Krugman’s Call for a Housing Bubble

In 2009, Lew Rockwell posted this quote of Paul Krugman’s from a 2002 New York Times editorial:

To fight this recession the Fed needs…soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Krugman. 2002. Calling for a housing bubble.

What’s more, by explicitly calling for a new bubble to replace the recently burst one, he anticipated by 6 years The Onion‘s hilarious “report” that “demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income.” Except Krugman was being serious.

The quote caught on in the blogosphere, to such an extent that Krugman actually responded in his New York Times blog:

Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened.

So with a deft little two-step, Krugman painted himself as a doctor who gave an excellent diagnostic, and not a disastrous prescription. One of his ditto-heads posted on his blog that saying Krugman advocated or caused the housing bubble was “Like saying Nostradamus caused the rise of European fascism.”

Even economist Arnold Kling bent over backwards to interpret the column in a benign light:

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.

Mark Thornton on Mises.org followed up with a devastating collection of 2001 Krugman quotesclearly documenting his support for inducing a housing bubble. The most damning of this batch is the following from a 2001 interview with Lou Dobbs:

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. [emphasis added]

How can anyone spin that as a purely academic musing, and not a policy recommendation for artificially inducing housing spending?

Ignoring the other quotes for a moment, and just judging from the 2002 column, did Krugman support pumping up a housing bubble or not? Given that, even in his blog post defending himself, he explicitly stated his belief that “the only way the Fed could get traction would be if it could inflate a housing bubble,” there are only two possibilities:

1. He did not support inducing a housing bubble, and wanted the Fed to not fight the recession.
2. He did support inducing a housing bubble.

Anyone even somewhat familiar with Krugman’s attitude toward Fed activism should know that proposition #1, that Krugman supported a do-nothing policy, is preposterous. So, especially after bringing back in the quotes gathered by Mark Thornton, the case for proposition #2 is overwhelming.

And what about his 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 as an economic sage should realize that the neo-Keynesian principles that led 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.

Krugman’s first editorial could be twisted, if one was inclined to twist, into something seemingly benign. The second wave of quotes is much harder to mischaracterize (which is not to say that the most unquestioning of Krugman’s devotees don’t try). The laziest tactic of the Krugman apologists is to only address the more stretchable 2002 editorial, and completely ignore the 2001 quotes. But not even that approach, if accepted, helps Krugman’s case, since the 2002 editorial is damning enough on its own, once the benign interpretations of Krugman’s apologists are shown to be nonsense.

One protestation offered has been that a quotation offered above omits the context, which shows that Krugman was “merely” quoting someone else:

To fight this recession the Fed needs … soaring household spending to offset moribund business investment. [So] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

The last sentence quoted reads in full,

And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

“Partisan misquoting!” the apologists cry. But lets pull the lens back even further, and add even more context by including the whole paragraph, and the one preceding it.

A few months ago the vast majority of business economists mocked concerns about a”double dip,” a second leg to the downturn. But there were a few dogged iconoclasts out there, most notably Stephen Roach at Morgan Stanley. As I’ve repeatedly said in this column, the arguments of the double-dippers made a lot of sense. And their story now looks more plausible than ever.

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. [Emphasis added.]

So the first paragraph introduces the “double-dipper iconoclasts”, and then clearly states that he, Krugman, agrees with them. The second paragraph then outlines the “basic point” of the double-dippers, which again, he agrees with. And the basic point in question is that to “fight this recession the Fed … needs soaring household spending.”

Krugman then continues to say how the Fed would need to accomplish this goal, which again, he supports; he says that the recession needs to be fought with soaring household spending, which Alan Greenspan needs to induce by creating a housing bubble to replace the Nasdaq bubble. By writing, “as Paul McCulley of Pimco put it”, Krugman is not “merely” quoting another person; he is using someone else’s phraseology to express his own opinion.

Another protestation is that Krugman was saying the housing bubble won’t work, since later in the editorial he wrote,

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.

But this protestation completely ignores the fact that when Krugman wrote in the editorial,

Despite the bad news, most commentators, like Mr. Greenspan, remain optimistic.

and

But wishful thinking aside, I just don’t understand the grounds for optimism. Who, exactly, is about to start spending a lot more? [Emphasis added.]

he was clearly characterizing a housing bubble as an object to be desired, whether or not he thought it was possible. In other words, at best, Krugman could be interpreted as saying that it would be great if Greenspan could pull off a housing bubble, but that he, Krugman, doubts whether he’ll be able to accomplish such a worthy feat.

So it should be clear that the Fed causing a housing bubble in order to bring about “soaring household spending” was Krugman’s optimal situation, whether or not he thought it was doable at the time. Given the consequences of the housing bubble that did ultimately happen, that alone should be enough cause for the public to stop listening to this fellow.

Another question is, how did he see the Fed bringing about his optimal situation? He answered this question himself in a 2002 interview with Lou Dobbs (which can be found here, though not at the page originally linked to in Thornton’s collection):

Low interest rates, which promote spending on housing and other durable goods, are the main answer. [Emphasis added.]

