Must-Read: Paul Krugman: Confidence Games: "OK, one more round in this models versus instincts go-round...
...As Robert Waldmann points out... my... claim... countries in a liquidity trap borrowing in their own currencies shouldn’t fear Greek-style confidence crises... [is not] the claim that confidence never matters, and the Blanchard result that is being cited has little bearing on that assertion.... Was it reasonable [in 2009]to worry about an excessive package spooking markets, and was it essential to combine stimulus with measures to produce “medium term fiscal credibility”?
My answer was and is no – that such concerns didn’t reflect a level of insight deeper than the models, but rather a gut feeling insufficiently disciplined by models... [of]... Greece. But Greece doesn’t have its own currency, and as I pointed out in my Mundell-Fleming lecture, the effect of the Greek confidence crisis was a sharp fall in the monetary base, which wouldn’t happen here. Instead,.. doubts about U.S. finances would be reflected in higher inflation expectations and a weaker dollar – both of which would be expansionary.... That was... what happened in the only historical case I was able to find... the French franc in the 1920s.... Were people worrying about a loss in confidence from excessive stimulus in 2009 right to be so worried? Or were they simply not thinking it through?
