Topic: Finance, Banking & Monetary Policy

Imaginary Squabbles Part 3: Krugman and DeLong’s Changing Theories and Missing Facts

Responding to a student question after a recent Kansas State debate with Brad DeLong I posed a conceptual puzzle.  I asked students to ponder why textbooks treat Treasury sales of government bonds as a “stimulus” to demand (nominal GDP) in the same sense as Federal Reserve purchases of such bonds.  “Those are very different polices,” I noted; “Why should they have the same effect?”  

The remark was intended to encourage students to probe more deeply into what such metaphors as “stimulating” or “jump starting” really mean, not to accept as dogma that fiscal and monetary policy are equally effective or that economists are certain just how they work.

DeLong’s misinterpretation of my question led him to lecture me that, “if you really do think that monetary expansion undoes fiscal expansion because monetary expansion buys bonds and fiscal expansion sells bonds, you need to educate yourself.” Citing that wholly imaginary rewriting of my question, Paul Krugman wrote, “My heart goes out to Brad DeLong, who debated Alan Reynolds and discovered that his opponent really doesn’t understand at all how either fiscal or monetary policy work.”

Did I really say that “monetary expansion undoes fiscal expansion”?  Of course not.  If that had been my question, I would have answered myself by saying that piling more debt on the backs of taxpayers is unlikely to stimulate private spending (much less encourage more or better labor and capital) unless the added debt is “monetized” by the Fed and regulators allow banks to lend more to private borrowers.  DeLong made much the same point by saying, “Expansionary monetary policy makes it a sure thing that expansionary fiscal policy is effective by removing the channels for interest-rate and tax crowding out.” 

The Fed’s current bond-buying spree is bound to have some effect, if only to facilitate cheap corporate buybacks of shares and speculative day trading of such stocks on margin.   But selling more government bonds per se (if the Fed won’t buy more) would be just as much an added burden for taxpayers as it would be a benefit to whoever receives the resulting government transfers, contracts or subsidies. 

This make-believe squabble about monetary expansion undoing fiscal expansion exists only in DeLong’s imagination, like my non-prediction of mammoth inflation or Krugman’s non-facts about Ireland’s fiscal frugality.

Imaginary Squabbles Part 2: Krugman and DeLong on Ireland

A short 2010 article of mine in Politico, which still annoys Paul Krugman and Brad DeLong, dealt with Ireland’s brief effort to restrain spending, which (while it lasted) was smarter than imposing uncompetitive tax rates as Greece had done. 

Krugman ridiculed my Politico article in at least four columns.  He imagines I predicted a “boom” in Ireland, because I wrote in June 2010 that, “the Irish economy is showing encouraging signs of recovery.”  That the Irish economy was turning up at the time is undeniable. Although I did not yet have the benefit of real GDP data, Ireland’s GDP was clearly rising before the third quarter of 2010 in this Krugman graph and this one.  What went wrong? Bonds and the economy collapsed after Black Thursday, September 30, when the government wasted millions on a gigantic bailout of Irish banks. My unforgivable blunder was in not predicting on June 9 what was going to happen on September 30.  Mea culpa.

Ironically, Krugman and I agree Ireland should have let the banks fail. We likely agree that is has been foolhardy to enact higher income tax rates in Ireland,  Portugal, Greece, Spain, France and the UK.   Although Krugman wants to label me “an austerian,” I have been rebuking IMF austerity schemes since 1978 for imposing rising tax rates and falling currencies on troubled countries.

There is another important point of agreement between Krugman and I, but only in recent years. In February 2004, I debunked fears that projected budget deficits would raise interest rates in a paper presented at the U.S. Treasury. That paper was largely aimed at Brookings Institution scholars but also at Krugman, who was “terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.”  He has since come around to my view.

What Krugman and I cannot agree about, however, is his fantasy about Ireland’s “harsh spending cuts.” On The Colbert Report last year, for example, Krugman said, “Ireland is Romney economics in practice. They’ve … slashed spending; they’ve had extreme austerity programs.”

