Tuesday, April 6, 2010

Krugman and his "Bubblicious" Advice

Poor Paul Krugman is on the defensive again. The "haters" are out there, and they are accusing him of promoting a housing bubble. Krugman, of course, is innocent of such bad conduct. He gives only good advice.

Since Krugman's latest crusade has been "financial reform," some people are reminding the Great Man of some words he wrote in 2002 when he was predicting a double-dip recession. Here is the controversial "bubble" paragraph:
The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.
I tend to agree with Krugman that he was not promoting such a bubble, but rather was saying that the only way to ratchet up the kind of spending that Keynesians believed would end the recession was for Greenspan to create a housing boom. However, the next paragraph demonstrates that even Krugman did not realize that a bubble really was possible:
Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off. But the Fed chairman's crystal ball has been cloudy lately; remember how he urged Congress to cut taxes to head off the risk of excessive budget surpluses? And a sober look at recent data is not encouraging.
Interestingly, Krugman attacks Bush for pushing a tax-rate cut even though one of the Keynesian "solutions" to a recession is for government to cut taxes. Well, I guess Keynesians are happy only when the proper political party does the cutting.

Unfortunately, Krugman really gets it wrong when he denies that the Federal Reserve System's practice of holding down interest rates to artificially-low levels was foolish policy. Again, Krugman in his own words:
But did I call for low interest rates? Yes. In my view, that’s not what the Fed did wrong. We needed better regulation to curb the bubble — not a policy that sacrificed output and employment in order to limit irrational exuberance.
Here is the problem. The housing boom occurred not only because the government shoved interest rates down to ridiculously-low levels, but also because the government aggressively promoted policies of home ownership. Greenspan himself was pushing the kinds of interest-only, teaser-rate mortgages that ultimately exploded and triggered a wave of foreclosures.

The only kind of regulation that would have kept the housing bubble from happening was the regulation that violated the government's stated policies of promoting home ownership, not to mention dealing with the demands from the political Left that people be able to have "affordable housing." How Krugman thinks that we could have had effective regulation in this situation is beyond me.

Unfortunately, Krugman really is not capable of a serious thought when it comes to regulation. Instead, he depends upon the politically-infantile "Democrats are good regulators, Republicans don't believe in Regulation" nonsense. Economists such as the late George Stigler, Sam Pelzman, Robert Tollison, Gary Becker, and Bruce Yandle actually have done real work in regulation, and they approach the subject like adults.


Anonymous said...

Keeping interest rates artificially low while regulating the "use" of the money is like doling out heroin but hoping to control its use and at the same time complaining that people don't pay enough attention to what they eat. What Keynesians don't seem to get is that interest rates are prices just as other prices and who manipulates the prices of tyres, bread or houses inevitably gets the same distortions as anywhere else only that interest rates due to the general function of money as a unit of reckoning have more generally detrimental effects than manipulated prices of any other "good". I have yet to see the logic of why interest is different.

William L. Anderson said...

I was thinking about that earlier and I am going to do another post on that particular subject. Indeed, if Krugman believes that (1) the Fed can hold down interest rates but (2) government regulations will stop the malinvestments (Oh, I forgot, Krugman doesn't believe in malinvestments), he is mistaken.