Paul Krugman has long advocated negative real interest rates for Japan. He is now also advocating that policy for the US.
The idea that it would be good if we could raise expected inflation comes straight out of this minimalist framework: the economy “wants” a negative real interest rate, and the only way to get that given the zero lower bound is to have positive expected inflation.
The case for fiscal expansion also comes out of this fairly straightforwardly: if you can’t raise employment by cutting interest rates, deficit spending — which doesn’t crowd out private spending when the interest rate doesn’t change — becomes a way to put unemployed resources to work.
The point is that I’m not making it up as I go along; I have a consistent view here, which yields unorthodox conclusions right now only because we’re in an unusual situation.
His analysis is based on this model.
While I don’t agree with Krugman – he has been consistent on this issue for a long time, albeit in the context of Japan. What he is really doing is advocating another bubble.
The problem with this type of argument is that inflation distorts the economy leading to a boom-bust economic cycle. Roger Garrison has a nice little model to explain how that happens. He shows the market loanable funds, interacting with a production possibility frontier leading into a Hayekian triangle.
Full employment is indicated by the locus of this economy on its production possibilities frontier. The particular location on the frontier is determined by the loanable-funds market, in which the rate of interest reflects the saving preferences of market participants. The corresponding consumption preferences are accommodated by the output of the final stage of production in the Hayekian triangle. Resources are being allocated among the stages of production on the basis of the cost of investment funds, such that the rate of return in the real sector, as reflected in the slope of the triangle’s hypotenuse, corresponds to the rate of return in the financial sector, as depicted by the market-clearing interest rate in the loanable-funds market.
All good. But what happens if a policy induced inflation occurs?
(Source)
The trouble starts in the market for loanable funds. While the authorities have engineered a decrease in the interest rate, the time preference of consumers hasn’t changed and conflicting signals are sent from that market through the production possibility frontier and onto the Hayekian triangle. These conflicting signals mean that consumers save less and attempt to consume more, while producers attempt to investment more into longer-term more risky projects. The credit expansion masks the credit shortage but does not overcome the problem.
The double disequilibrium in the loanable-funds market has as its counterpart the two limiting points on the production possibilities frontier. Saving less means consuming more. But with a falsified interest rate, consumers and investors are engaged in a tug-of-war. If, given the low rate or return on savings, the choices of consumers were to carry the day, the economy would move counterclockwise along the frontier to the consumers’ limiting point. Similarly, if, with artificially cheap credit, the decisions of investors were to carry the day, the economy would move clockwise along the frontier to the investors’ limiting point. Of course, neither set of participants in this tug-of-war is wholly victorious.
As we know, it always ends in tears.
The time-discount effect, which is strongest in the early stages, attracts resources to long-term projects. Low interest rates stimulate the creation of durable capital goods, product development, and other activities whose ultimate payoff is in the distant future. The excessive allocations to long-term projects are called “malinvestment” in the Austrian literature. The derived-demand effect, which is strongest in the late stages, draws resources in the opposite direction so as to satisfy the increased demand for consumer goods. The Hayekian triangle is being pulled at both ends against the middle.
As and when the inflation stops all those misallocated resources are released and boom turns to bust.
So this has been a long story – what Krugman needs is a story about what happens next. How would he prevent boom from becoming bust? Inflation can only defer economic problems into the future, it cannot solve economic problems.
(HT: Steve Horwitz)
This is truly one of the more foolish comments amongst many.
It doesn’t create another bubble .
it attempts to get the US economy moving.
you might note on interest rates Greg Mankiw agrees on where interest rates should be on the Mankiw version of the Taylor rule.
Only sinkers get get a bubble when the US is trying to gain a broad based recovery.
no wonder he believes 6% equals 18%!
oh yeah we have at present deflation in the US.
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 10:40 am
No Homer, you’re assuming that Taylor implictly infers that negative real interest rates are good. This is predicated on maxmimising short term GDP. This is not the purpose of the Taylor rule.
The US has negative short term rates.
