Defending what Paul Krugman Wrote

“3. I personally do not think that Greenspan caused the housing bubble. I do not believe that monetary policy and short-term interest rates are as all-powerful as many economists do.”

I thought that was the set up for a joke… but… I don’t see a punchline…

Jesse writes:
“3. I personally do not think that Greenspan caused the housing bubble. I do not believe that monetary policy and short-term interest rates are as all-powerful as many economists do.”

“I thought that was the set up for a joke… but… I don’t see a punchline…”

Repeatedly, over the course of centuries, when large asset bubbles burst, a real estate bubble follows. This suggests that there is something more fundamental about real estate bubbles than Fed actions….something more intrinsic to human behavior…that drives creation of real estate bubbles.

I’m not sure why you are so willing to believe that Greenspan single-handedly created the housing bubble.

Think again…

German Interview, undated
http://www.pkarchive.org/global/welt.html
“During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn’t you lower interest rates?”

May 2, 2001

http://www.pkarchive.org/column/5201.html

I’ve always favored the let-bygones-be-bygones view over the crime-and-punishment view. That is, I’ve always believed that a speculative bubble need not lead to a recession, as long as interest rates are cut quickly enough to stimulate alternative investments. But I had to face the fact that speculative bubbles usually are followed by recessions. My excuse has been that this was because the policy makers moved too slowly — that central banks were typically too slow to cut interest rates in the face of a burst bubble, giving the downturn time to build up a lot of momentum. That was why I, like many others, was frustrated at the smallish cut at the last Federal Open Market Committee meeting: I was pretty sure that Alan Greenspan had the tools to prevent a disastrous recession, but worried that he might be getting behind the curve.
However, let’s give credit where credit is due: Mr. Greenspan has cut rates since then. And while some of us may have been urging him to move even faster, the Fed’s four interest-rate cuts since the slowdown became apparent represent an unusually aggressive response by historical standards. It’s still not clear that Mr. Greenspan has caught up with the curve — let’s have at least one more rate cut, please — but the interest-rate cuts do, cross your fingers, seem to be having an effect.
If we succeed in avoiding recession, this will mark a big win for let- bygones-be-bygones, and a big loss for crime-and-punishment. And that will be very good news not just for this business cycle, but for business cycles to come.
July 18, 2001
http://www.pkarchive.org/economy/ML071801.html
“KRUGMAN: I think frankly it’s got to be — business investment is not going to be the driving force in this recovery. It has to come from things like housing, things that have not been (UNINTELLIGIBLE).
DOBBS: We see, Paul, housing at near record levels, we see automobile purchases near record levels. The consumer is still very much in this economy. Can he or she — or I should say he and she, can they bring back this economy?
KRUGMAN: Well, as far as the arithmetic goes, yes, it is possible. Will the Fed cut interest rates enough? Will long-term rates fall enough to get the consumer, get the housing sector there in time? We don’t know.”
August 8th 2001
http://www.pkarchive.org/economy/ML082201.html
“KRUGMAN: I’m a little depressed. You know, inventories, probably that’s over, the inventory slump. But you look at the things that could drive a recovery, business investment, nothing happening. Housing, long-term rates haven’t fallen enough to produce a boom there. The trade balance is going to get worst before it gets better because the dollar is still very strong. It’s not a happy picture.”
August 14, 2001
http://www.pkarchive.org/column/81401.html
http://www.nytimes.com/2001/08/14/opinion/reckonings-delusions-of-prosperity.html
“Consumers, who already have low savings and high debt, probably can’t contribute much. But housing, which is highly sensitive to interest rates, could help lead a recovery…. But there has been a peculiar disconnect between Fed policy and the financial variables that affect housing and trade. Housing demand depends on long-term rather than short-term interest rates — and though the Fed has cut short rates from 6.5 to 3.75 percent since the beginning of the year, the 10-year rate is slightly higher than it was on Jan. 1…. Sooner or later, of course, investors will realize that 2001 isn’t 1998. When they do, mortgage rates and the dollar will come way down, and the conditions for a recovery led by housing and exports will be in place.”
October 7, 2001
http://www.pkarchive.org/economy/ML071801.html
“Post-terror nerves aside, what mainly ails the U.S. economy is too much of a good thing. During the bubble years businesses overspent on capital equipment; the resulting overhang of excess capacity is a drag on investment, and hence a drag on the economy as a whole.
In time this overhang will be worked off. Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. But it seems inevitable that there will also be a fiscal stimulus package.”
Dec 28, 2001
http://www.pkarchive.org/column/122801.html
“The good news about the U.S. economy is that it fell into recession, but it didn’t fall off a cliff. Most of the credit probably goes to the dogged optimism of American consumers, but the Fed’s dramatic interest rate cuts helped keep housing strong even as business investment plunged.”

