Friday, March 25, 2011

Krugman Retreats, Again!!!

Paul Krugman is out with another big, fat, juicy, post that has a lot of meat on it that needs to be chewed up, but that will have to wait until tomorrow. But I do want to note, now, another, important retreat Krugman has made in the post.

Earlier this month, I critiqued him for saying  that interest rates were at zero bound:

Paul Krugman probably makes more economic errors per reach of population than any economist alive. It's a big number, but even small numbers have meaning. This is something that Krugman can't seem to understand. He writes in a post today that:

... we’ve been at the ZLB [Interest Rate Zero Lower Bound] for two and a half years now
Admittedly, the Fed Funds rate has dropped dramatically. As of Friday, it was at 0.13%. This is low, but it ain't zero. In fact, the one month yield on Treasury bills is much lower at 0.07%.

If the Fed wanted to be accomodative on this end of the interest rate curve, it would have to drop the effective fed funds rates below the one month Treasury bill rate of 0.07%. (Note: Further out on the interest rate curve the Fed is somewhat accomodative via QE2).

Thus, the current short-tern interest rate situation has nothing to do with zero or a zero bound. We are at a low number, but we are not at a 0.00% interest rate.

The danger in Krugman promoting his zero bound thesis is that it has profound policy implications. In Krugman's mind, he is able to call for more fiscal policy spending because "interest rates are at zero and the Fed can't do anything more," when, in fact, the Fed isn't even accomodative on this end of the interest rate spectrum with the Fed funds rate above the Treasury bill rate. The Fed shouldn't be manipulating interest rates at all, but for Krugman to be charging that the Fed is at the zero bound, simply doesn't match the facts and distorts a true understanding of the current economic situation. A small number is not zero, and it will never be so.
Just to be clear, when Krugman says Zero Rate Bound, he does mean that rates can't go lower. Here I also called him on it last July:
Paul Krugman is out today with a seriously incorrect economic observation. Discussing the current interest rate policy, he writes:

When short-term interest rates are up against the zero lower bound...short rates can go up, but not down.
This promotes the idea that the Fed is near the zero bound and that they can't lower rates any further. It also promotes the idea that the Fed is currently maintaining an easy money policy. Interest rates are very low, but they are not at the zero lower bound and the Fed is conducting a very tight money policy, not the reverse.

The effective Fed Funds rate is at 0.18%, which is much higher than the current 1-month T-Bill rate of 0.015%.
It looks like he has finally gotten part of the message. Check out what he writes in his post today. The concept of Zero Rate Bound is gone and replaced with, "roughly zero":
The key thing to remember is that current conditions — lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate...
Actually, he is even wrong here. "Roughly zero" is inaccurate. If the Fed dropped its rates to zero (especially its rate on excess reserves) money would likely flow out of excess reserves by, literally, hundreds of billions.  It would have a mind boggling inflationary impact on the economy. There is nothing "roughly" about current rates. Zero rate would have a  far different impact from the current low rates.  Prices are relative, including interest rates. Krugman doesn't seem to get this.

A car priced at $30,000 and one priced at $30,100 are "roughly" the same price, relatively speaking. A candy bar priced at $1.00 and one priced at $101.00 are not "roughly" the same price, relatively speaking. When the Fed Funds rate, and the rate on excess reserves are near the one month Treasury Bill rate, nothing is at zero, relatively speaking, If the Treasury bill rate was at 13% and Fed Funds were at 0.15%, we might say that the Fed Funds rate is "roughly zero", but not when market rates are in the same general facility. It's all relative.

Maybe Krugman will figure this out down the road, but it is good to see him retreating on his absurd claim that interest rates are at the zero bound. A zero bound world would be an entirely different world.

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