Arnold Kling  

Defending what Paul Krugman Wrote

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In 2002, he passed along a joke that the economy needed a housing bubble. Krugman is controversial, so the post generated comments on this blog and elsewhere, some of which are overly "gotcha" in character.

Some points I would make:

1. 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.

2. In the event, we had a housing bubble and we got out of the recession. To me, this raises the question of whether a distorted recovery is better than an undistorted recession. That question might be asked in the context of fiscal stimulus as well--at what point do the distortions of the stimulus outweigh getting out of a recession?

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. What I was writing in August of 2002 was this.

4. Paul Krugman and Brad DeLong thought that Greenspan kept rates too high in 2002. This makes them poorly positioned to criticize Greenspan now for keeping rates too low. I am pretty sure that Brad is guilty of this hypocrisy. I believe that Paul is not.
[UPDATE: Brad denies committing this hypocrisy, and he is right. He has stood by his views that interest rates in 2001 and 2002 were, if anything, too high. I stand corrected.]

5. The main reason I put Paul's quote on my blog was because I am compiling a history of the events that caused financial crisis. I have a paragraph that says:


the current crisis led to a sharp recession that could not be mitigated with monetary expansion. This suggests that in hindsight more should have been done to prevent the housing bubble from expanding as much as it did. This in turn suggests that the monetary easing that took place from 2001-2003 was excessive. However, at the time, the sluggish growth in employment (the 2001-2003 period was commonly referred to as a "jobless recovery") was thought to justify the monetary expansion and low levels of interest rates.

The Krugman quote can help to support that paragraph. I can pick other quotes, obviously, but the one about needing a housing bubble is particularly poignant.


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CATEGORIES: Macroeconomics



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The author at Enemy of der Staat in a related article titled Kling: Krugman was Joking writes:
    Arnold Kling thinks what Paul Krugman said in 2002 was just a joke. I'm not convinced. [Tracked on June 18, 2009 12:14 AM]
COMMENTS (54 to date)
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...

Daniel Kuehn writes:

Nice restatement - thank you. I suppose I agree with Krugman more often than not, but I still can admit he can be hyper-partisan, and as a result I agree with him less on his politics than I do on his economics.

However - no matter what criticisms can be leveled against Krugman for his "shrillness", as it's been called, no objective person could have read that op-ed and seriously believe he was advocating a bubble. It's beyond absurd.

Excellent reconsideration.

Patrick writes:

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.

baconbacon writes:

"no objective person could have read that op-ed and seriously believe he was advocating a bubble. It's beyond absurd."

Krugman

A. supports lowering interest rates by central banks during times of recessions as a general tool.
B. States in the article that there is good reason to fear a "double dip" recession.
C. Frequently (and recently) mocks "liquidationists" for for their stance on letting recessions run their course.

Now if you believe that the Fed was responsible or partly responsible for the housing bubble it can only realistically be tied to their lowing of the Fed rates.

So what is Krugman saying in this piece then?

ben writes:

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.”

S Andrews writes:

Krugman despertately wanted to blow up a housing bubble. He consistently suggested that the PTB blow up one to solve the crisis. Here is a laundry list.

J Cortez writes:

"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.

Daniel Kuehn writes:

bacon -
RE: "so what is krugman saying in this piece then?"

I think Kling summarizes it very well - that there is a serious risk of a double-dip recession, that there is no good way out, and that a bubble is the only conceivable source of growth (which is exactly why it's such a pessimistic prediction!).

spencer writes:

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.

Jesse writes:

Patrick wrote: "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."

I guess I'll just start with that I don't "believe Greenspan single-handedly created the housing bubble."

What I do think, however, is that he was a central figure in providing the environment for a housing bubble and that the blame should be directed primarily at him. There is plenty of blame to go around (Presidents, congress, fannie, freddie, blah blah, etc.) but it jumps out at me that easy credit can drive up prices of real estate to bubble like prices which are unsustainable (POP!). Now to say that is an oversimplification is a real understatement, as there are many conditions to go along with the easy credit, but my blamedar (radar for detecting blame that I'm patenting) beeps very loudly and sharply when I point it at the fed.

As to your mention of real estate bubbles being almost a natural occurrence after asset bubbles (hmm... who should we blame for those?), I assume you're talking pre-Fed eras, in which case, I would guess that there was a discrepancy between credit and savings causing such conditions. I'm not saying you need a central bank to cause bubbles, but if there is a supply of credit that doesn't reflect real savings and you happen to have a central bank hangin' around that caused that discrepancy- I would blame the central bank.

