Of Krugman & Minsky

Paul Krugman just did something mind-bending.

KrugMan-625x416

In a recent column, he cited Minsky ostensibly to defend Alan Greenspan’s loose monetary policies:

Business Insider reports on a Bloomberg TV interview with hedge fund legend Stan Druckenmiller that helped crystallize in my mind what, exactly, I find so appalling about people who say that we must tighten monetary policy to avoid bubbles — even in the face of high unemployment and low inflation.

Druckenmiller blames Alan Greenspan’s loose-money policies for the whole disaster; that’s a highly dubious proposition, in fact rejected by all the serious studies I’ve seen. (Remember, the ECB was much less expansionary, but Europe had just as big a housing bubble; I vote for Minsky’s notion that financial systems run amok when people forget about risk, not because central bankers are a bit too liberal)

Krugman correctly identifies the mechanism here — prior to 2008, people forgot about risk. But why did people forget about risk, if not for the Greenspan put? Central bankers were perfectly happy to take credit for the prolonged growth and stability while the good times lasted.

Greenspan put the pedal to the metal each time the US hit a recession and flooded markets with liquidity. He was prepared to create bubbles to replace old bubbles, just as Krugman’s friend Paul McCulley once put it. Bernanke called it the Great Moderation; that through monetary policy, the Fed had effectively smoothed the business cycle to the extent that the old days of boom and bust were gone. It was boom and boom and boom.

So, people forgot about risk. Macroeconomic stability bred complacency. And the longer the perceived good times last, the more fragile the economy becomes, as more and more risky behaviour becomes the norm.

Stability is destabilising. The Great Moderation was intimately connected to markets becoming forgetful of risk. And bubbles formed. Not just housing, not just stocks. The truly unsustainable bubble underlying all the others was debt. This is the Federal Funds rate — rate cuts were Greenspan’s main tool — versus total debt as a percentage of GDP:

fredgraph (18)

More damningly, as Matthew C. Klein notes, the outgrowth in debt very clearly coincided with an outgrowth in risk taking:

To any competent central banker, it should have been obvious that the debt load was becoming unsustainable and that dropping interest rates while the debt load soared was irresponsible and dangerous. Unfortunately Greenspan didn’t see it. And now, we’re in the long, slow deleveraging part of the business cycle. We’re in a depression.

In endorsing Minsky’s view, Krugman is coming closer to the truth. But he is still one crucial step away. If stability is destabilising, we must embrace the business cycle. Smaller cyclical booms, and smaller cyclical busts. Not boom, boom, boom and then a grand mal seizure.

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44 thoughts on “Of Krugman & Minsky

  1. Its all relative.
    The ECB was “less” expansionary, I’d contest “much”, but excluding Germany, most of ECBrope was booming throughout the noughties.
    Spain was never near recession, so its relative interest rate was much lower than those in the US. As Ambrose is quick to remind, 0% interest can be too high, just as 100% can be too low.

  2. John writes:
    “Central bankers were perfectly happy to take credit for the prolonged growth and stability while the good times lasted.”

    The only thing that grew was debt. Stability** was a illusion, as GDP was constructed from compressed debt-bricks, that, when taken apart, revealed decades-long decreasing real incomes, savings and almost every other metric that might indicate prosperity for the vast majority.

    One of the ways you know that bankers have the power they do is to examine the feebleness of their lies. Any four-year-old could do a better job of fabricating the truth then do these fraudsters who fear no retribution what-so-ever.

    **Stability is one of those notions that refuses to be real in any way, shape, or form, if you accept the idea that all things are constantly changing.

    • The Second law of Thermodynamics results from the fact that there are always more disordered states than ordered ones. It also states that the energy converted to “hot air” during attempts to bring order to any state of being can do nothing but create more disorder and disorder inevitably increases with time.

  3. The safe asset chart mirrors what I believe was the cultural redefining of risk both financial and in personal behavior that took place. Additionally the glut of information available that was mistaken for truth/wisdom and blurred right and wrong made risky behavior acceptable and even fashionable. Much of the recent rise in percent of safe assets does not indicate anything other than that assumed wealth created by risky assets has evaporated.

