Economist Noah Smith has a recent blog post in which he looks at Paul Krugman’s predictive powers the past few years, and specifically why he has been right and the Austrians / gold bugs / faux conservatives have gotten it wrong with respect to interest rates, inflation, etc.
While Krugman likes to credit the IS/LM model, Smith writes that it’s something else, since the model is more about guiding policy and is not meant to forecast what the reaction of the economy will be to policies like QE2. So, despite his own appeals, Krugman is not getting it right because he uses one of the basic Keynesian models. No, Smith says, it’s actually because Krugman understands the dynamics taking place in Japan over the past 20+ years, and sees that the US very much resembles it in the period following 2008. Therefore, despite huge QE measures and higher levels of debt, inflation simply is not going to get traction.
Of course, you know I disagree.
First off, the claim about inflation is only part of what the contra-Krugman contingent represents. It also very much believes that the QE measures and fiscal steps will not generate growth. And, so far, they’ve been right. Krugman, even though he always like to hedge by saying that what has been done is not enough (how convenient), is supportive nonetheless of these policies as steps in the right direction.
The second part, about inflation, is a different beast. Yes, part of the narrative is that interest rates will ultimately rise, but another and larger consideration for the counter-position is that easy money policies engender bubbles that ultimately have to burst. So, while the CPI tells us that inflation is nowhere near out of control, it sure does strike me as inflation when I look at the stock market (despite weak underlying fundamentals), or see how frothy things are getting in the multi-family space (where I play on a regular basis). The “trolls”, as Smith describes them, think that sustainable recovery is not possible in a manipulated economy where the Fed keeps rates low, and that the ultimate consequence is more pain.
(Side-point: Krugman and others like to point to interest rates as a measure of something, but seem to ignore how rates are where they are because of interventions – or are we to believe that rates would be even lower without these policy steps. After all, they don’t think rates should be raised, so are they suggesting that rates would go up or down without the QEs?)
When and where inflation comes cannot be predicted in advance, but by the measure of food and energy prices, it has gone up. In terms of financial assets, it has gone up (something you did not see in Japan, given that Mr. Smith thinks it is such an apt comparison). In addition, we know that the social dynamics in Japan are far different. Higher levels of savings, a Central Bank that generally reverts to a deflationary stance when things start to heat up, very few foreign creditors – none of which are the case in the U.S. I would also point out that the BOJ has finally started to act more like the Fed recently. And what have we seen? Much greater volatility in JGBs, a surging Nikkei, and a much depreciated currency.
Hmmm.
