Monday, March 14, 2011

Note to Paul Krugman: Just Because a Number is Small, Doesn't Mean It's Zero

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.

He then shows a chart of the Effective Federal Funds Rate:

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 notthing 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.

1 comment:

  1. Plotting the interest rate on a log scale makes much much more sense.