“I personally do not think that Greenspan caused the housing bubble. I do not believe that monetary policy and short-term interest rates are as all-powerful as many economists do.”

I completely disagree. Greenspan’s bad policy is not the only piece of the puzzle, but it’s a very large one.

In my models Fed policy was OK until August 2002.

But that should have been the bottom for fed funds and the Fed should have started the tightening that they did not start till two years later in 2004.

I’ve expressed it that too easy monetary policy in 2003 and 2004 was a necessary condition for the housing bubble, but it was not a sufficient condition.

I personally do not think that Greenspan caused the housing bubble.

Greenspan:Bush::Burns:Nixon

Because you’re a Republican, I’m sure this association doesn’t worry you.

Dr. Kling,

Your article on the weakness of the Fed is woefully shallow and misses several important points. I’ll highlight one here

”
Since May, the real or inflation-adjusted interest rate, as measured by the yield on TIPs, has fallen from over 3.5 percent to 3 percent. The long-term real interest rate has declined by 20 percent!

One of DeLong’s concerns is that the drop in Treasuries could simply reflect a flight from corporate bonds into safer securities. In that case, the drop in Treasury yields would not be matched by a reduction in private-sector borrowing costs. However, corporate bond rates also have declined. The average interest rate on Corporate bonds rated Baa by Moody’s has fallen from 8.09 percent in May to 7.52 percent recently.”

The cost of private borrowing is NOT just bond rate because there are two methods for raising money available to most companies. One is the sale of bonds but the other is the sale of additional equity stakes. The drop in the value of stocks (the S&P dropped from 1170 in Jan to 800 at one point in October) represents additional costs of raising money through the sale of stock.

The federal reserve influences the cost of raising capital, this is much broader than the interest rate on bonds.

“Repeatedly, over the course of centuries, when large asset bubbles burst, a real estate bubble follows. This suggests that there is something more fundamental about real estate bubbles than Fed actions….something more intrinsic to human behavior…that drives creation of real estate bubbles.”

Basically for every one of these bubbles that we have good historical data for we can point to a large increase in the money supply driving these bubbles. Since the fed is in control of the money supply it seems quite easy to point the finger at them and feel correct.

“Go read Manias, Panics & Crashes. I have doubts that back during the Dutch Tulip crisis there was a central bank that increased the money supply. ”

I never said that there had to be a central bank altering the money supply. During tulip mania there was a vast increase of gold (the coin of the time) coming in from the Americas. The dutch were leading bankers at the time and the fact that the gold flowed through Holland is no surprise.

Artificial expansion of money supply happened even before the central banks. The central banks merely institutionalized it.

Give me a break. These were not isolated remarks by Krugman. Here a many more:

German Interview, undated

http://www.pkarchive.org/global/welt.html

“During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn’t you lower interest rates?”

May 2, 2001

http://www.pkarchive.org/column/5201.html

I’ve always favored the let-bygones-be-bygones view over the crime-and-punishment view. That is, I’ve always believed that a speculative bubble need not lead to a recession, as long as interest rates are cut quickly enough to stimulate alternative investments. But I had to face the fact that speculative bubbles usually are followed by recessions. My excuse has been that this was because the policy makers moved too slowly — that central banks were typically too slow to cut interest rates in the face of a burst bubble, giving the downturn time to build up a lot of momentum. That was why I, like many others, was frustrated at the smallish cut at the last Federal Open Market Committee meeting: I was pretty sure that Alan Greenspan had the tools to prevent a disastrous recession, but worried that he might be getting behind the curve.

