April 20, 2004

#155: No and no!

P. Krugman

The historically low long-term interest rates as reflected currently by the yield on the 10-year US Treasury bond are an embarrassing problem for Paul Krugman and Democrat economists. At a lethargic 4.3%, the long bond yield continues to be "the dog that won't bark" and greatly complicates his assaults on the Bush administration's fiscal policies. In Questions of Interest (04/20/04) Krugman gives that dog a kick to see if he can't at least get a yelp out of it. We didn't hear anything yet.

Here's Krugman's problem. Under orthodox Rubinomics (named for former Treasury Secretary Robert Rubin) an omniscient bond market is the ultimate arbiter of economic well-being. Governments pursuing reckless fiscal policies are quickly brought to heel by higher yields in the bond market which sees right through their chicanery. Hence, a cogent argument for economic gloom and doom based on "irresponsible tax cuts for the rich", "fiscal deficits as far as the eye can see" and looming "banana republic-hood", requires some sort of a red flag coming from the 10-year bond. But the bond market is not cooperating. Instead yields are just lollygagging around near a 40-year low.

So Krugman tries a new tack. WHAT IF, he asks rhetorically, interest rates and inflation go back up to their long-run averages of, say, 7% and 3% respectively? Isn't that terrible? Won't the dog be barking then?

No and no! It's not bad at all. And it might even happen – Krugman has been right before on occasion. However, his larger problem is that to get us to that point he has to assume that the economy either recovers fully or is perceived to be recovering fully. Contrast that with the current perception reflected in polls showing that the economy is under performing. If that perception changes toward more optimism in the next 6 months Bush will be reelected with growing legislative majorities. Rates may rise some, but the dog still won't bark.

[The Truth Squad is a group of economists who have long marveled at the writings of Paul Krugman. The Squad Reports are synopses of their discussions. ]

Posted by John Weidner at April 20, 2004 9:40 AM
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