David R. Henderson  

Paul Krugman's Switch on the Housing Bubble

The Feeling is Mutual... Supply, Demand, and the Rise o...

From advocate to opponent.


The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. 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.

From Paul Krugman, "Dubya's Double Dip?" New York Times, August 2, 2002.


Some say the worst is already over. Mr. Greenspan, who's been an optimist all the way, now argues that the latest data on new-home sales and mortgage applications suggest that housing has already bottomed out. Business investment is still growing briskly, and so far consumers haven't cut their spending. So maybe this is as bad as it gets.

But I think the pessimists have a stronger case. There's a lot of evidence that home prices, although they've started to decline, are still way out of line. Spending on home construction remains abnormally high as a percentage of G.D.P., because banks are still lending freely in spite of rapidly rising foreclosure rates.

This means that home sales probably still have a long way to fall. And you don't want to make too much of the fact that some housing indicators have turned up; those indicators tend to bounce around a lot from month to month.

Moreover, much of the good news in the latest economic report is unsustainable at best, suspect at worst. Almost half of last quarter's estimated growth was the result of a reported surge in automobile output, which some observers think was a statistical illusion, not something that really happened.

So this is probably just the beginning. How bad can it get? Well, you don't have to go far to find grim forecasts: Merrill Lynch predicts that the unemployment rate will rise from 4.6 percent now to 5.8 percent by the end of next year.

In case you're wondering, I don't blame the Bush administration for the latest bad economic numbers. If anyone is to blame for the current situation, it's Mr. Greenspan, who pooh-poohed warnings about an emerging bubble and did nothing to crack down on irresponsible lending.

From Paul Krugman, "Bursting Bubble Blues," New York Times, October 30, 2006.

HT to Justin Rietz and Jeff Hummel.

Update: Like commenter David Clayton below, I recommend that readers read Krugman's whole 2002 article. I think my interpretation, that he was saying a bubble would be a good thing, holds up to scrutiny.

Update 2: More advocacy from Krugman

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. [italics added.]
From LOU DOBBS MONEYLINE, July 18, 2001: Interview with Paul Krugman.

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CATEGORIES: Macroeconomics

COMMENTS (16 to date)
GoogleBingAsk writes:

"So did I call for a bubble? The quote comes from this 2002 piece, in which I was pessimistic about the Fed’s ability to generate a sustained economy. If you read it in context, you’ll see that I wasn’t calling for a bubble — I was talking about the limits to the Fed’s powers, saying that the only way Greenspan could achieve recovery would be if he were able to create a new bubble, which is NOT the same thing as saying that this was a good idea."


Really, there is this wonderful tool called Google. Try it the next time.

David Clayton writes:

How exactly is it advocacy when a writer mentions somebody else's idea, doesn't back it up, and doesn't use it to create or strengthen an argument? Perhaps the nuance is too subtle, but in the context of the paragraph, the bubble idea is a fanciful possibility.

The column, which I encourage everyone to actually read and process for themselves, was talking about the increased chances of a recession, and wondering from where the growth that might avert it could possibly come.

Just the tiniest bit of context shows the absurdity of your assertion here. Surely you can do better than this? If Krugman was really advocating a housing bubble, you must have more than a single clause that clearly doesn't indicate anything more than the difficulty of the situation Greenspan was in?

Bob Murphy writes:

I don't see how anyone can read the 2002 column and doubt that Krugman was *for* a housing bubble to rescue the economy. Otherwise, his movie analogies make no sense. Are you guys saying Krugman wanted the protaganists in the movies to get overrun by enemy forces?

Anyway, in 2006 Krugman was more explicit. Here's his exchange with a reader:


Neeraj Mehra, Amritsar, India: Mr. Greenspan has done a disservice to the nation by creating the housing boom. As a layman-observer, that’s the lingering thought I’ve had. Your article reaffirms it.

The question I have is this: Did he do the right thing — acting morally by engineering a housing boom, more as a bridge loan, until something else showed up at the horizon to shore up the economy — because he didn’t have a choice, or did he undertake a path of mere political expediency? And, that’s a question that’s nagging me for a while.