Of course I would be happy to hear your view on things, and I hope my reply doesn't sound too sarcastic- I'm willing to accept that it's very likely that there's something I'm not seeing (historical perspective, asset bubble to real estate bubble correspondences, something!).

SavageView writes:
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.

SavageView writes:
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.

Greenspan:Bush::Burns:Nixon

baconbacon writes:

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.

baconbacon writes:

"I think Kling summarizes it very well - that there is a serious risk of a double-dip recession, that there is no good way out, and that a bubble is the only conceivable source of growth (which is exactly why it's such a pessimistic prediction!)."

Yes, its obvious that Krugman is saying a bubble (or risking a bubble) is the only way to prevent a recession at that time. He is also saying (in that article and many other quotes that have surfaced now) that we should choose the bubble route. Given the events of the past 2 years can anyone actually say that is the rpeferable choice?

baconbacon writes:

"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.

Patrick writes:

baconbacon writes:
"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.

baconbacon writes:

"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.

Crawdad writes:

As a novice it seems that the original critique of Krugman stands. Ben's laundry list above proves Mr. Krugman's repeated explanations of his personal assessment of the need for Fed and governmental response to recessions.

I just keep questioning the assumption, held by Krugman and his defenders here (if I understand the points correctly), that all recessions require immediate Fed and other governmental responses. Aren't recessions necessary for clearing out misallocated capital and resources? And if the only way the government can reverse recessions is to create misallocations of resources in other areas of the economy (bubbles) then isn't that just postponing, and expanding the depth and width of the problems?

I repeat, I'm a novice.

S Andrews writes:

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

Lee Kelly writes:
The current crisis led to a sharp recession that could not be mitigated with monetary expansion. This suggests that in hindsight more should have been done to prevent the housing bubble from expanding as much as it did. This in turn suggests that the monetary easing that took place from 2001-2003 was excessive. However, at the time, the sluggish growth in employment (the 2001-2003 period was commonly referred to as a "jobless recovery") was thought to justify the monetary expansion and low levels of interest rates.
Doesn't this just vindicate the position that macroeconomic meddling is a bad idea, and a conceit that is best not indulged in.
Greg Ransom writes:

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."

Badtux writes:

I read the original Krugman article the same way that Dr. Kling did: i.e., that Krugman was not advocating a bubble but, rather, gloomily predicting an attempt to create one (and predicting that the attempt to create a housing bubble would fail -- so much for Dr. Krugman's infallibility, eh? Oh well!). Quoting someone else's comment about a bubble is not the same as advocating a bubble. Krugman's own opinion about whether the creation of a bubble would be a good idea or not is unknown after reading the actual text of the article, and can only be read into the article by people with axes to grind and reading comprehension deficiencies to spare.

Brad DeLong writes:

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

S Andrews writes:

Badtux,

Here is the list that confirms Krugman's fetish for bubbles - especially one in housing. yes, definitely he thinks housing bubble was a wonderful idea.

portuguese man writes:

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

Bernie writes:

Prof. Krugman actually praised Greenspan for keeping interest rates low in a March 3, 2008 blog entry, "Hair of the dog:"

"One argument I’ve been hearing a lot lately runs as follows: 'Low interest rates got us into this mess, so it’s crazy to think that low interest rates are the solution.'

"Now, I don’t actually buy the first premise: I blame Greenspan for ignoring warnings about subprime and housing, but I still think keeping the Fed funds rate at 1% for a long time was justified by the economy’s weakness, which lasted until late 2003 or even beyond. But it’s true that we had an orgy of over-borrowing in the housing market. So the question remains: does an effort to encourage even more borrowing make sense?

"Yes."

Troy Camplin writes:

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.

Lee Kelly writes:

I think I respect Krugman less after this defence. But mostly I don't want to spend time thinking about him at all. He is either an well-educated fool, or a court economist, so it is unsurprising that he writes for the New York Times.

Arun writes:

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."

Arun writes:

May 28, 2002

"Perhaps the most striking difference between the Reagan recession and the Bush recession involves housing. In 1982, thanks to several years of very high interest rates, home building was moribund: real residential investment was at a 13-year low, more than 40 percent below its previous peak. So there was a lot of demand ready to roll as soon as interest rates fell. In fact, during the first year of the Reagan recovery residential investment rose 46 percent. Basically, it was a housing-led boom.

This time, residential investment kept rising through the recession, thanks to the Fed's interest rate cuts. It's hard to see a dramatic further increase; if anything, housing may be in a mild bubble.