They also have inflation, not deflation:
http://www.inflationdata.com/inflation/Inflation_Rate/CurrentInflation.asp
Deflation was persistent through 2009 but it was also genrally small.
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24 Aug 10 at 10:58 am
A nuanced reading of this paper would reject such a monetary policy:
http://www.economics.harvard.edu/faculty/mankiw/files/mp90-2.pdf
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24 Aug 10 at 11:01 am
at present the inflation rate as measured by the trimmed median or mean is either 0.2 or 0.5% on an annual basis.
the CPI OVERSTATES inflation by around 0.7% so the US actually is experiencing DEFLATION.
Try reading a bit on the subject!
Only Sinkers could ask what does Krugman advocate coming next.
Try looking down a couple of articles!!!
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 12:00 pm
“the CPI OVERSTATES inflation by around 0.7%”
Even if you’re right about this, they are still not in a deflationary period.
“at present the inflation rate as measured by the trimmed median or mean is either 0.2 or 0.5% on an annual basis.”
Right. How much data manipulation are you going to use?
Actually the current CPI inflation for the US is 1.24.
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24 Aug 10 at 12:06 pm
we do not use the headline CPI rate here because the trimmed mean or median is a much better measure!
People have examined the problems of how much the CPI overstates inflation and indeed produce trimmed mean and median results each month.
please keep up
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 12:10 pm
If you’re not using a certain measure, why then are you adjusting the new one with an adjustment for one you’re not using?
Shameful dishionesty, that’s why.
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24 Aug 10 at 12:13 pm
Only sinkers get get a bubble when the US is trying to gain a broad based recovery.
You don;’t think there’s a bubble developing in bonds?
JC
24 Aug 10 at 12:18 pm
Marky,
you do not understand how the trimmed estimates are made.
just for.
Since last October, the consumer price index (CPI) has gone up an annualized 0.7 percent. On an ex-food and energy basis, the number is a little lower, at 0.5 percent. And the Cleveland Fed’s trimmed-mean and median CPIs, at 0.7 percent and 0.2 percent, respectively, also put the recent trend in consumer prices in pretty low territory.
And this is before we take into account any potential mismeasurement, or “bias,” in the construction of the CPI.
How big is the CPI’s bias? Well, in 1996, the Social Security Administration commissioned a study on the accuracy of the CPI as a measure of the cost of living. This so-called “Boskin Commission Report” said the CPI was overstated by about 1.1 percentage points per year. The commission identified several sources of potential bias, but about half of the 1.1 percentage points resulted from new products and quality changes that were slow or otherwise imperfectly introduced into the price statistic.
Since that time, the Bureau of Labor Statistics has initiated a number of methodological changes that have reduced the CPI’s mismeasurement. In a 2001 paper, Federal Reserve Board economists David Lebow and Jeremy Rudd put the CPI bias at only about 0.6 percentage points. And again, of this amount, the big share of the bias (about 0.4 percentage points) resulted from the imperfect accounting of new and improved goods.
Now, in an article (available to all in its working paper version) appearing in the latest issue of the American Economic Review, Christian Broda and David Weinstein say the earlier estimates of the new goods/quality bias may be a bit understated. The authors examine prices from the AC Nielsen Homescan database and conclude that between 1996 and 2003, new and improved goods biased the CPI, on average, by about 0.8 percentage points per year. If this estimate is accurate, consumer price increases since last October would actually be around zero, or even slightly negative, once we account for the mismeasurement of the CPI caused by new and improved goods.
But (oh, you just knew there was going to be a “but” in here, right?) the authors also point out that, because new goods are introduced procyclically, this bias tends to be larger during expansions and smaller during recessions. In other words, given the severity of the recession and the modest pace of the recovery, there may not be a whole lot of innovation going on right now in consumer goods. This is a bad thing for consumers, of course, but it would be a good thing for the accuracy of the CPI.
no there isn’t a bubble in bonds
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 12:22 pm
Homer
Please take the courtesy of attributing text that is not written by you to the correct author. The contrast is as stark as that between Shakespeare and a monkey with a typewriter.
jtfsoon
24 Aug 10 at 12:24 pm
if you cannot recognise it. then you are a bigger idiot than Forrest.
