Monday Smackdown: Paul Krugman Tut-Tuts at David Frum for the Soft Bigotry of Low Expectations

Comment of the Day/Monday Ken Rogoff Smackdown: Robert Waldmann: Trying to Understand: "As you know I have attempted to sketch a model to evaluate dynamic inefficiency when there are risk premia and the growth rate is less than the risky interest rate...

...Here is the post (to which you have kindly linked already)

I think it is easy to find cases in which g greater than the safe interest rate implies dynamic inefficiency even though there is a risky return higher than g. It is easier to find cases in which there is dynamic inefficiency if g is greater than some number in between the safe and risky interest rates.

These are super simple models. I think the burden of, not proof, but of coming up with a plausible model, must shift to people who argue that economies are currently dynamically efficient.

The passage with the unclear meaning 'in a ...' has a very simple clear meaning. It is:

Models are not reality. The fact that something is true in our models doesn't meant it is true. So we can't know for sure that the US economy is dynamically inefficient, simply because we can never know anything for sure.

It is a 'might' makes right argument.

Rogoff is saying that the economy might be dynamically efficient even though safe interest rates are lower than the long term average growth rate. This is certainly true. Nothing is ever 100% sure.

Then Rogoff actually argues that extremely high asset prices are evidence against dynamic inefficiency. He knows perfectly well that dynamic inefficiency implies that asset bubbles can last forever, so they can occur (and never burst) even if people have rational expectations. He knows that, in all standard models, anomalously high asset prices are evidence of dynamic inefficiency not of dynamic efficiency.

Basically, he is saying:" The dividend yield is low too, so we can ignore the fact that the safe interest rate is low." The dividend yield is additional evidence about 'the broader credit surface'. It isn't a very informative datum (stock prices are crazy and carry little useful information) but it tends to undermine the argument he just made. Presenting it as evidence against dynamic inefficiency makes no sense at all (I don't mean 0 sense since it makes negative sense).

Also, it is amazing to read a complaint about 'a world where regulation has sharply curtailed access for many smaller and riskier borrowers' so soon after 2008.

So we have:

  1. the world is more complicated than your model. I won't present a different model with the opposite implication. I consider the burden of proof to be on Summers, so I win, since nothing is ever proven (certainly not in economics)

  2. Extremely high asset prices are evidence of dynamic efficiency even though the past few decades of literature has explained how they can occur as a result of dynamic inefficiency.

  3. Restrictions on lending to risky borrowers are a problem as we have learned from the recent episode of poor economic performance. 2008 doesn't matter because next time it will be different.

The man is very very smart. I have no idea what is going on in his mind.