As the table below the jump shows, government spending as percent of GDP nearly doubled in Ireland, from 34.3 to 66.8 percent from 2006 and 2010, with bank bailouts after September 2010 pushing the deficit to 31.2 percent of GDP. By Krugman’s definition, Ireland had extremely “stimulative” spending and deficits since 2008. Does it matter that most spending since late 2010 was for bailing out bank creditors? Krugman’s new book says, “not at all: spending creates demand, whatever it’s for.”

Imaginary Squabbles Part 1: Krugman and DeLong on Inflation

Paul Krugman and Berkeley blogger Brad DeLong appear peculiarly agitated about two of the many articles I have written over the past 42 years. The first, from 2009, summarized a longer critique of Krugman’s claim that “liquidity traps” left monetary policy powerless in the U.S. in the 1930s and in Japan since the 1990s. The second, in June 2010, voiced premature optimism about Ireland’s nascent recovery – months before that country wasted a fortune bailing out the banks.

In these cases and others, Krugman and DeLong go to great lengths to put words in my mouth – a proclivity that others have observed.

Krugman writes, “here’s what I find remarkable about Reynolds and people like him: they have a track record. Here’s Reynolds in 2009 ridiculing my claims that we were in a liquidity trap, so that even large increases in the monetary base would not be inflationary. Here he is in 2010 declaring that Ireland’s embrace of harsh spending cuts will produce an economic boom… . And here we are in 2013, with the Fed’s balance sheet up by more than 200 percent and no inflation, with Ireland still mired in a deep slump …”

What I find remarkable about Krugman and DeLong is that they provide links to my articles. That makes it easy to discover they are misquoting me egregiously. Let’s focus first on Krugman’s notion that my skepticism about the notion of a “liquidity trap” is tantamount to predicting that large increases in the monetary base (bank reserves and currency) must be wildly inflationary.

Student Loans: From Completely Disastrous, to Just 99 Percent

the state of higher ed fundingOn Thursday, the U.S. House of Representatives is scheduled to take up The Smarter Solutions for Students Act, which would end the practice of Congress designating interest rates for federal student loans, and instead link rates to the 10-year Treasury note. It would be a miniscule improvement. Basically, this change is like banging out a single dent in a car that’s careened off a cliff, rolled over twenty times, and caught fire.

It seems reasonable that if Washington is going to provide student loans, interest rates should be pegged to broader rates. There is disagreement about how much you add to base rates—Rep. George Miller (D-CA), for instance, is unhappy that the act’s rates could result in profits that would be used for deficit reduction—but letting Congress designate set rates is why we are once again scrambling to keep the subsidized loan rate from suddenly leaping to 6.8 percent from 3.4 percent. 

Of course, the root problem is that Congress furnishes student loans at all, killing the natural discipline that comes from people paying for something with their own money, or money they get from others voluntarily. Getting major dough from taxpayers has enabled massive overconsumption of higher education punctuated by dismal completion rates and huge underemployment for those who manage to finish. And giving people cheap money largely just enables colleges to raise their prices at breakneck speeds, often to provide frills that heavily subsidized students seem to happily demand.

Congress may inject a milliliter of sanity into a swimming pool of irrationality, but what it really needs to do is drain the whole thing.

Cross-posted at

The Misery Index: A Look Back at Bulgaria’s Elections

With Bulgaria’s May 12th election fast approaching, it is useful to reflect on past elections and the resulting economic performance of each elected government. To do this, I have developed a Misery Index inspired by the late Prof. Arthur Okun, a distinguished economist who served as an adviser to U.S. President Lyndon Johnson.

The Misery Index measures the level of “misery” in the economy. My modified Misery Index is equal to the inflation rate, plus the bank lending rate, plus the unemployment rate, minus the annual percent change in GDP.

An increase in the Misery Index indicates that things are getting worse: misery is increasing. A decrease in the Misery Index indicates that things are improving: misery is decreasing. The accompanying chart shows the evolution of Bulgaria’s Misery Index over time.  


The Socialist Party government of Prime Minister Zhan Videnov created hyperinflation and a lot of misery. The Misery Index under the Videnov government’s watch peaked at 2138 in the first quarter of 1997. That number isn’t shown on the accompanying chart—if it was, the chart would take up an entire page of Trud.