  4. Krugie seems to like inflation for whatever reason — I think it’s something like ‘Let’s throw some wooden nickels to the schmucks and thereby preserve capitalism for another day,’ but I really don’t know. Or maybe he owes a lot of money on his home — I’ve seen pictures of it in the NYT (where else?) and it looks pretty expensive, even for a Nobel Prize winner. However, money-printing (by which I mostly mean the expansion of credit) doesn’t seem to have done the trick. Huge bundles of dollars are brought forth out of the void and are given to the rich, but the rich just stick them away somewhere where they don’t circulate and thus drive up the cost of potatoes. Which is probably a good thing for the potato eaters. For the moment.

  5. Pingback: Of Krugman & Minsky | My Blog

  6. ‘Unfortunately Greenspan didn’t see it’. Well, this is practically incomprehensible if any credence is given to Greenspan’s supposed expertise and considering the range and quantity of expert advisors at his service. The true answer is probably in the previous comments of either impermanence or El Zombo – lying fraudsters or culturally redefined risk (temporary).

  7. Aziz,
    You say you are “appalled” by “people who say that we must tighten monetary policy to avoid bubbles”. Doesn’t that contradict your point from a few days ago (which I fully agreed with) namely where stimulus is required, it should not come from artificial reductions in interest rates, but rather in the form of extra public spending and/or feeding more money into consumers’ pockets? You described the latter policy as “market led”, I seem to remember.

    • Krugman’s view is that he is appalled by tightening monetary policy to avoid bubbles. That’s not my view.

      Personally, I am not even sure that central banks should be in the business of managing interest rates at all. I prefer the idea that monetary tightening and loosening should be done directly, through loosening or tightening the monetary base, exactly because it is more market-led and less central planning.

      That said, had the Fed tightened significantly using Greenspan’s pre-existing policy framework in 2003, 2004, 2005 (instead of keeping rates low to put a floor under Bush’s stupid, awful spending binge) I think the bubble in 2008 would have been significantly less bad.

  8. Greenspan must have known what he was doing. He was a student of Ayn Rand and in his youth he even wrote about the hard money and the benefits of gold.

    I think it is a larger plan by the ruling elites to break some eggs and to make an omelet. Greater centralization, and loss of liberty in the west.

        • Ayn Rand’s philosophy is iatrogenic. It is no surprise to me that her former student, a self-proclaimed champion of “free markets” presided over an era of institutionalised theft, massive corporatism and the beginning of the end of the American Empire. Emperor’s new clothes for both Rand and Greenspan.

        • Interesting use of the word [iatrogenic]. Please elaborate.

          Greenspan’s disavowing this kind of basic economic knowledge would be like Einstein suggesting that he forgot how to add and subtract.

          The more outrageous the bullshit, the more people believe as you might, that perhaps he didn’t “get it.”

        • Her philosophy is iatrogenic to the extent that it claims to extol individualism, personal liberty, creativity and it ends up producing the exact opposite (just as Stalinism claimed to extol equality, classlessness etc, and produced the opposite).

          A free market capitalist society requires voluntary altruism above everything else, and Rand claims altruism is the root of all evil, extolling selfishness. So it is no surprise that when Randians get into government (Greenspan, Ryan, etc), they end up making laws and decisions that empower the corporate Borg, social authoritarianism and bubble-blowing economics — the exact opposite of what they might claim philosophically to desire.

          I’ve read enough Fed minutes and enough of Greenspan’s speeches to know that his belief in the Efficient Markets Hypothesis and neoclassical economics was real. Greenspan might have known his policies were creating bubbles and institutionalising theft, but he believed that the market would subtly and without disruption correct for it. Ironically, he may have been correct, but the correction (2008-present) was far uglier and more disruptive than he might ever have imagined.

      • I am no expert on Randian economics all I know is that she liked the idea of smsll government, and limited government with hard money as currency. Greenspan knew these well, yet he was made chairman of the fed and he created a giant bubble with cheap money. He must have known what that would lead to. This might have been gross incompetence but I doubt it. So it must have been deliberate or he may have not cared the problems were so much in the future. Any teen who has read the book what happened to penny candy by richard maybary would understand what money printing does. I find it impossible that greenspan a highly educated man would fail to grasp what he was doing.

        If you have not already had a read of greenspans writings about hard money you should read it and you will see that he understood plenty.

        • I am no expert on Randian economics all I know is that she liked the idea of smsll government, and limited government with hard money as currency.

          And her ideology of misanthropy and the idea that altruism is evil is exactly what makes small and limited government much more difficult. If Rand wanted smaller and more limited government, her moral and political philosophy will get exactly the opposite.

          Greenspan knew these well, yet he was made chairman of the fed and he created a giant bubble with cheap money. He must have known what that would lead to. This might have been gross incompetence but I doubt it.