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 12:25 pm
“you do not understand how the trimmed estimates are made”
You don’t understand that it is then dishonest to further adjust them downwards with the alleged adjustment weights for raw CPI.
Halfwit.
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24 Aug 10 at 12:31 pm
Of course WE can recognize it, Homer. However , newbies, people that are not yet attuned to your diction issues and other mental problems may think it’s you writing this stuff.
And think of the writers, even if you’re lifting it off a government website. They would be aghast that anyone could be tricked into thinking it’s you.
Just attribute the stuff, you dolt.
JC
24 Aug 10 at 12:31 pm
if you cannot recognise it. then you are a bigger idiot than Forrest.
Homer is arguably the most lazy and shameful plagiarist alive or dead.
dover_beach
24 Aug 10 at 12:35 pm
Homer
Remember when you were lifting talking points off Krugman?
Remember that?
jtfsoon
24 Aug 10 at 12:36 pm
At least Rog goes to the trouble to mis-attribute observations to somebody who didn’t make them.
C.L.
24 Aug 10 at 12:38 pm
No Statman.
It is always obvious when I quote someone.
Simply because you haven’t read something you should have is no excuse.
Oh dear Snoopy tried that previously and I demolished that was well.
Marky ,
go on tell us what happens in trimmed estimates ,
Then tell us why the CPI overstates inflation.
but then again you made a halfwit of yourself trying to say a large reduction in marginal effects was an increase.
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 12:57 pm
Tell me why you are adjusting down the trimmed estimate with the adjustment for the raw figure?
“but then again you made a halfwit of yourself trying to say a large reduction in marginal effects was an increase.”
No Homer, I never said this, you have verballed me since your utter stupidity on marginal and average effects was pointed out.
Why are you so dishonest?
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24 Aug 10 at 1:06 pm
if you understood both figures it would help.
Marky you clueless fool.
you alleged the marginal effect of the insulation fires rose.
BUT we know there was a stable pattern of fires from insulation over a number of years UNTIL they dropped tenfold.
Yet you claimed the marginal effect rose.
you either lied straight faced or was simply to ignorant to understand marginal analysis properly.give your history it is undoubtedly the latter as we can observe from even this post.
by gingo only a complete imbecile would knowingly mix up gross and net debt as you have
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 1:13 pm
Homer,
Explain why you are adjusting a trimmed (adjusted) figure with an adjustment factor for the raw datum.
If you don’t have a good reason, it is dishonest. You are double counting.
Sorry Homer you showed a poor understanding of marginal and average effects.
Deal with it and answer the above.
“you either lied straight faced or was simply to ignorant to understand marginal analysis properly.give your history it is undoubtedly the latter as we can observe from even this post.”
No, you’re verballing me and reinventing the story.
“by gingo only a complete imbecile would knowingly mix up gross and net debt as you have”
I never did Homer. You did not understand the context to which it was brought up, to show that debt had been issued far beyond what was needed for the stimulus or to hold spending otherwise constant.
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24 Aug 10 at 1:21 pm
I should have thought there is a very respectable case for mild inflation in the US. If the choice is between deflation and inflation then it is not too hard to make. Mild inflation now is not going to store away problems for the future.
pedro
24 Aug 10 at 1:23 pm
pedro – that is what they have. Homer is gilding the lilly.
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24 Aug 10 at 1:27 pm
My reading suggests that what the US has is a real risk of deflation, which would be quite an intractible problem. Sinc is worried that Krugman’s suggestion will lead to a classic Austrian boom. I think I know which is the bigger issue to deal with right now.
pedro
24 Aug 10 at 1:34 pm
They had deflation last year and now don’t.
Also read some of Mankiw’s introduction in his paper. He outlines why “deflation risk” is a half arsed theory, both in terms of antecedants and effects.