This brings us to the key point that all the Krugman apologists egregiously ignore: namely that it would be surprising if such an arch-Keynesian economist as Krugman (he’s written extensively on what he has called “the greatness of Keynes”) didn’t adovocate a housing bubble to replace the dot-com bubble, since doing so would dovetail perfectly with basic Keynesian doctrine. As a Keynesian, Krugman should have wanted lower interest rates (as he actually did want, as is revealed by the previous quote). To quote Keynes himself,

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom. (General Theory, p. 322; emphasis added, but the exclamation point is Keynes’s own.)

To be true to his Keynesian principles, Krugman ought to have to welcomed the housing bubble, since to him,

1. it was a good way to achieve his coveted “soaring household spending”, and
2. it was the likely result of Keynesianism-prescribed lower interest rates.

Now let’s take a look at some even more directly damning evidence of Krugman’s pro-bubble economics. Above, I pointed out that in Krugman’s 2001 editorial, he implicitly agreed with theOnion’s facetious call for a new bubble to replace the old one. In a brilliant comment left in Krugman’s own blog (which you can still read), one “M Ingelmo” reveals that in 2009 Krugmanexplicitly agreed with the Onion piece.

Mr. Krugman,

I don’t know if you were on the grassy knoll, too, but you certainly were in Spain in March, chatting with that most fervent of your admirers, Prime Minister Mr. Zapatero, and interviewed in the Spanish public TV channel.

Since these days a video is worth a thousand words, allow me to quote you and say: “guys, watch it for yourselves”. The program is about other things, innovation, and in Spanish (sorry), so go straight to the 35 seconds in the interview after minute 2:50. Under the Spanish translation I’m sure you’ll be able to hear the English original. Quite enlightening:

To be honest, a new bubble now would help us out a lot even if we paid for it later. This is a really good time for a bubble…

There was a headline in a satirical newspaper in the US last summer that said: “The nation demands a new bubble to invest in” And that’s pretty much right.

http://www.rtve.es/mediateca/videos/20090502/innovar-para-salir-crisis-informe-semanal/495712.shtml

Not a piece of policy advocacy? Just economic analysis? Will it look like it to all your defenders and commentators here? Personally I am delighted with the words “pay for it later”; are we paying right now for the last one, advocated in 2002, or maybe not enough yet, Mr. Krugman?

If governments follow your “not-a-piece-of-policy-advocacy-just-economic-analysis”, (as it seems certain at least with ours), when that new bubble thus inflated eventually bursts, and we are “paying for it” in a few years time, what will you write in your blog then, Mr. Krugman?

But perhaps the most instructive lesson out of all this is that, implicit in Krugman’s quotes, there is a big fat finger of blame pointed directly (and correctly) at the Federal Reserve. Krugman himself would only admit to blaming other factors for our present crisis. But, if

1. as any sane person will recognize in hindsight, the housing bubble was disastrous for the economy
2. as Krugman himself stated, the Fed can induce such a bubble by lowering interest rates, and
3. as the public record shows, the Fed did drastically lower interest rates in the time leading up to, and in the thick of, the housing bubble,

…then according to the vanishingly few economic principles Krugman actually gets right, he shouldblame the Fed for the present crisis.

As it turns out, Krugman’s apologists shouldn’t demand more context for his notorious quotes, since it only shines even more light on how backward are his economic doctrines and prescriptions.

Paul Krugman Advised Fed To Create A Housing Bubble In 2002

Americans have been whipsawed by devastating cycles of boom and bust over the past three decades. Now some at the Fed want us to go through it again.

The excesses of the 1980s — leveraged buyouts, the junk bond bubble and wild property speculation — led directly to the original “jobless recovery” of the early 1990s. This occurred despite a prolonged period of very low interest rates. (The 1990 tax increases and post-Cold War defense cuts were probably counterproductive.) In many ways, that episode was a dress rehearsal for the recent crisis, so it makes sense that some of the most interesting writings about the dangers of excessive private borrowing come from that earlier time.

It didn’t take long for the next boom and bust cycle to hit. In the second half of the 1990s, the irrational exuberance of stock investors fueled a binge of business spending.Real nonresidential private investment increased at an annualized rate of more than 12 percent between the beginning of 1996 and the middle of 2000. That changed once firms realized that they had been wasting their money on bad investments and unneeded capacity. Capital expenditures plummeted by nearly 20 percent between the middle of 2000 and the end of 2001. Real business investment didn’t return to its pre-recession level until the beginning of 2005.

The massive swing in capital spending plunged the economy into recession and held back the recovery for years. According to the Census Bureau’s Current Population Survey, real median incomes (for individuals, not households) increased at an annualized rate of just 0.2 percent from 2001 through 2007. More Americans wereworking in the private sector in December, 2000, than in May, 2005. Since the population of prime-age workers was expanding throughout this period, the actual damage was even worse. Again, this was in spite of the fact that real interest rates were very low for a long time and in spite of the large tax cuts and spending increases of the early 2000s.