However, let’s give credit where credit is due: Mr. Greenspan has cut rates since then. And while some of us may have been urging him to move even faster, the Fed’s four interest-rate cuts since the slowdown became apparent represent an unusually aggressive response by historical standards. It’s still not clear that Mr. Greenspan has caught up with the curve — let’s have at least one more rate cut, please — but the interest-rate cuts do, cross your fingers, seem to be having an effect.

If we succeed in avoiding recession, this will mark a big win for let- bygones-be-bygones, and a big loss for crime-and-punishment. And that will be very good news not just for this business cycle, but for business cycles to come.

July 18, 2001

http://www.pkarchive.org/economy/ML071801.html

“KRUGMAN: I think frankly it’s got to be — business investment is not going to be the driving force in this recovery. It has to come from things like housing, things that have not been (UNINTELLIGIBLE).

DOBBS: We see, Paul, housing at near record levels, we see automobile purchases near record levels. The consumer is still very much in this economy. Can he or she — or I should say he and she, can they bring back this economy?

KRUGMAN: Well, as far as the arithmetic goes, yes, it is possible. Will the Fed cut interest rates enough? Will long-term rates fall enough to get the consumer, get the housing sector there in time? We don’t know”

August 8^th 2001

http://www.pkarchive.org/economy/ML082201.html

“KRUGMAN: I’m a little depressed. You know, inventories, probably that’s over, the inventory slump. But you look at the things that could drive a recovery, business investment, nothing happening. Housing, long-term rates haven’t fallen enough to produce a boom there. The trade balance is going to get worst before it gets better because the dollar is still very strong. It’s not a happy picture.”

August 14, 2001

http://www.pkarchive.org/column/81401.html

“Consumers, who already have low savings and high debt, probably can’t contribute much. But housing, which is highly sensitive to interest rates, could help lead a recovery…. But there has been a peculiar disconnect between Fed policy and the financial variables that affect housing and trade. Housing demand depends on long-term rather than short-term interest rates — and though the Fed has cut short rates from 6.5 to 3.75 percent since the beginning of the year, the 10-year rate is slightly higher than it was on Jan. 1…. Sooner or later, of course, investors will realize that 2001 isn’t 1998. When they do, mortgage rates and the dollar will come way down, and the conditions for a recovery led by housing and exports will be in place.

October 7, 2001

http://www.pkarchive.org/economy/ML071801.html

“Post-terror nerves aside, what mainly ails the U.S. economy is too much of a good thing. During the bubble years businesses overspent on capital equipment; the resulting overhang of excess capacity is a drag on investment, and hence a drag on the economy as a whole.

In time this overhang will be worked off. Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer. But it seems inevitable that there will also be a fiscal stimulus package”

Dec 28, 2001

http://www.pkarchive.org/column/122801.html

“The good news about the U.S. economy is that it fell into recession, but it didn’t fall off a cliff. Most of the credit probably goes to the dogged optimism of American consumers, but the Fed’s dramatic interest rate cuts helped keep housing strong even as business investment plunged.”

Arnold–

Re: “I am pretty sure that Brad is guilty of this hypocrisy…”

You don’t have to tell lies about me. It’s not a mandatory part of your job description. You *can* tell it straight–if you want to.

Yours,

Brad DeLong

Greenspan didn’t create the housing bubble single-handedly.
Bernanke had his part as well.

The Austrians demonstrated a long time ago that there is a close connection between government-manipulated interest rates. And sure enough, here we are again. I think Rothbard, Mises, and Haek all would be saying “I told you so” to us right now. I talk about the connection between interest rates and the recession here:

http://zatavu.blogspot.com/2009/04/interest-rate-manipulation-and.html

Insofar as Krugman is a Keynesian macroeconomist, he is wrong about just about everything. Whenever I read him I am blown away by how incredibly wrong he is about most things economic.

