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.

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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.”

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