          He’s talked about gold favourably since the crisis, too. Greenspan however very clearly became a convert to Walrasian neoclassical economics, much the same as Bernanke. He replaced his belief in gold with a belief in informationally efficient markets. In other words, that loose monetary policy would be absorbed by the markets without ill effect.

        • Agreed. At the time, 911, I felt he was reducing rates to help George Bush. Not save the economy. It was Political. There was no need to drop rates to settle the markets. Then they raised rates when the economy was reeling from higher Gas prices due to oil speculation. They knew the system was fragile. The question is, who benefited from the GFC?

          These guys should be investigated, but the problem is, which Economist would be the expert witness? They are all crooks.

          These people have the ability to print Monopoly money. They are stealing from everybody.

        • John writes:
          “And her [Rand’s] ideology of misanthropy and the idea that altruism is evil is exactly what makes small and limited government much more difficult. If Rand wanted smaller and more limited government, her moral and political philosophy will get exactly the opposite.”

          John, I believe you misinterpret AR’s intention. What I believe she is saying is that you do more harm than good when attempting to “engineer” society. What we enjoy today [the welfare society as a response to economic distortions] I believe is EXACTLY what she was getting at.

          Charity should be given only when all the resources of the individual have been exhausted, and then only through private resources.

          Government, as a balance for an unbalanced “private” sector, becomes easily corrupted, as again, we can easily view. The simpler things are, the better the result [in almost all cases].

        • Altruism —the placing of others above self, of their interests above one’s own — is incompatible with freedom, with capitalism and with individual rights.

          Ayn Rand

          I would say it’s the exact diametrical opposite. I’d say a loss of altruism is incompatible with freedom, capitalism and individual rights.

          And I would say that Objectivism as a political philosophy is very much an attempt to engineer society.

  9. EVERYBODY knows what’s going on. These are not stupid people.

    The vast majority of the people still doing well in the American health care system also have little problem with the massive dis-function on-going, and analogous to their corporate brethren in finance, only see the solution to the problem as one of throwing more money their way.

    These are people in groups, expect less!

  10. I think Krugman is saying that you don’t need to raise rates to stop bubbles. He argues it’s better to stop them using regulations. I agree – that’s how Texas and Germany avoided housing bubbles.

    Texas limits home refinancing to 80% of the home’s value.
    Germany has a “flipper tax”. Gains on real estate held less than 10 years are taxed at 50%.

    Raising rates to stop bubbles has side effects on the rest of the economy, and there are other ways to stop bubbles that don’t.

    • “I think Krugman is saying that you don’t need to raise rates to stop bubbles. He argues it’s better to stop them using regulations. I agree – that’s how Texas and Germany avoided housing bubbles.”

      Krugman is a buffoon. This guy has sold-out more times than the bi-weekly half price offer at, Madame Chere’s Salon for the Discriminating Gentleman, in Paris.

      • Texas limits home refinancing to 80% of the home’s value.
        Germany has a “flipper tax”. Gains on real estate held less than 10 years are taxed at 50%.

        Raising rates to stop bubbles has side effects on the rest of the economy, and there are other ways to stop bubbles that don’t.

        I think a flipper tax may be effective in stopping or slowing flippers, but the effects of artificially lowered interest rates go far beyond housing flippers. They are systemic, and filter throughout the entire economy.

        Personally, even in the present system I don’t think the central bank should be in the game of forcing interest rates beyond adjusting the monetary base and setting reserve requirements.

    • Agreed. Monetary policy is a blunt economic instrument and should be relegated to the dust bin of economic history. Let the market set rates.

  11. Aziz, if you don’t win the Nobel some day for a new theory of Economics, you should at least win one for making it much easier to understand. The problem I have is that your explanations sound so logical and so reasonable and well backed up….why don’t the Krugman’s of the world get it? Thanks for all the time and effort you put into making things clear (at least clearer) for the non-economists of the world.

    Enjoying “House of Cards”, the original U.K. version, as of late. I find it interesting that the dark, murderous conservatives at one point say “if we return to the welfare state of pre-Thatcher times this country will find itself mired in debt…..” The show is great fun, all those bright faced, idealist socialists vs. the dour, murderous, cynic right wingers.

    So what can we do to get out of this mess sooner rather than later?

    Cheers,

    Rick

    • The problem I have is that your explanations sound so logical and so reasonable and well backed up….why don’t the Krugman’s of the world get it?

