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Interest Rates: The Phantom Menace: Hoisted from Paul Krugman's Archives from 2009

Time-Tested Rules for Life:

  1. Paul Krugman is right.
  2. If you think Paul Krugman is wrong, consult rule (1).

Josh Bivens reminds Mike Konczal reminds me of how out-to-lunch the Obama Treasury was about the macroeconomic situation back in late 2009:

Paul Krugman (November 20, 2009): Interest Rates: The Phantom Menace: "From various bat squeaks...

...what I think lies behind the surprising--and damaging--deficit squeamishness of the Obama administration....

On the face of it, there’s no reason to be worried about interest rates on US debt. Despite large deficits, the Federal government is able to borrow cheaply, at rates... well below the pre-crisis levels:


Underlying these low rates is, in turn, the fact that... the surge in government borrowing has... less than offset a plunge in private borrowing. So what’s the problem?... Officials don’t trust the demand for long-term government debt, because they see it as driven by a ‘carry trade’: financial players borrowing cheap money short-term, and using it to buy long-term bonds.... What’s wrong with this picture? First of all, what would things look like if the debt situation were perfectly OK? The answer, it seems to me, is that it would look just like what we’re seeing. Bear in mind that the whole problem right now is that the private sector is hurting, it’s spooked, and it’s looking for safety. So it’s piling into ‘cash’.... Meanwhile, the public sector is sustaining demand with deficit spending, financed by long-term debt. So someone has to be bridging the gap between the short-term assets the public wants to hold and the long-term debt the government wants to issue.... You could and should be worried if... long-term rates looked unreasonably low given the fundamentals. But do they? Long rates fluctuated between 4.5 and 5 percent in the mid-2000s.... Now we face the prospect of a prolonged period of near-zero short-term rates--I don’t see any reason for the Fed funds rate to rise for at least a year, and probably two--which should mean substantially lower long rates.... And if we’re facing a Japanese-type lost decade, which seems all too possible, long rates are in fact still unreasonably high.

Still, what about the possibility of a squeeze?... [That] is a financial system problem--not a deficit problem... that the people conveying funds from savers, who want short-term assets, to the government, which borrows long, are undercapitalized. And the remedy should be financial, not fiscal. Have the Fed buy more long-term debt; or let the government issue more short-term debt. Whatever you do, don’t undermine recovery by calling off jobs creation.... It’s crazy to let the rescue of the economy be held hostage to what is, if it’s an issue at all, a technical matter of maturity mismatch. And again, it’s not clear that it even is an issue....

And one last point: I just don’t think the inner circle gets how much danger we’re in from another vicious circle, one that’s real, not hypothetical. The longer high unemployment drags on, the greater the odds that crazy people will win big in the midterm elections--dooming us to economic policy failure on a truly grand scale.