So what will lead us into a full-fledged recovery? Beats me."

http://www.pkarchive.org/column/052802.html

Robz writes:

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!"

Arun writes:

To summarize: on May 28, 2002, Krugman wrote that the Bush recession was unlike the Reagan recession, in that housing recovered from a true slump and led the Reagan recovery; whereas housing had remained healthy during the Bush recession, and could hardly get stronger without entering bubble territory. Therefore (August 2, 2002) the only thing that could lead to a recovery was a housing bubble. But (August 16, 2002) the US had lost 3 of the 4 qualities that made it resistant to a Japanese-style slump (interest rate headroom, strong budgetary outlook, good corporate governance) and was on the verge of losing the fourth - no real estate bubble. "If we do have a housing bubble, and it bursts, we'll be looking a lot too Japanese for comfort.""

How all you commentators come to conclusions you do beats me. If Krugman is controversial it is because most of you can't read. I'm sorry I wasted an evening over this.

The Rage writes:

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.

P Allen writes:

This is no defense of Krugman, but we all must get beyond this “bubble” talk. It’s disruptive, inaccurate, and more importantly misleading. Housing was fueled by a growth in leverage. Leverage increased because of a large imbalance in productivity. To quantify it, productivity has outpaced GDP by an average of 0.62% per quarter since 2000 By the way of comparison, productivity historically lagged GDP by over 1.0 percent per quarter over the last 60 years.

This subsequent productivity imbalance (i.e. surplus) revealed itself in the form of the Fed’s conundrum in early 2005 which they blissfully ignored and therefore began deleveraging the economy (quite unnecessarily mind you) shortly thereafter. That is why the economy is releveraging itself through lower long-term interest rates. That is why interest rates are staying well below the unemployment rate. That is why there are absolutely no sustainable inflationary pressures despite the “unprecedented” amount of manipulation with respect to the money supply.

Libertarians please entertain the thought if only for a minute: We were not over-leveraged; we were underleveraged with respect to the current amount of productivity. You extrapolate on that and not only will recent events make economic sense, but you will also begin to discern future trends such as a strengthening US dollar, a growing trade deficit (to double digits of GDP), further pockets of deflation, and a falling unemployment rate over the course of the next 10 years, at least.

ihaterepublicans writes:

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!

Troy Camplin writes:

Let's take a look at Krugman's latest article in the NYT. First, he is either lying or doesn't understand that almost none of the money in the so-called stimulus hasn't been spent at all yet. Second, he doesn't seem to be aware of the fact that government actions in the economy tend to take about 2 years to be felt. We won't feel the repercussions of Obama's actions for another 16 months or so (to use one of Krugman's numbers). He is right that we shouldn't be taking deflationary measures. But that's about the only thing he's right about.

Tom Maguire writes:

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?

Greg Ransom writes:

I love it that Pimco's McCulley advocated a Fed generated housing boom -- and then a few years later Pimco's Bill Gross advocated having the U.S. government bulldoze 1/10 of the U.S. housing stock

..

don't tell me these guys aren't in it for the money and they wouldn't just as soon burn down the whole country if it made them an extra buck.

Greg Ransom writes:

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.

William writes:

Brad DeLong criticized the rates at the time, but has not blamed the current recession on Greenspan "keeping interests rates too low for too long". That's the hypocrisy Arnold Kling was referring to, which DeLong has not committed.

Fortunately, Arnold re-read his employment contract and discovered that there actually is no clause requiring that he tell lies about Brad DeLong. It's a fairly standard item, which many employers require, but for whatever reason it isn't in Arnold Kling. I guess Arnold is just a shrewd negotiator.

Neil D writes:

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?

Jeremy, Alabama writes:

Let us accept as reasonable the statement "provoking a housing bubble either fixes, or defers and worsens an asset bubble".

Therefore, choosing whether or not to provoke a housing bubble becomes a political not an economic question. Conservatives and libertarians would let the initial bubble collapse without intervention. Left-leaning thinkers would certainly intervene. It is no surprise that Krugman chose the housing bubble route.

Mike writes:

Re #2:

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

Tom writes:

In stating "this in turn suggests that the monetary easing that took place from 2001-2003 was excessive," do you think that this easing resulted from the events following 9/11? In other words, was that easing an overreaction (in hindsight) to the economic impact (or perceived expected impact) of 9/11?

If your answer is "yes," then it would appear that the current federal stimulus is another overreaction.

Does government always need to do anything other than create crisis by its interventionist hand?

Chris Bolts Sr. writes:

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 writes:

Dr. Kling,

>1. 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.

