Monday DeLong Smackdown Watch: Paul Krugman on the Confidence Fairy, The Expectations Imp, and the Rate-Hike Obsession
The Confidence Fairy, The Expectations Imp, and the Rate-Hike Obsession: Brad DeLong has a long meditation on policy that, surprisingly, includes some things I strongly disagree with. I guess I should start by saying that when he describes his fairly complacent view of macroeconomics on the eve of the crisis, he’s describing a view that many economists shared — but I wasn’t one of them. Japan’s troubles and the Asian financial crisis destroyed my faith that we had the business cycle under control; I wrote a whole book about the return of depression economics back in 1999.
Agreed: Paul was smart and I was stupid about the implications of Japan and 1997-8 in East Asia...
But here’s where I think Brad is getting something wrong now: when he says that: "It is unfair for Keynesians to be making fun of the people who call for austerity by saying 'confidence fairy' when they are making similar expectational-shift arguments themselves." He’s referring to calls for the Fed and other central banks to raise expectations of future inflation as a way to get some traction in a liquidity trap — which is certainly something I and others support. But there are two crucial differences between us and the expansionary austerity types.
First, our expectations argument is a hope; theirs is a plan… those of us hoping to summon the expectations imp want to do so with policies that are at worst harmless…. The austerians, on the other hand, have pushed directly destructive policies — fiscal contraction in depressed economies — in order to achieve their hoped-for shift in expectations. So this is the difference between “Let’s try this possibly ineffective remedy, it might work and in any case won’t do any harm” and “Let’s do the opposite of what standard analysis says we should be doing, just trust me”.
Touché… That is an important difference.
One other thing: Brad takes fairly seriously the calls for higher interest rates to avoid bubbles, or something, essentially because low rates create moral hazard for the financial sector. Can we say that those moral hazard problems would have to be incredibly severe to justify contractionary monetary policy in a depressed economy?
I would say that the argument that low interest rates add to pressure for financial-sector moral hazard is an argument not so much for tighter monetary policies as for much easier fiscal policies--they are, principally, I think, arguments for much easier fiscal policies…
And Paul has an effective and accurate Parthian shot:
And… I don’t think we should ignore the evidence that some people always want higher rates, and just keep changing the justification.