The not-so-new New Business Cycle from Paul Krugman

Submitted by John on Mon, 07/21/2008 - 5:08pm. Tags:

Economics and Business

Hat tip to The Economist blog for pointing to this NYT EDITORIAL (you like that Spartacvs? ;)) by Paul Krugman.

Passages like the one that is about to follow make me wonder whether the analytical foundations of some talented PhD economists, like Krugman, are so different from mine (and real PhD economists who don't think like Krugman) that he doesn't even see the gaping flaw that jumped out at me as I read it:

These prolonged recession-like episodes probably reflect the changing nature of the business cycle. Earlier recessions were more or less deliberately engineered by the Federal Reserve, which raised interest rates to control inflation. Modern slumps, by contrast, have been hangovers from bouts of irrational exuberance — the savings and loan free-for-all of the 1980s, the technology bubble of the 1990s and now the housing bubble.

Ending those old-fashioned recessions was easy because all the Fed had to do was relent. Ending modern slumps is much more difficult because the economy needs to find something to replace the burst bubble.

The Fed, in particular, has a hard time getting traction in modern recessions. In 2002, there was a strong sense that the Fed was “pushing on a string”: it kept cutting interest rates, but nobody wanted to borrow until the housing bubble took off. And now it’s happening again. The Onion, as usual, hit the nail on the head with its recent headline: “Recession-plagued nation demands new bubble to invest in.”

What jumped out at me in the bold part is how Krugman seems to see no connection between raising interest rates to provoke an "old-fashioned" recession (so to speak) and lowering interest rates to create the false-positive conditions that that will lead to recessions or economic slowdowns....not to mention INFLATION.

To me, it's all the same thing. Nothing is new and nothing has changed in terms of how it all works. What HAS changed is the amount background noise and technicalities that lead some economists away from the fundamentally obvious and into a whirl wind of "exceptions" and "differentiating illusions".
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Those old-fashioned recessions (#104577)

by Bird Dog on Tue, 07/22/2008 - 8:49am

Volcker raised interest rates because he wanted to control inflation. In the next two recessions, inflation was licked, so the Fed's responsibility came down to keeping the economy on an even keel.

"I want America to know that I'm, like, totally ready to lead." -- Paris Hilton

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I have a rather low opinion of economists (#104565)

by Floater on Tue, 07/22/2008 - 5:48am

of all political persuasions. Krugman is no exception but he did foresee the problems in the credit markets that are unfolding now several years ago which is better than most of them did. At this point it's easy enough to say anyone should have seen it coming but the fact is that a lot of them didn't.

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More than just Krugman... (#104578)

by John on Tue, 07/22/2008 - 9:00am

Libertarian economists, particularly Austrian, have been warning about the housing bubble for years.

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Huh? (#104443)

by Gabriel on Mon, 07/21/2008 - 6:48pm

Sorry, I read and reread your diary but don't get your point.
K is pointing out that the causes of modern recessions are different than the ones from the past so what worked in the past to fix it may not work this time. What, exactly, is the 'gaping flaw'?

Standard Disclaimer: I only speak for myself. I may or not agree with others. Ask, if you are curious. If I post about X I may not have an opinion about Y, no matter how closely related you think they are.

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Here, Gabriel (#104501)

by John on Mon, 07/21/2008 - 11:59pm

Read this article. I was looking for something that might convey my views a bit better than I do.

Never mind the gold part, just read how the author analyzes and comprehends the actions of Greenspan and the Fed and how that is then used to explain the course of economic events over the last 15-20 years.

I know you're no Austrian but that you do take an interest in reading about it. Tell what strikes you as wrong about how this Austrian in the article understands monetary events. Then superimpose it over what Krugman wrote.

I'd really like to know.

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The gaping flaw to me, Gabriel (#104498)

by John on Mon, 07/21/2008 - 11:37pm

is that Krugman mentions raising interest rates as causing a "normal" recession...but he doesn't make the connection to the symbiosis of the effects of lowering interest rates too far and for too long. I guess to me, too-low rates and inflated money supply are basically the same thing in the long run. Same vice versa with high rates. I'm calling for stagnant money supply but this has been ridiculous.

Consider Krugman:

Earlier recessions were more or less deliberately engineered by the Federal Reserve, which raised interest rates to control inflation.

And what prompted this? Inflated money supply and rates that were too low. What Krugman cites is merely a monetary reaction to a previous monetary (bad)action. But he doesn't see it this way. Sure, it may LOOK different and have different contexts and get dressed as being overall "different" but I just don't buy it. It's the same.

Then he says:

Modern slumps, by contrast, have been hangovers from bouts of irrational exuberance — the savings and loan free-for-all of the 1980s, the technology bubble of the 1990s and now the housing bubble.

Again, low rates...for too long. OK, perhaps the tech bubble was a slight bit of irrational exuberance. But again, I think rates were too low and for too long. There was a lot of malinvestment in that boom. And since then, we have had rates that were too low for almost the entire 2000s as people sought to regain their losses in a fake real estate bubble fueled by low rates. But now, the Fed won't let go. Bernanke won't jack up rates...nor did Greenspan before him. The economy is carrying around a lot of bad money that won't die. Now the Fed doesn't know what else to do. It's only choice to avoid a repeat of its own mistakes is to RAISE RATES like Volcker did. And we could do it now instead of later. The longer we wait, the more painful it will be. We aren't at Volcker's "1981" yet. We're still in the late 70s..so to speak.

Perhaps this all flies in the face of how you understand monetary policy. I dunno. But all the rationalizations that Bernake passes off as reasons to not think it's what I think it is are just that...rationalizations. It's all excuses that artfully conceal the simple truth that rates must reflect something other than a analytical caprice of the Fed chairman.

Call me stubborn but I think it's all monetary in nature....all of it....at least insofar as "general economic slowdowns" are concerned. Getting better at passing the hot potato around longer doesn't change the fact that it has to drop at some point.

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If you read Krugman (#104740)

by Gabriel on Tue, 07/22/2008 - 7:48pm

you'll see he has, repeatedly, said that Greenspan's much too relaxed approach is one of the reasons for the current mess.

But even if we accept the idea that lax Fed policy is the reason behind the bubbles and the 'new' recessions (and it's not clear to me that's the case) it doesn't mean that it can be fixed by raising rates.

And that's K's key argument here. Past recessions could be 'easily' fixed by the Fed but current ones can't.

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no economist I (#104568)

by nyoos junkey on Tue, 07/22/2008 - 7:08am

but I suppose it's a choice between raising rates and hitting those who borrowed very hard, or keeping them low and hitting everyone pretty hard with inflation. I don't really have a feel for the size of the problem, but if it is as big as some suggest, and given how asset prices also seem to be falling fast, then raising rates won't just kick the borrowers in the proverbials, it could really hose the banks too.

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