Would appreciate it if you could shed some light.

Paul Krugman: As Paul McCulley of PIMCO remarked when the tech boom crashed, Greenspan needed to create a housing bubble to replace the technology bubble. So within limits he may have done the right thing. But by late 2004 he should have seen the danger signs and warned against what was happening; such a warning could have taken the place of rising interest rates. He didn’t, and he left a terrible mess for Ben Bernanke.

Justin R. writes:

Looking at the 2002 article, the paragraph after the one quoted here does provide context:

"Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off. But the Fed chairman's crystal ball has been cloudy lately; remember how he urged Congress to cut taxes to head off the risk of excessive budget surpluses? And a sober look at recent data is not encouraging."

In this paragraph, Krugman opines that Greenspan is too optimistic about the economy and by implication won't take the needed measures to turn things around. So the contrast Krugman is making is NOT that Greenspan and the Fed were limited in what they could do, but rather that they were unwilling to do what was needed because they didn't understand how bad the economy was.

As far as the clarification, it's a classic case of CYA. At least JM Keynes admitted when he had changed his mind.

Lord writes:

There was nothing wrong with promoting a housing based recovery in 2002, and nothing wrong with pointing out how bad it had become by 2006. The mistake was not lower interest rates but allowing bad lending. There is no inconsistency in supporting what would be good when it would be good and decrying what is bad when it is bad. What is good in some circumstances and in some measure does not make it good in all circumstances and without measure.

Daniel writes:

I think you are reaching here.

A lot.

No one but no one openly advocates for a bubble. Bubbles are universally seen as bad things, unless they happen to your enemies. That, by itself, should have been enough to show the irrelevancy of the first quote. (In fact, your own blogging partner thinks that this quote should be used this way...


Then you double down by equivocating.

A lot.

Advocating for a lower interest rate during economically slow times is a far cry from advocating for a bubble. If you wanted a thesis of "Paul Krugman pushed for lower interest rates in 2001", fine. But it's a LONG ways from there to "Paul Krugman advocated for a housing bubble." A very long ways.

Krugamn denies he ever favored a bubble (and, again, who in their right mind would). If there's a lack of clarity in someone's words (though here there is not much even of that), they should be the prime interpreter. Benefit of the doubt doesn't go other commentator.

John Brennan writes:

Krugman has been a crafty head faker on this issue. Of course, he has to careful how he approaches Greenspan's culpability because, within his column and blog between 2001 and 2003, he was for extremely low interest rates to ward off deflation. This sets him up as being supporting Greenspan in fomenting the bubble. As such, he reasons that the low interest rates had nothing to do with increased housing investment and that the real culpability lie in an international savings glut during the time (how this is separate from the Fed keeping rates low is not entirely clear). Notice that his critique of Greenspan lies in his regulatory malfeasance (which is true to a large degree) not in his power to set interest rates (which is John Taylor's core critique). This is pretty deft on his part given that fact that he also has opined that Fannie and Freddie had nothing to do with the financial crisis--which is very factually challenged. To confuse things further, Greenspan made statements regarding increased regulation for the GSEs (such as Fannie and Freddie), but never really followed through--but Krugman has not jumped on Greenspan for this specifically. Krugman is smart and slick!

Justin R. writes:

Daniel -

Read Bob Murphy's post (and follow the link to verify what is said). To directly quote Krugman:

"As Paul McCulley of PIMCO remarked when the tech boom crashed, Greenspan needed to create a housing bubble to replace the technology bubble"

Yes, he later says that the Fed should have pulled back in 2004. But that's a bit easier to say in October 2006 looking back. And considering that Krugman was making his initial statement in August of 2002, he expected an amazing amount of fine tuning in a short period of time.

David R. Henderson writes:

@John Brennan,
just to be clear, though, I agree with Krugman and Bernanke that a savings glut was behind the decline in real interest rates. I was focusing only on Krugman's lack of consistency, not on Greenspan's alleged control over the economy.