So, the chart starts in the second quarter of 1997, with the Kostov government. Shortly after Kostov took power, Bulgaria installed a Currency Board System, based on a draft Currency Board Law, which I authored at the request of President Petar Stoyanov. The Currency Board brought an end to Bulgaria’s hyperinflation, which peaked with a monthly inflation rate of 242%, in February 1997.

Dollarize Argentina Now

Argentina is once again wrestling with its long-time enemy, inflation. Now, it appears history may soon repeat itself, as Argentina teeters on the verge of another currency crisis. As of Tuesday morning, the black-market exchange rate for Argentine pesos (ARS) to the U.S. dollar (USD) hit 9.87, meaning the peso’s value now sits 47.3% below the official exchange rate. This yields an implied annual inflation rate of 98.3%. For now, the effects of this elevated inflation rate are being subdued somewhat by Argentina’s massive price control regime. But these price controls are not sustainable in the long term. Indeed, the short-term “lying prices” only distort the economic reality, ultimately leading to scarcity. There is, however, a simple solution to Argentina’s monetary problems: dollarization. I have advocated dollarization in Argentina for over two decades, well before the blow up of their so-called “currency board.” To put the record straight, Argentina did not have a true currency board from 1991 to 2002. Rather, as I anticipated in 1991, the “convertibility system” acted more like a central bank than a currency board. This pegged exchange rate system was bound to fail—and fail, it did. The 2001-02 Argentine Crisis could have easily been avoided if the country had simply dollarized. Argentina had more than sufficient foreign assets to dollarize their economy even late into 2001. But the Argentine government, through a series of policy blunders, ended up “floating” the currency. Not surprisingly, Argentina is now back to where it was in the late 1980s. So, how can Argentina dollarize? In short, the Banco Central de la Republica Argentina (BCRA) would take all of the assets and liabilities on its balance sheet denominated in foreign currency and convert them to U.S. dollars. The Central Bank would then exchange these dollars for all the pesos in circulation (monetary base), at a fixed exchange rate. By my calculation, the BCRA would need at least $56.36 billion to dollarize at the official exchange rate (as of April 23, 2013).

Regulator to the World? Not the SEC…

I don’t often commend regulators, but for those interested in preserving national sovereignty, new SEC chairwomen, Mary Jo White, is off to a good start if yesterday’s New York Times’ editorial is anything to go by. The Times criticized White for approving new SEC derivatives regulations that defer oversight of foreign security-based swap transactions, including those relating to the foreign subsidiaries of U.S. banks, to foreign regulators. The Times also derided White for approving rules that were “weaker” than the similar rules released by the Commodity Futures Trading Association.

Like the CFTC, the Times’ editorial board has clearly not heard of the concept of international comity, which it seems to confuse with “weakness”. In particular, it is not clear why the Times believes that unelected U.S. regulators should have the right to be self-appointed derivatives tsars to the rest of the world. The Times also appears to have overlooked the recent letter, signed by the finance ministers of nine of the United States’ largest trading partners and addressed to their U.S. counterpart Jack Lew. The letter was a thinly-veiled attack on the CFTC’s so called “extra-territorial” application of its cross-border swap rules and noted that an approach “in which jurisdictions require that their own domestic regulatory rules be applied to their firms’ derivatives transactions taking place in broadly equivalent regulatory regimes abroad is not sustainable.”

Of course, the Times does raise one important point: that it is undesirable to have two agencies releasing different rules on what amounts to the same topic. But the arbitrary distinction in the oversight of security-based swaps (regulated by the SEC) and OTC derivatives (regulated by the CFTC) is just one of Dodd-Frank’s many design flaws. Moreover, the SEC is under no obligation, pursuant to Dodd-Frank or otherwise, to follow the CFTC’s approach just because the CFTC released its regulations first. Especially as those regulations have proven to be so contentious (and not just with U.S. banks who legitimately fear being shut of international derivatives markets, but, more importantly, the foreign regulators on whom the U.S. may have to rely in a crisis).

It has become an unwelcome trend for U.S. regulatory agencies to overreach their jurisdictional and geographical boundaries. This began with the IRS’ FATCA implementation and has continued in the financial regulatory space. That White does not wish to follow her CFTC counterpart, Gary Gensler, down the rabbit hole and alienate the U.S.’s trading partners and allies is commendable, even if the Times is disappointed.