Paul Krugman (2015): Artificial Unintelligence: "In the early stages of the Lesser Depression, those of us who knew a bit about the macroeconomic debates of the 1930s... felt a sense of despair...

...Everywhere you looked, people who imagined themselves sophisticated and possessed of deep understanding were resurrecting 75-year-old fallacies and presenting them as deep insights. A lot of water has passed under the bridge since then.... I feel an even deeper sense of despair.... People are still rolling out those same fallacies, even though in the interim those of us who remembered and understood Keynes/Hicks have been right about most things, and those lecturing us have been wrong about everything. So here’s William Cohan in the Times, declaring that the Fed should “show some spine” and raise rates even though there is no sign of accelerating inflation. His reasoning:

The case for raising rates is straightforward: Like any commodity, the price of borrowing money—interest rates—should be determined by supply and demand, not by manipulation by a market behemoth. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying...

Oh dear. Cohan’s theory of interest rates is basically the old notion of loanable funds.... [But] loanable funds doesn’t determine the interest rate; all it does is define a relationship between interest rates and income.... What determines where we end up on that curve? Monetary policy. The Fed sets interest rates, whether it wants to or not—even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it’s a monetary policy choice. And how would you know if the Fed is setting rates too low? Here’s where Hicks meets Wicksell: rates are too low if the economy is overheating and inflation is accelerating. Not exactly what we’ve seen in the era of zero rates and QE....

There are arguments that the Fed should be willing to abandon its inflation target so as to discourage bubbles. I think those arguments are wrong—but in any case they have nothing to do with the notion that current rates are somehow artificial, that we should let rates be determined by “supply and demand”.... Crude misunderstandings along these lines are widespread even among people who imagine themselves well-informed and sophisticated. Eighty years of hard economic thinking, and seven years of overwhelming confirmation of that hard thinking, have made no dent in their worldview. Awesome.

#noted

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