Wednesday, February 27, 2013

What Miles Kimball Gets Wrong About Krugman on Italy's Economy

     Kimball went after Krugman on his Italy post criticizing the austerity imposed in the name of growth. He argues that arguing for fiscal stimulus even during this recession is dangerous as leads to more and more debt:

     "In the last few days, while the US political debate centers on ways to deal with burgeoning debt, UK government debt has been downgraded and investors are demanding much higher yields on Italian debt in the wake of the Italian election results (paywall). As concerns about national credit ratings push economies around the world toward austerity–government spending cuts and tax hikes–some commentators are still calling for economic stimulus at any cost. Joe Weisenthal wrote that David Cameron must spend more money in order to save the British economy. Paul Krugman wrote in “Austerity, Italian Style” that austerity policies simply don’t work. The downside of their prescription of more spending—and perhaps lower taxes—is that it would add to the United Kingdom’s and to Italy’s national debt. And national debt beyond a certain point can be very costly in terms of economic growth, as renowned economists Carmen ReinhartVincent Reinhart, and Kenneth Rogoff convincingly show in their National Bureau of Economic Research Working Paper “Debt Overhangs, Past and Present.”

      Kimball notes that Britain's debt is predicted to rise to 98% of GDP in 2013 with Italy rising to 120%.

      He argues instead for his pet idea of open lines of credit to individuals and businesses-something he's argued for in the past. It seems to be based on the idea that paper cash should be treated differently than electronic cash.

      "First, instead of raising spending or cutting taxes, the Italian and UK governments can directly provide lines of credit to households, as I have proposed for troubled euro-zone countries and for the UK. Although there would be some loan losses, the ratio of stimulus in addition to the national debt would lead to a much better outcome. In particular, after full economic recovery in the short-run, there would be much less debt overhang to cause long-run problems after such a national lines of credit policy  than under Weisenthal’s or Krugman’s prescriptions."

      He then educates Joe Weisenthal on the Zero Bound:

