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Paul Krugman on Bubbles and Secular Stagflation

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    Paul Krugman, New York Times, November 16, 2013: Secular Stagnation, Coalmines, Bubbles, and Larry Summers

    We haven't talked monetary policy in a while and hopefully Carlitos Bam Bam is still browsing this website for anything interesting. In the above article, Krugman cites a presentation by Larry Summers at the IMF Research Conference that he agrees with. First the basics:

    Basically what Krugman and Summers are saying is that our current economy is driven by a monetary policy that is "de facto constrained" by the zero lower bound on interest rates...and that the natural rate of interest that balances desired savings and investment for full employment is negative. Nothing new here...saving hurts the economy and hurts investment. Worrying about debt and deficits only exasperates the recession...or depression.

    Furthermore, he states that while spending is good, and productive spending is the best, spending on unproductive things is still better than no spending. And while that certainly applies to public spending, it also applies to the private sector...wholly or partially wasteful private sector spending is also beneficial to the economy unless it "stores up trouble for the future." He is specifically targeting corporations that are sitting on trillions of dollars in cash. Again there is nothing new here that many economists haven't already cited.

    Now carry that kind of line of thinking into an analysis of the cyclic bubbles over the past 25 years. While some would argue that loose monetary policies and low interest rates encourage bubbles that will drive up inflation later, it simply has not happened. Quoting Krugman:

    "So how can you reconcile repeated bubbles with an economy showing no sign of inflationary pressures? Summers’s answer is that we may be an economy that needs bubbles just to achieve something near full employment – that in the absence of bubbles the economy has a negative natural rate of interest. And this hasn’t just been true since the 2008 financial crisis; it has arguably been true, although perhaps with increasing severity, since the 1980s."

    He further theorizes that without the successive bubbles, our economy would be stuck in a liquidity trap, and that looking forward to the continuation of current monetary policy, one needs to thinking of the liquidity trap as "the new normal."

    On the topic of secular stagflation, census projections indicate that the population of workers aged 18 to 64 will grow at a very slow annual rate of 0.2 percent between 2015 and 2025...and that translates into slower growth and lower investment demand.

    Krugman further states that "in a liquidity trap saving may be a personal virtue, but it’s a social vice. And in an economy facing secular stagflation, this isn’t just a temporary state of affairs, it’s the norm."

    He concludes with this statement: "If we’re going to have persistently negative real interest rates along with at least somewhat positive overall economic growth, the panic over public debt looks even more foolish than people like me have been saying: servicing the debt in the sense of stabilizing the ratio of debt to GDP has no cost, in fact negative cost."

    There is much more to read in Krugman's article and I recommend it for anyone that likes to think about this stuff in a different way. CBB if you are reading this, I would be interested in the MMT perspective of the Summers/Krugman "radical manifesto."
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    So from what I've read, we won't expect any changes in monetary policy next year with the new Fed Chair Yellen. Hence the Fed's quantitative easing policy will continue well into 2014 and maybe longer. And the more bonds the Fed buys, the more they have to unload at some point when the economy gets better...measured by a sustained uptick in GDP. But what further changes in the Fed's monetary policy would make the GDP go up? Nothing. Corporations are not going to start spending their cash reserves in the USA without tax concessions.

    I don't see any changes in fiscal policy, e.g. increased government spending, with this Congress. So maybe the only thing left is cuts in taxes. But that won't happen with this Congress without Democrats also giving in to cutting spending.

    Looks like the liquidity trap and slow growth will continue...for a long time.
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    Negative interest rates would be like a tax on all deposits.

    And it doesn't mean that borrowers at private banks would be borrowing at negative rates, and it doesn't do away with credit risks.

    Moreover, this all comes from fixed exchange thinking and loanable funds. We don't have fixed exchange and loans made in the banking system create deposits in the banking system.

    So it's all insanity.

    And yes, what we need is a big fat government spending increase or tax cuts.
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    Every single credit expansion or "credit bubble" we've experienced has had a significant fraudulent-criminal leg to it.

    Reagan had the S&Ls. Clinton had the dotcom boiler rooms and LTCM. Bush II had the Enron accounting scandal in his first term and then the trifecta of liar's loans, appraisal fraud, and fraudulent reps and warranties all blow up in his second.

    So maybe it's kind of hard to have or sustain a bubble without fraud?

    Japan's been trying to re-inflate for 20 years with monetary stimulus. The FED's been trying with all its might for the last 5 years. Maybe it's kind of hard to jump start lending via monetary policy?
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    CBB -- I'm inclined to agree. Monetary policy is being implemented as a last resort because our Congress is incapable of implementing a fiscal policy. Once the effects of the 2009 stimulus ran its course, the economy has been in a slow walk. The Fed's low interest rates and quantitative easing have not had the desired effect. We need a massive jobs act to repair our infrastructure and stimulate the economy, but instead all we get is sequestration and paranoia about debt.

    Well a metro train derailed in New York City today...perhaps as a result of our failing infrastructure again. But who cares...until Obama leaves office and Republicans are back in control, they will not consent to any kind of a jobs act...or even a farm bill with food stamps. Nothing. In the meantime our infrastructure is crumbling. Another thing to blame on Obama. And Americans have no clue.
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    Yes, the deficit got big enough to support a modest recovery. Then they went to chomping at it with pro-active measures (spending cuts + tax increases), instead of letting the deficit wind down from new revenues due to economic growth.

    The stabilizers work in both directions. When the economy is cold, they catch it from from free fall, and when the economy heats up, they cut off the expansion. One of the reasons why we have a recession/financial crisis every 7 years.

    If they had just left things alone, we might have had a nice, respectable expansion. And if they had done what MMT'ers have been calling for, e.g. payroll tax cuts, job guarantee, federal infrastructure spending, etc. we could have launched an era of unimaginable prosperity.

    The problem is the space between our ears.