Krugman was cheerfully advocating a housing bubble in 2002 and before. How about this quote from 2001:

"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."

>2. In the event, we had a housing bubble and we got out of the recession. To me, this raises the question of whether a distorted recovery is better than an undistorted recession.

And you call yourself a free market economist? Hello!

>That question might be asked in the context of fiscal stimulus as well--at what point do the distortions of the stimulus outweigh getting out of a recession?

Oh I don't know, at the precise point where one person or group of people initiate physical force against another person or group of people? How about as soon as the government decides to take people's money away from them by force, only to then spend it on the victim's products, and then have the gall to call that "stimulus"?

Do you not even know the meaning of the word "liberty" anymore?

>3. I personally do not think that Greenspan caused the housing bubble.

You are personally wrong. Without persistently low interest rates set by the Fed, the housing boom could not have gotten out of hand like it did.

>I do not believe that monetary policy and short-term interest rates are as all-powerful as many economists do.

Then why doesn't the government give this power away to anyone who wants to use it? Why do they only allow the Fed to produce money?

>[UPDATE: Brad denies committing this hypocrisy, and he is right. He has stood by his views that interest rates in 2001 and 2002 were, if anything, too high. I stand corrected.]

You should rethink all your other claims, because then you will realize you stand corrected on them too.

WOW. I am never coming to this site every again. I never knew a libertarian economics site could be so statist and against liberty! You ought to be ashamed of yourself, MISTER Kling.

Jesse writes:

@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.

Brian Macker writes:

Arnold,

You are full of it. There are too many other articles in which Krugman advocates a housing bubble in order to increase spending to get us out of th recession.

His "Dubya's double dip" article clearly is advocating a housing bubble to offset spending and get us out of the recession. His point being that Greenspan would not be able to pull it off because he was not doing enough. He was wrong on both accounts.

"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off.

...

But wishful thinking aside, I just don't understand the grounds for optimism. Who, exactly, is about to start spending a lot more? At this point it's a lot easier to tell a story about how the recovery will stall than about how it will speed up. And while I like movies with happy endings as much as the next guy, a movie isn't realistic unless the story line makes sense."

Your interpretation of his article is also bogus for another reason. Krugman's response to the current recession. He is again stressing that the government is doing too little monetary pumping despite the unprecidented levels. When the results of this pumping, massive inflation occur he's going to disown that too.

Admit it, the Austrians have been right about this all along, and Krugman and you are the sham economists.

Brian Macker writes:

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.

Wes Dillard writes:

So what about Kugman's strawman protests that he didn't cause the housing bubble, much less the Enron scandal or Kennedy's assassination? The man is willfully missing the point. What is damning about these quotes is not that he necessarily caused anything. What is devastating about them is that they expose the intellectual bankruptcy of his economic principles. Those who look up to him like the second coming of Adam Smith should realize that the neo-Keynesian principles that lead him to advocate aggressive interest-rate cuts and mammoth public spending now, are the very same principles that led him to advocate inducing a housing bubble then. He would himself affirm that his economic principles haven't fundamentally changed since then. So the conclusions and policy prescriptions he infers from them are just as wildly wrong now as they were then.

~Lilburne

Ivan writes:

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.

Dude writes:

[Comment removed pending confirmation of email address and for rudeness. Email the webmaster@econlib.org to request restoring your comment privileges. A valid email address is required to post comments on EconLog.--Econlib Ed.]

Brian Macker writes:

"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.

john writes:

Mr. Kling you are wrong for defending Krugman here. In his response to criticism Krugman wrote: "What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble." Those are his words. From this there are only two possible positions Krugman can take:

1. He supported the housing bubble as it would give the Fed "traction".

or

2. He did not support the housing bubble and didn't want the Fed to fight the recession.

Based on Krugman's writing and economic philosophy can you seriously write that Krugman did not advocate a housing bubble? When has Krugman ever wanted the Fed to NOT fight recessions?

Your questioning of whether a distorted recovery is better than an undistorted recession is also off base. In the first place, the "recovery" was not a real recovery; it was an artificial boom that only prolonged the inevitable bust. The economy must adjust to reflect the real amount of capital and real wealth. Capital is finite; therefore, distorted recoveries (as you say) are doomed to become busts. Additionally, undistorted recessions are exactly those that recover quickest, as they allow the real economy to adjust. "Distorted recoveries" haven't worked presently, in the 1970s, in Japan during the 1990s or in the U.S. in the 1930s. However, a true "undistorted recession" where government didn't get involved led to a quick, neat turnaroud. See 1920-1921

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