This from 2002 suggests Krugman did not approve of a housing bubble (emphasis added).

August 16, 2002
http://www.pkarchive.org/column/081602.html

“Back when I first got professionally obsessed with Japan’s problems, around four years ago, I made myself a mental checklist of reasons that Japan’s decade of stagnation could not happen to the United States. It went like this:

1. The Fed has plenty of room to cut interest rates, which should be enough to deal with any eventuality.

2. The U.S. long-term budget position is very strong, so there’s plenty of room for fiscal stimulus in the unlikely event interest rate cuts aren’t enough.

3. We don’t have to worry about an Asian-style loss of confidence in our business sector, because we have excellent corporate governance.

4. We may have a stock bubble, but we don’t have a real estate bubble.

I’ve now had to strike the first three items off my list, and I’m getting worried about the fourth.

More and more people are using the B-word about the housing market. A recent analysis by Dean Baker, of the Center for Economic Policy Research, makes a particularly compelling case for a housing bubble. House prices have run well ahead of rents, suggesting that people are now buying houses for speculation rather than merely for shelter. And the explanations one hears for those high prices sound more and more like the rationalizations one heard for Nasdaq 5,000.

If we do have a housing bubble, and it bursts, we’ll be looking a lot too Japanese for comfort.“

And after the “Yes”, Krugman went on to write:

“There’s an old joke that Jacob Frenkel, formerly of Chicago and then the Bank of Israel, used to tell to illustrate the fallacy of thinking that you always have to do the opposite of what caused the initial problem. A driver runs over a pedestrian; he looks back, realizes what he’s done. “I’m so sorry,” he says. “Let me fix the damage.” So he backs up, running over the pedestrian a second time.

What we have now is a spending slump. It’s the consequence of easy credit that led to reckless spending in the past — but the problem now is how to sustain spending; trying to encourage austerity at this point will just make things even worse. Keep cutting, Ben!”

The “Austrians” also forgot to tell you about the panic’s of the 19th century which have behaved similiarly to the current mess. The FED essentially followed the market on rates as it usual always has(except for some points in time). The market got what the market wanted. Grandma,Grandpa,grandson and granddaughter spent like mad. Mommy and Daddy Boomer were shaking their head. I lived and saw it personally.

Here is the deal as I said earlier. Greenspan/FED yada yada didn’t “CREATE” the housing bubble. They ACCOMADATED it when, as was seen to be created. They act like 2005, but I think it was more like 2003 if not earlier. That is where the Austrians are right, but in that motiff, it still didn’t fault the FED/Greenie. If Austrians could admit to market failure, they would be a MUCH better group of intellectuals to be around because they do have insights, I think Haydek was darn close by the end of his life to admitting market failure exists, how today’s thinkers would be upset by that.

You see, America had a good deal of cash(ok, the leftists can cry not enough got down the ladder but that isn’t the point) after the 80/90’s tech innovation. But the party was over with that so they were looking for the next big thing but nothing was found in the real economy. That led the animal spirits into housing and with the tech inspired innovations in mortgage products, crack dealers in Asia, a accomadating FED/government who wanted to stay in power: It created one hell of a mess. We got little REAL growth and a whole bunch of debt, now the gubmit is indebted through the roof to save a liquidationist collapse.

We could have used that money better and invested in this country instead of against it as personal decadent hedonism and overinvestment globally.

Only the government can fix that kind of mis-allocation of interest of the market players in our country. The pain in the short term would have sucked, but the long term would make it worth it.

Instead it will take 10-15 years to get out of this and it won’t end to they outright take the pain ala early 80’s. The current downturn is no clearing signal recession. It is mid-70’s welcome to hell recession type.

http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/1999-2001/FF_08_2001.htm

DIRECT QUOTE:

“Thus, monetary policy ease is all about getting, maintaining and turbo-charging traction in household spending, fueled by rising prices for the pillar of the American Dream, the home. Or, as I said last month:”

‘There is room for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand Mr. Greenspan deny any such thing (just like he denied belatedly attacking the NASDAQ bubble).’