In 2002, economist Paul Krugman, who would go on to win a Nobel Prize in 2008,advised that the Fed “create a housing bubble to replace the Nasdaq bubble.” In his view, this would allow “soaring household spending to offset moribund business investment.” (Krugman began warning that the housing bubble was dangerous in 2005.)

We now have extensive evidence that the wanton borrowing that fueled the recent housing bubble made the economy vulnerable to the devastating downturn the U.S. endured. This shouldn’t have been surprising. After studying every business cycle experienced by 14 rich countries since 1870, Oscar Jorda, Moritz Schularick and Alan Taylor found that excessive private credit growth systematically predicts deeper downturns and slower recoveries.

Back in the 2000s, however, most people just wanted to get out of the funk associated with the aftermath of the tech boom. There was also a widespread belief that bubbles aren’t dangerous as long as the central bank is around to “clean up” the mess when they burst. This view was best articulated by Ben Bernanke in 1999. As a result, many monetary policymakers were untroubled by the prospect of creating a new bubble to replace the old one.

Transcripts of the Fed’s internal meetings make it clear that this was their conscious plan. On March 16, 2004, Donald Kohn, a longtime Fed staffer who later became the Fed’s vice chairman, said that the credit bubble was “deliberate and a desirable effect of the stance of policy.” According to Kohn, the Fed’s strategy was: “boost asset prices in order to stimulate demand.” That appeared to work for a short time, but it ended badly. We’re still struggling to emerge from the wreckage despite, yet again, incredibly low real interest rates and very large government budget deficits. Clearly, cleaning up after bubbles is harder than it’s made out to be.

One might think that the Fed has learned something from this experience. A recent speech from Nayarana Kocherlakota, the president of the Minneapolis Federal Reserve Bank, suggests otherwise. He said that the Fed “will only be able to achieve its congressionally mandated objectives by following policies that result in signs of financial market instability.” In other words, he wants to repeat the exact same formula that Donald Kohn endorsed in the 2000s.

According to Kocherlakota, the Fed is incapable of lowering the unemployment rate without creating more bubbles. This attitude is strange; Kocherlakota implicitly denies the possibility that the economy could ever grow at a healthy pace without the stimulus provided by unsustainable asset bubbles. More precisely, he said that the Fed needed real interest rates to be “unusually low for a considerable period of time” and that this would lead to “unusual financial market outcomes” including “inflated asset prices, high asset return volatility and heightened merger activity.” Surely there must be a better way.

To his credit, Kocherlakota acknowledged the possibility that “raising the real interest rate may reduce the risk of a financial crisis — a crisis which could give rise to a much larger fall in employment and prices.” However, he seemed confident that this would be unnecessary. In his view, regulators will do a far better job in the 2010s than they did in the 2000s. Troublingly, Kocherlakota’s only support for this assertion was that “the Federal Reserve System now dedicates a significant amount of our best staff resources to financial system surveillance.”

A different view comes from Jeremy Stein, a governor on the Federal Reserve Board. Back in February, he warned that the most pernicious consequences of low real interest rates could not be prevented by regulation:

“Despite much recent progress, supervisory and regulatory tools remain imperfect in their ability to promptly address many sorts of financial stability concerns. If the underlying economic environment creates a strong incentive for financial institutions to, say, take on more credit risk in a reach for yield, it is unlikely that regulatory tools can completely contain this behavior.”

Stein went on to argue that there will be times when the Fed has to use monetary policy to maintain financial stability and fulfill its long-term objectives:

“While monetary policy may not be quite the right tool for the job, it has one important advantage relative to supervision and regulation — namely that it gets in all of the cracks. The one thing that a commercial bank, a broker-dealer, an offshore hedge fund, and a special purpose ABCP [asset-backed commercial paper] vehicle have in common is that they all face the same set of market interest rates. To the extent that market rates exert an influence on risk appetite, or on the incentives to engage in maturity transformation, changes in rates may reach into corners of the market that supervision and regulation cannot.”

Regrettably, Stein’s perspective seems to be a minority view at the Fed right now. The issue isn’t what to do right now so much as the tradeoffs policymakers will face in the near future. Raising interest rates today would probably do more harm than good. At some point, though, the relative costs and benefits will be less clear and these distinctions will start to matter.

Kocherlakota expects real rates to be “unusually low” for “the next five to 10 years.” By contrast, Stein is concerned that the worst practices of the go-go years will return sooner — along with their predictable consequences — if preventive action isn’t taken sooner. This disagreement will be one of the most important economic policy debates of our time.
There is a word for people who do the same thing over and over again, expecting different results: insane. Let’s hope that they don’t constitute a majority of the Fed’s voting members, or we will once again be doomed to another destructive and pointless cycle of boom and bust.

Bubble? What Bubble?

Even this crappy looking hone just sold for 1.5 million in Totonto … And you know what, this property is described as “This house is a hazard for kids that play around there[…] it has been there for ages now.”

Isn’t Canada a wonderland for real estate?

Well, you can only envy.