      "But for the UK, it is an even more important mistake to think that monetary policy can’t cut short-term interest rates below zero. Weisenthal quotes a post on Barnejek’s blog, “Has Britain Finally Cornered Itself?” that illustrates the faulty thinking I’m talking about:
Before I start, however, I would like to thank the British government for conducting a massive social experiment, which will be used in decades to come as a proof that a tight fiscal/loose monetary policy mix does not work in an environment of a liquidity trap. We sort of knew that from the theory anyway but now we have plenty of data to base that on.
     “Liquidity trap” is code for the inability of the Bank of England to lower interest rates below zero. The faulty thinking is to treat the “liquidity trap” or the “Zero Lower Bound,” as modern macroeconomists are more likely to call it, as if it were a law of nature. The Zero Lower Bound is not a law of nature! It is a consequence of treating money in bank accounts and paper currency as interchangeable. As I explain in a series of Quartz columns (123 and 4) and posts on my blog—that is a matter of economic policy and law that can easily be changed. As soon as paper pounds are treated as different creatures from electronic pounds in bank accounts, it is easy to keep paper pounds from interfering with the conduct of monetary policy. In times when the Bank of England needs to lower short-term interest rates below zero, the effective rate of return on paper pounds can be kept below zero by announcing a crawling peg “exchange rate” between paper pounds and electronic pounds that has the paper pounds gradually depreciating relative to electronic pounds."
     "In his advice for the UK, Weisenthal should either explain why having an exchange rate between paper pounds and pounds in bank accounts is worse than a massive explosion of debt or join me in tilting against a windmill less tilted against. And for those who read Krugman’s columns, it would take a bad memory indeed not to recall that he gives the corresponding advice of stimulus by additional government spending for the US, which faces its own debt problem. I hope Paul Krugman will join me too in attacking the Zero Lower Bound."
     "In 1896 William Jennings Bryan famously declared: “… you shall not crucify mankind on a cross of gold.”
     "In our time it is not gold that is crucifying the world economy (though some would return us to the problems that were caused by the gold standard), but the unthinking worldwide policy of treating paper currency as interchangeable with money in bank accounts. So for our era, let us say: You shall not crucify humankind on a paper cross."
     I'm glad to see Krugman got back to him quickly:
     "Mark Thoma points me to a post by Miles Kimball titled What Paul Krugman Got Wrong About Italy’s Economy. So I wondered what important features I got wrong — but to my great disappointment all I found was yet another invocation of the Reinhart-Rogoff claim that bad things happen when debt goes about 90 percent of GDP.
     "Look, this is just not an established result. It’s a correlation; but it could just as well reflect a pathway from slow growth to high debt, or from third factors like political and institutional dysfunction to both slow growth and high debt."
    "This last possibility becomes especially persuasive when you look at the full list of advanced countries that have exceeded the supposed 90 percent threshold in the past 50 years: Japan, Italy, Belgium, Greece. That’s it. So yes, Japan and Italy have had high debt and slow growth; do you really want to say that debt was the only reason for slow growth, or that the Japanese slowdown of the 1990s had no role in causing the rise in debt? Do you really want to say that debt is the only reason for Italy’s poor performance? If your answer to either question is no, you have just said that you don’t believe in Reinhart-Rogoff’s results."
      Yes, this correlation has not been proven to be a causation. Krugman expresses surprise that a serious economist like Kimball would get this wrong-he ends up sounding like David Brooks, Bob Woodward, or David Gregory-a Very Serious Person, rather than a serious economist. 
      Krugman doesn't bother to get into it, but Kimball sounds even more userious with his naive equating of Britain and Italy-as if the fact that Britain has it's own printing press doesn't make it's monetary system a horse of a wholly different color than Italy's. 
      On the other hand I would have been interested to hear what Krugman makes of Kimball's overarching idea of lines of credit. While he's clearly wrong in evoking a debt scare, is his idea of lines of credit a good one? I haven't seen many who have even analysed this idea. Is there a lot to gain by eschewing paper cash?
      P/S. I apologize that many of the links I've been putting up haven't been ready to be clicked. It seems that since I started using Google Chrome I've had this problem. Does anyone know how to format it properly? I stopped using Internet Explorer as I was having so many problems with it the last week-it keeps freezing up. 
      However, Google Chrome seems not to let these links actually be linked to-forcing you to have to cut and paste in the browser. If I can't figure it out-I might try Firefox next. 
      I notice that it's not all links that don't work. Politico seems to work although often when I cut and past stuff the font comes in at the wrong size or something. 


  1. IMO the federal lines of credit are a bad idea, at least as currently conceived. Who will be eligible for credit? How much can household receive and at what rate? The central bank doesn't have any profit incentive, which suggests the loans are likely to be severely under-priced. The CB also does not involve elected officials, so the funds can be given to whomever has favor with the Fed. The most likely outcome is that wealthier individuals get a chance to borrow at below market rates for the primary purpose of boosting asset prices.


  2. Do you agree with Krugman-and my-criticism of Kimball?

    As far as the lines of credit I imagined it was need based-have to read more about it I guess.

    What does the Fed ever do from a profit motive? Why would you want a government agency-that's in theory supposed to work for the public good-serving partiuclar private interests, which is what a profit motive would encourage-admittedly that's the case to a good extent with the Fed now.

    1. Yes, I think Kimball was on the wrong track with his criticisms.

      The point of a profit motive is creating incentives for aligning risk with reward. Here's an example without a profit motive...

      The Fed decides the inventory of $1+ million houses is too high. Trying to create a wealth effect, the Fed lends $1 billion at 0% interest to individuals with spotty credit histories. Imagine that 10% default on these loans. The Fed loses $100 million, which was effectively fiscal 'stimulus'.

      Now in that situation the Fed, a govt agency, was working for the public good-serving particular private interests. The only catch is that the Fed was transferring sizable economic profits to upper-middle class households. Is that better than our current system?

      Another problem is that if the govt provides loans at 0% (or simply below private bank rates), why would anyone borrow from a bank? Ok, so you nationalize the banking/credit system. Now how much lending is appropriate (i.e. how much inflation will you tolerate)? If a limit exists, than there is a significant first-mover advantage to borrow as much as possible from the govt and buy real goods before prices shoot higher. If the govt is unable to limit itself, then you actually do get hyperinflation.

      These are just some of the risks inherent in a system of federal credit lines.