In addition to his regularly scheduled left-wing agitprop, Krugman has been cranking out a number of blog posts claiming vindication over those commentators who predicted that runaway deficits and money-creation would lead, eventually, to higher interest rates and high inflation. Over the weekend, he posted the latest in this series:
So, how has it turned out? The 10-year bond rate is about 2.5 percent, lower than it was when Ferguson made that prediction. Inflation keeps falling. The attacks on Keynesianism now come down to “but unemployment has stayed high!” which proves nothing — especially because if you took a Keynesian view seriously, it suggested even given what we knew in early 2009 that the stimulus was much too small to restore full employment.
The point is that recent events have actually amounted to a fairly clear test of Keynesian versus classical economics — and Keynesian economics won, hands down.
I have a problem with Krugman’s victory laps. Having just completed a fairly extensive review of Krugman’s commentary for my cover story in the latest NRODT, I am familiar with the fact that Krugman spent the better part of the early aughts predicting that the Bush tax cuts would cause interest rates to spike. Here are a few examples:
“Eleven and Counting” (December 14, 2001): Has the sudden return of federal deficits had an impact on long-term interest rates? Of course it has. Just a few months ago everyone expected the federal government to pay off its debt, drastically reducing the supply of bonds; now it turns out that it will actually be borrowing money. Inevitably this depresses bond prices, which is the same as raising long-term interest rates. [10-year rates, then around 5 percent, proceeded to collapse, hitting 3.1 percent by June of 2003]
“A Fiscal Train Wreck” (March 11, 2003): How will the train wreck play itself out? … my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. [Krugman now laughs at similar predictions.]
And as that temptation becomes obvious, interest rates will soar. It won’t happen right away. With the economy stalling and the stock market plunging, short-term rates are probably headed down, not up, in the next few months, and mortgage rates may not have hit bottom yet. But unless we slide into Japanese-style deflation, there are much higher interest rates in our future. [We did not slide into deflation, yet we did not experience much higher interest rates.]
I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared — the ultra-establishment Committee for Economic Development now warns that ‘’a fiscal crisis threatens our future standard of living’’ — investors still can’t believe that the leaders of the United States are acting like the rulers of a banana republic. But I’ve done the math, and reached my own conclusions — and I’ve locked in my rate. [Note that Krugman's "cognitive dissonance" explanation is very similar to the "bond bubble" explanation for why recent deficits have not led to higher rates; this hasn't stopped Krugman from mocking the latter.]
“Questions of Interest” (April 20, 2004): My calculations keep leading me to a 10-year bond rate of 7 percent, and a mortgage rate of 8.5 percent — with a substantial possibility that the numbers will be even higher. … As I’ve pointed out before, the twin U.S. budget and trade deficits would set alarm bells ringing if we were a third world country. For now, America gets the benefit of the doubt, but if financial markets decide that we have turned into a banana republic, the sky’s the limit for interest rates. [10-year rates never rose above 5.2 during the Bush years; mortgage rates hovered around 6.5 at their high point.]
“CSI: Trade Deficit” (April 24, 2006): Of course, optimists have a comeback: if things are really that bad, why are so many foreign investors still buying U.S. bonds? And they point out that those predicting problems from the trade deficit have been wrong so far. But I have two words for those who place their faith in the judgment of investors, and believe that a few good years are enough to prove the skeptics wrong: Nasdaq 5,000. [This isn't just similar to the "bond bubble" explanation that Krugman has been ridiculing lately. This is the bond bubble explanation, used here to explain why the interest-rate spike Krugman predicted in the early aughts never came about.]
As I wrote in my piece:
Then there is his bald inconsistency. In 2002, the disappearance of the projected surplus and the sudden appearance of chronic deficits led him to wonder, quite sensibly, “What happens [when foreign creditors] lose their enthusiasm” for financing our deficits? But these days, when policymakers tremble at the truly staggering size of the deficit, Krugman mocks them for worrying about “invisible bond vigilantes.” The bond vigilantes were also invisible in 2002, when Krugman feared them. All that has changed is the size of the deficit: It has gotten much, much larger. Krugman’s justification for his inconsistency is that things are different now: Interest rates will stay low because creditors will continue to view U.S. Treasuries as a safe haven in uncertain times. But that’s an awfully big assumption for policymakers to rely upon. They have responsibility for the solvency of the U.S. government. Krugman has a newspaper column.
The moral of the story is that economic models don’t always capture everything that is going on in the world. Liquidity trap or no liquidity trap, interest rates did creep up in late 2009 after the size of our future deficits started to register. But then a newly elected government in Greece announced that previous governments had used accounting trickery to understate the Greek budget deficit as a percentage of GDP by a factor of four and, in everything that followed, the flight to safety resumed. As for inflation, I have already noted that Krugman is being extremely unfair to economists such as Allan Meltzer, whose inflation warnings came with caveats. Just as Krugman was arguing, in the early aughts, that the Bush deficits created the conditions for a fiscal crisis (without predicting that such a crisis would happen immediately), Meltzer et al have argued that the actions of the Federal Reserve have created the conditions for runaway inflation. (“When will it come? Surely not right away. But sooner or later …” etc.)
My problem is that when Krugman’s prognostications don’t come true, he’s quick to find some excuse, some unforeseen event, that explains why — he’s even gone to the “investor irrationality” well a time or two. But when other people’s predictions are wrong (or slow to materialize), it is their model that’s flawed, and only blind adherence to ideology can explain why they refuse to see the error of their ways. Hypocrisy is one word that comes to mind. Projection is another. Krugman is a very good economist who decided to transition mid-career into a very bad opinion writer. His transition shows up as a debit on both sides of the ledger.