Of course everyone seems to be forgetting PIMCO’s Paul McCulley is at the root of this entire debate!

sheesh!

FWIW, here is the original McCulley article cited by Krugman. It is hardly *advocating* for a housing bubble, but does identify the possibility.

http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/2002/FF_05_2002.htm

My puzzlement is caused by the link to the 2002 Kling piece, which quotes a DeLong article from 2002 saying that the Fed has left rates too high. SO why are we not told, in a correction, that DeLong said no such thing?

P Allen — there were Orange County, California subprime originating mortgage companies leveraged as much as 41-1 in the mid 00s.

41-1.

We wouldn’t want to deleverage from that, now, would we.

But why was the housing bubble the only way out? While there are many causes (automation and outsourcing to lower wage countries) the loss of manufacturing jobs over the years made home construction, retail (fed by HELOC) and the bubble jobs of realtor and mortgage broker the only ways to get mass employment.

So how do we get out of this recession?

Re #2:

Consuming capital does not make for a recovery, no matter how rich people feel in their misallocated jobs.

From your 2002 article, Mr. Kling, you gave this analogy:

“At the beach where we vacation every summer, my daughters like to ride the bumper cars at an amusement park called Funland. One thing I notice is how weak is the link between the steering wheel and the direction of the car. Often, it seems that while the girls are spinning the wheel frenetically, the change in heading that they purchase is slight.

“This flimsy steering mechanism strikes me as an apt metaphor for monetary policy. Federal Reserve Chairman Alan Greenspan can spin his steering wheel (the Federal Funds rate), but the correlation between those actions and the direction of interest rates in general is weak and inconsistent.”

The thing is that the car eventually turns, and where it turns we don’t know where it ends up. Trying to absolve the Fed of any responsibility is like saying a drunk driver is not responsible for the accident, but the alcoholic beverage he drank is. I’m pretty sure that we wouldn’t have had a housing bubble if there wasn’t loose credit and low interest rates.

@Private-Freedom

There’s no need to try to demean Kling by saying “MISTER Kling.” I doubt it offended him but I thought it rather silly.

Sure he made some statist points, but he didn’t preface his points with “I’m a free market kinda guy,” or “now I believe in liberty and everything, but…”

I am new here though, so maybe he does claim to be free market, in which case I think your criticism of his position is valid, yet there’s no need to be criticizing in an underhanded manner.

Defending Krugman is one thing for him to do, clarifying that maybe the Krugster was making a joke… but defending Krugman by defending his position is completely different, and deserves criticism, only without taunting.

Patrick,

“Go read Manias, Panics & Crashes. I have doubts that back during the Dutch Tulip crisis there was a central bank that increased the money supply.”

Well then you’d be spectacularly wrong. Besides it’s monetary expansion itself that is the problem. Central banks are a means to increase the magnitude of such expansions. So even if you were right you’d be wrong.

Dear Arnold,

I think you should correct your article by confessing obvious – that Krugman really advocated housing bubble many times, as evidence presented by many poster here clearly demonstrates. Or at least you should add post scriptum with those citations, so the interested reader can see wider context. This way, it looks you only wanted to please Krugman.

“Krugman was mainly expressing pessimism. He was not cheerfully advocating a housing bubble, but instead he was glumly saying that the only way he could see to get out of the recession would be for such a bubble to occur.”

Nonsense, he was pessimistic about Greenspan’s ability to inflate the bubble, not about the bubble itself. He was saying that Greenspan was being optimistic if he thought he could inflate a housing bubble (that was needed to increase spending) by the methods he was using. He was wrong about that too.

Seeing as how Krugman was and is forever saying “too little” when it comes to government stimulus your interpretation is very hard to swallow. It doesn’t match his economic philosophy at all. Plus he just got done saying that a housing bubble would be good because it would increase spending.