Paul Krugman

Paul Krugman has written two interesting comments (here and here) on my recent “Keynesian Yellen versus Wicksellian BIS” blog. Paul says that the Bank for International Settlements should not be labelled “Wicksellian”, and then asks a typically insightful question: what constitutes “artificially” high asset prices? Some of the discussion below on this point may seem a bit arcane, but in fact it could prove highly relevant for investors.

The crux of the matter is Knut Wicksell’s definition of the (unobservable) natural rate of interest, and its difference from the actual interest rate, as set by the central banks [1]. Krugman says that the Wicksellian or natural interest rate is that which would produce equilibrium between savings and capital investment in the real economy (“full employment”), and therefore leads to stable inflation. If the central banks set the actual rate below the natural rate, inflation will rise, and vice versa.

Since US inflation has generally been stable or falling for years, Krugman infers that the Federal Reserve must have been setting the actual interest rate at about the right level, or even too high (because of the zero lower bound). The further implication is that if current low interest rates are justified, so too are the high asset prices that they have triggered. In that sense, they are not “artificial” [2]. Read more

Global trade growth has stopped. Gavyn argues that this undermines global GDP growth, but The New York Times’s Paul Krugman disagrees. Mr Davies replies to Mr Krugman’s points in an interview with John Authers:

Keynes

Keynes – image by Getty

The exact nature and effects of economic uncertainty are subjects which have played a central role in macroeconomic theory for several decades, especially in the work of Keynes and his followers. Uncertainty, as defined by Keynes, is thought by many to be capable of explaining all of the key events of the past five years, including the intractability of the recession in the developed economies. More unexpectedly, the concept has started to play a starring role in the US presidential campaign, though in a very different context from anything contemplated by Keynes.

When I first studied Keynesian macroeconomics in the early 1970s, Keynes’ thoughts on the nature of uncertainty, which appear most famously in Chapter 12 of the General Theory, were not thought central to his analysis of the Great Depression, or for his policy prescriptions. The writings of Paul Davidson changed that perspective in the 1980s, but the subject was still mostly viewed as a special topic for rather obscure debates among post-Keynesian theorists. None of this had mass appeal until the crash of 2008, and the work of Robert Skidelsky in 2009. Read more

How rapidly should governments correct their fiscal deficits, which in the long run are unsustainable in the US, UK, Japan and many countries in the eurozone?

That is a question which continues to dominate the policy debate among economists. Rapid correction undoubtedly damages near term economic growth, but is intended to reduce the risk of a sovereign debt crisis coming suddenly out of the blue. Slow correction does the opposite. There is no theoretically “correct” policy on this. The result depends on how the near term loss of output should be weighed against the risk and consequences of a fiscal crisis, which is an empirical matter. (See this earlier blog: Assessing the risk of a financial crisis, which attempts to measure the risk of fiscal crisis.)

It is possible for reasonable economists to disagree about this, and for the “right” policy to be different in different countries. However, occasionally a piece of research comes along which changes the “dial” on the debate, and I believe that applies to the important Brookings Paper published last week by Brad DeLong and Larry Summers. This paper, which is well summarised here and here, essentially implies that the trade-off between near-term GDP growth and the probability of fiscal crisis can be irrelevant, because temporary fiscal expansions, at a time when interest rates are at the zero bound, are eventually self-financing.  Read more