Yancey Ward writes:

Well, back in 2002, what, exactly, was Krugman proposing to be done about the economy that he was worried about. If not the ultra low (for that day) interest rates that Greenspan initiated, then, if I go by the Krugman of today, then I can assume he was vigorously advocating for a strong stimulus program that gave no heed to growing budget deficits in 2002. Right?

Daniel writes:

Justin -

You aren't directly quoting from Krugman. He didn't say "...Greenspan needed to create a housing bubble", it's "Greenspan needs to create a housing bubble". I'll agree it's a trivial difference as long as you aren't saying that Krugman agreed with what happened looking back on it. It just seemed to be a strange slip, especially since I would have thought you'd use cut and paste.

More substantially, look at the end of the post. He's projecting a bad outcome, thinking that no help is coming. It isn't a post laying out a new plan. And, again, no one hopes for a bubble. They are bad news by definition.

What you've got are calls for cuts in interest rates from 2000 to like 2004. To the degree that that set off the housing bubble, Krugman has to take some of the bows. But a smoking gun to him actually calling for a bubble, that you don't have.

Justin R. writes:

As I said I am referring to the 2006 article that Bob Murphy quotes which clearly says "needed." As a practical matter it must be in the past tense as Greenspan was no longer at the fed when the article was written.

Dave writes:

With regard to the first comment and Krugman discussing the limits of the Fed's power, here's another quote from Krugman, just three years prior:

"If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God."

Sounds like a real skeptic...


David Clayton writes:

Let's do this in chronological order. First, the Moneyline quote, which is from July 2001:

"[B]usiness investment is not going to be the driving force in this recovery. It has to come from things like housing."

This is a statement of the problem - the usual savior, business investment, isn't going to save us this time, and housing is the most obvious other potential savior. Dobbs asks if consumers can do it.

"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."

Dobbs asked him if the consumer could fill the gap, with the implied question of HOW. Krugman answered the question. There's no advocacy here.

Move to your originally column quoted, from a year later. Here's the passage you're misunderstanding:

"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."

You think in the last sentence that "Greenspan needs to create" is a call to action. It's not. Here's an equivalent passage.

"To beat Tiger Woods at golf, you need more than your best-ever round; you need Tiger to fear for his life. And to do that, as Don Corleone put it, you need to make him an offer he can't refuse."

Did I just advocate threatening Tiger's life, or did I express how hard it would be to beat him?

roystgnr writes:

David's interpretation basically agrees with Krugman's after-the-fact reinterpretation of his own remarks...

But is this really an improvement? If Krugman really has converted to the belief that governments and central banks can't fix recessions without creating worse long-term problems, wouldn't it be better for him to be clearer about saying so, and for him to try to apply this belief in future recommendations rather than just in hindsight?

Otherwise, what other advocacy of "bad news by definition" policies do we need to re-evaluate?

Krugman, from alternate-universe 2015: "Well, yes, technically I did say that we needed a $2.9 trillion stimulus to fix the economy, but you weren't supposed to actually spend 2.9 trillion dollars! Mammoth debts are universally seen as bad things, and deliberately putting us on an unsustainable debt trajectory would just be absurd!"

David Clayton writes:

So let me get this straight - you seem to be choosing not to contest my "interpretation" that this is NOT advocacy, but instead try to set up an equivalence between Krugman's positions on additional stimulus and a 2000's housing bubble.

Your example hurts your argument. In how many of his columns, posts, and interviews do you think you can find words that could be "interpreted" as advocating additional stimulus? Do you think it might just be more than TWO?

If there were a mountaintop in Princeton, people in Lawrenceville might hear the word "infrastructure" floating on the wind. Krugman's advocacy of that notion is undeniable, and quite easy to find. If he was advocating a bubble, surely some Krugman hater has compiled every word written or uttered that supports this notion?

Or perhaps the original post and update were just that: a complete listing of every instance where Krugman might be considered to be advocating this. From hundreds of thousands of words of source material.

Please show me this is not the case. It would be so sad if so many could be so easily swayed by so little.

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