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Paul Krugman has been busy:

"April 1, 2013, 9:43 am 86 Comments

Very Ernstig People

The FT reports on the lonely life of an austerity skeptic:

Mr Teulings’ CPB let loose with a report in March accusing Dutch politicians of ignoring a consensus among macroeconomists that cutting deficits does much more economic damage than usual during so-called “balance-sheet recessions”, like the current one. Such contractions are driven by consumers and firms trying to pay down heavy debt loads, leaving government as the only actor in the economy still able to spend.
The Dutch government’s inability to acknowledge the damage done by austerity despite mounting evidence is a case of “cognitive dissonance”, Mr Teulings told the Financial Times. He said persisting with the proposed new deficit cuts, on top of planned austerity measures amounting to 8 per cent of GDP over seven years, would hurt consumer confidence.
“There’s different evidence that all fits [the argument] that the costs of austerity are currently higher, because there’s rising unemployment, there’s a financial crisis and we are close to the zero lower bound [on interest rates],” Mr Teulings said. He referred to recent papers by the IMF’s Olivier Blanchard and to work by Larry Summers, Paul de Grauwe and others that has rekindled the debate over the wisdom of austerity across the EU.
Mr Teulings is not the only economist in the Netherlands sceptical of austerity, but he has been the only one with any policy influence. Prominent austerity sceptics at universities and big banks say they have been shut out, not just from government policy-making bodies but from the counsels of political parties on both right and left.
“It’s not only the current government, basically all the sensible political parties have embraced austerity,” said Bas Jacobs, a professor at Erasmus University and austerity-sceptic. That includes the centre-right Liberals and the centre-left Labour party, who form the coalition government, as well as most mainstream opposition parties.

Despite writing about all this stuff for years, I’m still amazed not just by the way policy makers threw basic macroeconomics out the window, but by the absolute unanimity of the turn to austerity. After all, the critics weren’t exactly invisible or inaudible; how could everyone serious be so sure that prominent macroeconomists were all wrong, and bureaucrats with no predictive track record were right?"


"April 1, 2013, 10:17 am 84 Comments

Bond Bubble Brouhaha

Brad DeLong is puzzled by Martin Feldstein’s mental contortions as he tries to come up with a reason to raise interest rates in a depressed economy. So am I. But I’m also puzzled by Feldstein’s underlying economic analysis, in which he treats it as totally obvious that we have a massive bond bubble.
Now, maybe we do have a bond bubble. But the arguments Feldstein uses are one that I thought every sensible economist — a group I thought included Feldstein — had dismissed as bogus years ago. Feldstein writes:

Historically, the real interest rate on ten-year Treasuries has been above 2%; thus, today’s rate is about two percentage points below its historical average. But those historical rates prevailed at times when fiscal deficits and federal government debt were much lower than they are today. With budget deficits that are projected to be 5% of GDP by the end of the coming decade, and a debt/GDP ratio that has roughly doubled in the past five years and is continuing to grow, the real interest rate on Treasuries should be significantly higher than it was in the past.

In the words of Charlie Brown, aauuuggghhh! Why do we have large fiscal deficits? Because of the collapse of private demand, especially housing. The private sector’s financial surplus has surged; government deficits have risen in counterpart through the operation of automatic stabilizers, mainly revenue but also unemployment insurance and other safety-net programs.
This is a situation of weak demand for funds, not strong demand; it’s a situation in which you would expect bond yields to be lower than normal, not higher — and you’d be right.
One consequence of the economy’s weakness is that the Fed is keeping short-term interest rates down at the zero lower bound — and they’re likely to stay there for years to come. Take the CBO’s latest economic projection for unemployment and inflation, and apply a simple Taylor rule. Here’s the path for short-term rates that this implies:

So years of zero rates, and still fairly low rates thereafter; the implied 10-year rate is about 2. And if you believe that the CBO is overly optimistic, as it has been consistently through this crisis, you can justify an even lower rate. So why does Feldstein think that the 10-year rate might go to 5 percent any day now?
The thing is, Feldstein has invented a puzzle — how can rates be so low? — where there really isn’t any puzzle. He then grabs hold of an answer to his imagined puzzle — it must be the quantitative easing! — that assigns vastly more importance to Fed bond purchases than I think can be justified by any evidence I see. And out of all that he manages to conjure up an argument for tightening monetary policy in the face of still-disastrous unemployment.
Bizarre; and not what I expected from Feldstein.
Still, let me say something nice: at least it’s better than the Stockman screed."

