term capital gains should be brought back and pegged at 30% for gains realised within twelve months and the rate of tax should taper to 0.0% only for gains realised after five years. Financial Transaction Tax should be introduced and so should super-normal profits tax. All these revenues should be used to support the bottom of the pyramid that their stimulus policies would not end up supporting in any case.
These modern Keynesians should remember that the original Keynes favoured capital controls as he batted for maximum policy autonomy.
If they do not supplement their stimulus measures – allegedly aimed at full employment – with anti-speculation measures, then they are really batting for the rich and the elite (because they are the only ones who benefit from asset bubbles) and that is an immorality play.