Excessive, unpredictable & volatile inflation and deflation are both bad.
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24 Aug 10 at 1:37 pm
Marky simply doesn’t understand either the trimmed vseries nor how the CPI overstates inflation.
They have the LARGEST output gap since the Depression.
Inflation is only in some nutcase’s dreams.
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 2:37 pm
It is quite possible to develop the most elegant models, but do they work in practice?
It is possible to draw up all sorts of historic examples, but are they correctly annalised or if so are they relevant to the present situation?
Has deflation persisted anywhere at any time other than Japan recently?
We do know that adding to the cost of doing business either directly or via regulation, reduces the amount of business being done.
We do know that rushed govt stimulus spending is always extremely wasteful. Even more so than normal government spending.
Has any government’s greatly expanding the money supply ever failed to lead to inflation?
The US and many other governments must default, either directly or via inflation.
Rodney
24 Aug 10 at 2:43 pm
from your source you did not reference:
*this bias tends to be larger during expansions and smaller during recessions. In other words, given the severity of the recession and the modest pace of the recovery, there may not be a whole lot of innovation going on right now in consumer goods. This is a bad thing for consumers, of course, but it would be a good thing for the accuracy of the CPI.*
Twit.
US CPI Inflation for 2010 Jan-Jul
2.63% 2.14% 2.31% 2.24% 2.02% 1.05% 1.24%
If you don’t douible count, there is still small inflation on a trimmed or adjusted basis.
“Inflation is only in some nutcase’s dreams.”
An honest, literate and numerate nutcase.
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24 Aug 10 at 2:45 pm
yes Rodney that happened in Japan and what yield are their bonds again?
Yeah Mark inflation is a huge problem.
the annual inflation lies somewhere between 0.2 and 0.5%.
The overstatement of inflation well and truly eclipses that if you could count.
found out about how they get the trimmed measures yet?
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 2:54 pm
“inflation is a huge problem.”
Not what I said. Is there any chance you WON’T verbal somone you dishonest old coot?
“the annual inflation lies somewhere between 0.2 and 0.5%.
The overstatement of inflation well and truly eclipses that if you could count.”
You’re telling me the US on average has deflation?
Christ you’re an unhinged nut.
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24 Aug 10 at 3:30 pm
No idiot I am saying anyone who thinks the US has a problem with inflation now or in the immediate future as as stupid as you.
There is not now, has not been and will not be for this decade, going on CBO projections, any sort of problem with inflation
Butterfield, Bloomfeld % Bishop
24 Aug 10 at 7:38 pm
“No idiot I am saying anyone who thinks the US has a problem with inflation now or in the immediate future as as stupid as you.”
You prove this by falsely asserting they have deflation now?
Inflation will be a problem in America, as they engage in QE and bond financed deficits have been not supported by investors.
Just as inflation was a problem for Bush after Reagan.
Watch as Homer defends the Obama deficit but then pillories the much smaller Reagan deficit.
The man doesn’t know how to wipe his arse, let alone do economic analysis without Mark Arbib and Karl Bitar telling him how.
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24 Aug 10 at 10:38 pm
Let’s think this through. If we force firms to employ workers beyond where the value of employing a new worker has a negative marginal benefit, surely this would cure unemployment?
Surely negative real interest rates simply alter cost schedules to artificially allow this to happen?
This by definition is an economically damaging policy which simply shifts the deck chairs around.
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25 Aug 10 at 7:46 am
Mark, inflation and negative interest rates have their issues, no question. Chronic deflation is much worse. I believe Hayek recanted his liquidationist views and said that a flood of money was the right response to the depression.
pedro
25 Aug 10 at 8:14 am
I never said we shouldn’t maintain liquidity. The US currently has inflation, even if you adjust the figures down.
Note what Krugman says. He explicitly talks about employment.
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25 Aug 10 at 8:25 am
According to John Williams of shadowstats:
“… The government is effectively bankrupt. Using GAAP accounting principles, the annual deficit is running in the range of $4 trillion to $5 trillion. That’s beyond containment. The government can’t cover it with taxes. They’d still be in deficit if they took 100% of personal income and corporate profits.
