Power & Market

Krugman's Magic Bank Recapitalization

01/24/2018Jeff Deist

Paul Krugman's latest missive in the New York Times is a nice example of his two recurrent themes, namely self-regard and world-weariness.

Ostensibly, the piece is about economists who in Krugman's view incorrectly predicted hyperinflation would result from the Fed's aggressive actions following the 2008 Crash. His primary target is Marvin Goodfriend, nominated by Trump to serve on the Fed board and guilty of what Krugman calls "inflation derp." But all "right-wing" economists earn his ire, and even some non-economists like Glen Beck, Ron Paul— whom he labels "frothing at the mouth Austrian types predicting hyperinflation."

Why this durability of unrepentant, unprofessional derp? Surely at least part of it is political: predicting doom from money-printing appeals to powerful forces on the right, is indeed a sort of credential that guarantees favor, no matter how wrong the prediction. And let’s face it: the economics profession is essentially craven on such matters. There are no costs to unprofessional behavior that serves right-wing ideology; you’ll still get invited to all the meetings, get treated with respect, even get letters from liberal and moderate colleagues supporting your nomination to high office.

It strains credibility to imagine that being openly "right-wing" benefits economists professionally, particularly academic economists. But I suppose his point is that Trump by his very nature can't help but nominate know-nothings to the central bank, people lacking Krugman's foresight that creating trillions in new bank reserves would create no problems whatsoever for the US economy (and that we can know this, definitively, after just a decade even though most of those reserves remained parked at commercial bank accounts at the Fed). And it's fair to call out the strong tendency of presidential administrations to appoint central bankers who are politically aligned (so much for Fed independence). 

But in the case of hyperinflation derp, those know-nothings even include seemingly unassailable luminaries from the world of central banking and academia:

But there were also the seemingly respectable monetary “experts,” from Alan Greenspan to Allan Meltzer to John Taylor, who kept predicting high inflation from deficits and/or quantitative easing.

So do the scare quotes indicate Krugman thinks Alan Greenspan is not a monetary expert? That seems a remarkable stretch, even if one disagrees with Greenspan's policies or actions as Fed Chair. But Krugman undoubtedly hates Greenspan's connection to Ayn Rand and  his free-market attitudes on gold, taxes, and the like. 

Krugman takes pains to point out his own prediction that a few trillions dollars of new bank reserves, decided by Fed and Treasury Department fiat, would not create inflation:

Of course, quite a few economists did understand all that: Ben Bernanke, Olivier Blanchard, and yours truly, among others. And we correctly predicted that the massive rise in the monetary base would have no discernible effect on inflation...

OK, so some economists got it wrong. That happens to everyone, unless you’re too cowardly to make any testable predictions at all. But what you’re supposed to do when things don’t play out as you predicted is (a) acknowledge the mistake (b) try to understand what went wrong (c) revise your framework in an attempt to avoid making the same mistake again. I think I can fairly claim to have followed these rules.

There are some remarkable claims embedded in these few sentences.

First, that Krugman was right about inflation. While there clearly has not been hyperinflation, there is damaging price inflation in the US today— especially in food (including restaurant meals), health care, and housing. And of course we might argue there is dramatic inflation in equity prices, where stock market indices have risen radically faster than any real gains in productivity across the economy. Perhaps most importantly, the US dollar lost a whopping 12% of its value against a weighted basket of other currencies just in 2017. Combine these red flags with the aforementioned comment that we are only a decade into this radical monetary experiment, and it becomes possible that Mr. Krugman toots his own horn prematurely.

But he also strongly suggests that he, along with a few other nobles, is virtually alone in testing his hypotheses and having the courage to admit mistakes. He "revises his framework" based on facts, damnit, not ideology or animal spirits. Except that Krugman doesn't always do this, as Bob Murphy has explained ad nauseam. Did he apologize or revise anything after being utterly wrong about the Crash of 2008, the biggest economic event of his career? And isn't this constant revising the whole basis of "new economics," discarding old rules and creating new models that must be updated endlessly to reflect new and unforeseen developments? In other words, what virtually all mainstream economists purport to do? Krugman seems to be picking a fight where scarcely none exists, unless he thinks a bunch of a priori Austrians without a single spreadsheet control his profession.

Finally, it's important to understand the extent to which Krugman believes the Fed could simply recapitalize insolvent commercial banks with trillions of newly-created dollars to no ill effect (with his proviso that interest rates sta near zero). That those dollars mostly remain un-deployed in the economy, earning interest from the Fed no less, speaks more to a lack of creditworthy borrowers and real growth than it does to Krugman's insistence that inflation is not a threat. The Fed's balance sheet can unwind, however slowly, although we'll believe it when we see it. But increasing commercial bank reserves gives banks the ability to create more credit and loans. i.e. an increase in the monetary base creates the conditions for banks to increase the money supply. This is inflationary when/if it happens. And yes, the Fed really did simply monetize US debt in the process. Consider this howler from St. Louis Fed President James Bullard in 2010:

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Krugman's belief that QE and the staggering run-up in the Fed's balance sheet was salutary rather than harmful is no more proven than his other (endless) claims and predictions. Before this is over it may rank up there with Greenspan's promise of endless growth and Fukuyama's claims that history had ended. 

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