Commenting on Krugman

by Robert

Krugman is back to arguing that this recession will be followed by a long period of slack, that is low employment growth as were the last two and that therefore the standard argument in, for example, his textbook against fiscal stimulus and especially against spending as a stimulus is not convincing in this case.

The key paragraph is

So what is the right criterion? Actually, I think it’s quite straightforward. The reason we’re talking about fiscal policy is the fact that monetary policy is up against the zero lower bound. Stimulus will still be valuable as long as we’re still up against that bound — which is likely to be the case for a long time.

I quibble (addressing Prof Krugman in the second person something which I have never done in real life).

I would like to add one tiny comment on your excellent argument. You seem to be asserting that the key criterion is that the save short term nominal interest rate is zero. In fact you are also assuming that Greenspan knew what he was doing and that Bernanke does too, that is, that interest rates should be at the zero bound because inflation is not a risk (quite the contrary) so more stimulus is needed.

A Fed board along the lines of the Reichsbank 1918-1923 might very well keep nominal interest rates zero during a hyperinflation (they kept the discount rate 3% per year when the inflation rate was 50% per month and uhm rationed loans a bit).

There was a comment above by D. Sean who asks if the Fed kept interest rates high (sic meaning low) in 91 because it didn’t know the recession was over. A good question, but I think the answer is that the FED has excellent information and can detect an upturn long before the NBER business cycle timing committee makes a final irreversible decision.

The point is that you are assuming that Bernanke will keep interest rate at zero *and* that he will be wise to do so.