They’d also still be in deficit if they cut every penny of government spending except for Social Security and Medicare. Washington lacks the will to slash its social programs severely, to change its approach to ever bigger government.
The only option left going forward is for the government eventually to print the money for the obligations it cannot otherwise cover, which sets up a hyperinflation…”
http://www.marketoracle.co.uk/Article21676.html
Capitalist Piggy
25 Aug 10 at 9:06 am
Marky showing all his madness in gory detail.
the US has the largest output gap since the great Depression.
how in the hell is inflation going to ignite?
By the way Mankiw agrees with Krugman on his version of the Taylor rule and where interest rates should be if they could be ie -8/9%!
Actually you were the fool agreeing with Bitar and Arbib not me. oops!
A big difference between now ans then.
Its called a liquidity trap. Reagan’s largest deficit occurred in very strong economic growth.
Oh by the way just where were interest rates and where did they fall to?
Marky caught out again not having a clue!
Butterfield, Bloomfeld % Bishop
25 Aug 10 at 9:44 am
“the US has the largest output gap since the great Depression.
how in the hell is inflation going to ignite?”
They have inflation. I never said it was going to explode. Can you respond to a comment without verballing someone and lying your arse off?
“Mankiw agrees with Krugman on his version of the Taylor rule and where interest rates should be if they could be ie -8/9%!”
No he doesn’t you halfwit. You looked at a single graph and came to a conclusion you halfwit. Taylor doesn’t agree either. What Mankiw says is that stability matters and that policymakers looked like they followed something like a Taylor rule.
HE NEVER ADVOCATES NEGATIVE REAL INTEREST RATES.
“Actually you were the fool agreeing with Bitar and Arbib not me. oops!”
Sure Homer. Kevin could have won the election with a record slump in the polls.
“Its called a liquidity trap.”
Bullshit, they have low to moderate inflation.
“caught out again not having a clue!”
I’ve quoted CPI figures, which if adjusted, still show inflation.
You’re just flat out lying.
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25 Aug 10 at 10:16 am
Marky , go and look at mankiw’s blog before making another example of being shown for the fol you are.
Yeah Rudd was disposed when the ALP has 52% of the vote. an easy win.
Can’t read Can’t think
Butterfield, Bloomfeld % Bishop
25 Aug 10 at 10:30 am
Please show us where Mankiw advocates negative real interest rates or otherwise contadicts what I said.
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25 Aug 10 at 10:44 am
Mark,
Mankiw did advocate negative interest rates.
Capitalist Piggy
25 Aug 10 at 11:31 am
I am buying some more gold.
Rodney
25 Aug 10 at 11:34 am
He never said they should be -8%.
Note well:
“The idea of negative interest rates may strike some people as absurd, the concoction of some impractical theorist. Perhaps it is.”
Homer never notes the nuances.
They have short term negative raters around -1% and long term positive rates around +4%.
Such a policy can only ever effect short term rates, unless you propose a long term strategy of permamently lower economic growth, and permamntly downwardly sloping yield curves.
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25 Aug 10 at 11:41 am
Makiw
This scatterplot is from Paul Krugman. x is the core inflation rate minus the unemployment rate. y is the federal funds rate. It uses data from 1988 to 2008.
This graph is motivated by a version of the Taylor rule I once proposed. Paul uses a different sample than I did, so he gets slightly different parameter values. Nonetheless, I think Paul and I agree that this equation provides a reasonable first approximation to what the Fed will and should do in response to macroeconomic conditions.
Mark can’t read and can’t think.
Butterfield, Bloomfeld % Bishop
25 Aug 10 at 12:13 pm
“The idea of negative interest rates may strike some people as absurd, the concoction of some impractical theorist. Perhaps it is.”
Dolt.
Come on Homer. Explain how we get a long term negative rate. They already have short term negative rates and mild inflation.
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25 Aug 10 at 12:25 pm