"April 1, 2013, 12:54 pm 98 Comments

Financing the Deficit (More Feldstein)

OK, a bit more on the puzzle of people who think there’s an interest rate puzzle. Here’s the picture of what has happened to saving and investment in America in recent years:

The blue line is government saving, roughly speaking (leaving some public investment aside) the public sector surplus or deficit; the red line is the private sector surplus, the difference between private saving and private investment. So yes, the budget deficit has soared — but it’s just offsetting a surge in the private sector surplus.
Now, this is almost an accounting identity, so by itself the figure doesn’t tell you which side is driving the action. But we know the answer to that question from other evidence. For one thing, we know that most of that surge in the private sector surplus reflects the collapse of the housing bubble, and that most of the surge in the public deficit reflected automatic stabilizers. For another, we know that if government deficits were crowding out private spending, we should have seen rising interest rates; what we actually saw was falling rates.
So there isn’t any puzzle here, except the puzzle of people who are puzzled. I really don’t understand how Marty Feldstein can look at these facts and conclude that the only way to explain low interest rates is to imagine that the Fed is imposing massive market distortions."

"April 2, 2013, 11:46 am 16 Comments

One Size Fits None

In today’s Business Insider, Joe Weisenthal reports on Europe’s truly dismal PMIs (survey-based indexes that act as early-warning indicators for official economic data). There’s no doubt at all that the continent is falling deeper into recession, even in the core countries. And reading this news reminds me of something I’ve been meaning to write – namely, that discussions of Europe’s troubles, and the debate over austerity, often suffer from a tendency to blur two somewhat different issues.
One issue – which is the one that gets the most attention – involves the degree of austerity imposed on debtor countries. Clearly, debtor nations have very little choice about going along with the troika’s demands unless they’re willing to abandon the euro – and that’s a line nobody has yet been willing to cross, although Cyprus and the onset of capital controls bring the possibility closer. As for the troika itself, I would argue that enlightened self-interest on their part would call for milder austerity – loosening up by a few percent of GDP would make relatively little difference either to debt dynamics or to the pace of internal devaluation, but could be make or break for the political outlook. But even austerity skeptics would agree that some austerity in these countries is unavoidable; that’s the price of one-size-fits-all monetary policy.
But there’s a separate issue – the status of Europe as a whole. What has happened in Europe is that the peripheral countries have been forced into extreme austerity, but this has not been offset in the core – in fact, core countries have also engaged in austerity measures, albeit not as severe. So the overall result has been a sharp fiscal contraction in Europe – the cyclically adjusted balance is now much tighter than it was before the crisis, even though private-sector demand remains very weak — with no offset from looser monetary policy.
European policy makers seem surprised that this policy mix has led to a double-dip recession, but they have no right to be – it’s exactly what basic macroeconomics would have told you to expect.
And this in turn tells you that the euro is an even more flawed construction than optimum currency area theory might have predicted. OCA emphasized the problem of one size fits all in the face of “asymmetric shocks” – the problem of how countries are supposed to cope if they’re slumping while the rest of the currency area is booming. But it turns out that in times of broad economic weakness this problem is compounded by the asymmetry of the pressures countries face, in which troubled economies are compelled to tighten but less troubled economies feel no need to loosen, so that the overall stance of policy has a strong deflationary bias.
As Matt O’Brien says, this is the same issue countries confronted under the gold standard – a problem they dealt with, eventually, by going off gold.
If European policy makers really want to save the euro, what they should be doing is pushing hard against their system’s deflationary bias. Unfortunately, as far as I can tell they aren’t even willing to acknowledge that the problem exists."

"April 2, 2013, 12:10 pm 10 Comments

Jack-booted Insurance-bringing Thugs

Jonathan Chait and Aaron Carroll both have fun with Elizabeth Cheney‘s bonkers op-ed about how Obamacare will destroy our freedom.
As both note, the stirring quote from Ronald Reagan the younger Vader uses comes from the recording he made for Operation Coffee Cup, a 1961 project organized by the AMA to mobilize doctors’ wives and their friends against the looming horror of Medicare, which would clearly turn American into a totalitarian state.
However, neither Chair nor Carroll mention what seems to me to be an obvious parallel, which is with the whole Hayekian notion that the welfare state sets us on the slippery slope to Stalinism. Yes, I’m aware that defenders of Hayek claim that this wasn’t what he said — but as far as I can tell their argument is very weak, and anyway more or less irrelevant to the role Hayek plays in American political discourse. Even if that isn’t what Hayek meant to say (in which case, what exactly was his point?), it’s the message American conservatives chose to take from his work.
And with Hayek, as with Reagan, the truly amazing thing is that we have people citing as a source of wisdom someone who has been as thoroughly refuted by history as anyone can be. Three generations into the modern welfare state, and western democracies look less Stalinist than ever.
Of course, you can still say that social insurance destroys freedom if you define freedom as the absence of social insurance — which isn’t quite what these guys are doing, but may capture the spirit of the thing."

On with the dance!