      They will eventually.

      Thanks for all the time and effort you put into making things clear (at least clearer) for the non-economists of the world.

      It’s a real pleasure.

      Enjoying “House of Cards”, the original U.K. version, as of late. I find it interesting that the dark, murderous conservatives at one point say “if we return to the welfare state of pre-Thatcher times this country will find itself mired in debt…..” The show is great fun, all those bright faced, idealist socialists vs. the dour, murderous, cynic right wingers.

      I haven’t watched the UK version of House of Cards. I enjoyed the American version a lot. I’ve been watching Game of Thrones and reading math textbooks…

      So what can we do to get out of this mess sooner rather than later?

      The answer, in my honest opinion, is decentralisation and taking back our power to the individual level…

      http://azizonomics.com/2012/09/23/the-next-industrial-revolution/

      • “The answer, in my honest opinion, is decentralization and taking back our power to the individual level” the next industrial-revolution.

        John,
        Technology could aid in both endeavors but technology’s promise seems more often than not transformed into a tool for more centralization while providing only superficial individual freedom. The motivation of those who apply how technology is used is seldom the same as the creator. The inevitable battle over who controls new technology and how it is used will spark an ethical debate of biblical proportion (technology as god) and perhaps be the catalyst for a resolutionary(new word) war.

        • One could argue the use of computers and the internet on a worldwide scale to do things like crunch financial information, track inventories, shipping, increase volume of market trading, electronically move assets, debt and cash at lightning speed has surpassed the capacity of human beings to comprehend the results. Made centralization more profitable and to a large degree made it difficult to wait and see (restraint/resistance) what outcome will be produced. Its like having your finger on the nuclear economic button. You don’t want the other guy to press it first.(first strike economics) I believe the computer was the tool used to create the train wreck.

      • It will only decentralise when the people start making their own houses, their own cars, their own things and say a “BIG FUCK YOU”! to the authorities and big business. And “I AM A SOVEREIGN CITIZEN”!

        Bring back common law lawsuits to provide damages for anybody infringed by the individuals freedoms. This system of regulation is suffocating human existence and the economy.

        Open air markets with no planning permits. Free assembly of people to trade goods and services.

        • Personally, I think decentralisation will begin to really take off when it becomes profitable and easy for it to do so, as has already happened with the internet. With energy and manufacturing, things are going in the right direction, but they are not compeltely there yet.

    • He deserves a Nobel Prize in economics, just for making economics accessible and understandable to the common man.

  12. Pingback: Risk v. Credit | Economic Thought

  13. Am reading “Economics in One Lesson” by Henry Hazlitt. The chapter on “make-work” and the fear of automation takes me back to the library in my first year of college. I came upon a turn of the century magazine article discussing how many jobs electricity was going to eliminate! Just read an article in the local socialist paper talking about the same effect in a new Democrat party sponsored tech park initiative. Anyhow, interested parties will suppress technology one there lot is affected. For example, could not a college pay 3 profs to write a text book on their specialty and then make the text book public domain on the net? Think of the huge cost reduction in higher education. I am sure the publishers are thinking about it…..

    • Higher education is a racket today, colleges try and extort as much money as they can out of students so long as the Federally-backed non-dischargeable student loans keep flowing.

      The thing that will burst the bubble is free, easy-to-understand education on the internet. I am but one small part of this growing revolution. Much bigger parts are things like Khan Academy, etc. Slowly, gradually, internet education is bursting the higher education bubble.

  14. “Smaller cyclical booms, and smaller cyclical busts. Not boom, boom, boom and then a grand mal seizure.”

    This reminds me of the situation in the US with regards to forest fires. Officials took it upon themselves to prevent all forest fires from happening ever, and nipping them in the bud when they managed to happen. What happened is that over time, grass and small shrubbery which would have been removed by periodic, smaller fires started to accumulate. This only made it more likely for a huge, uncontrollable fire to occur, given the fact that more ‘fuel’ in the shape of excess shrubbery remained in tact. This is what’s happened in recent years, huge, uncontrollable fires have been pretty frequent. On top of that, they’ve destroyed much more of the forest compared to the smaller frequent fires that would burn themselves out before affecting some of the larger trees. Can’t help but note the parallels to our economy over the last 4 decades or so.

  15. Pingback: Risk v. Credit | Fifth Estate

  16. Pingback: Sparkassen — A De Facto Glass-Steagall? | azizonomics

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