Paul Krugman responds to Scott Sumner

The post is here, excerpt:

My view, which I thought was pretty clear, is that the liquidity trap
is real: no matter how much the Fed increases the monetary base, it has
no effect, because it just substitutes one zero-interest asset for
another. If the Fed could credibly commit to inflation at rates higher
than the 2-ish percent target it’s already believed to have, that would
be effective. But right now I don’t see that as a realistic option,
hence the emphasis on fiscal policy and bank recapitalization.

Sumner outlines in detail a number of ways the Fed might increase aggregate demand, through monetary operations, without simply substituting one zero-interest asset for another.  So I don't yet see how Krugman has responded to or even recognized Sumner's points.  It also seems that the Fed can announce an inflation target of, say, four percent a year.  That may not be one hundred percent credible, but if presented as an alternative to the trillions of dollars of bailouts, I believe it could be reasonably credible (and indeed popular) and of course it would become more credible all the time as the Fed's monetary policy was observed.  Bennett McCallum has written persuasively on how to establish central bank credibility when such a course is welfare-improving.  Sumner himself wrote:

One key to making the policy credible (as many have already argued) is
to set an explicit nominal target, and commit to make up for any
shortfall this year with even faster nominal growth in the future (and
vice versa.)  I know that your [Krugman] expectations trap argument raises
questions about credibility.  But explicit targets tend to be more
credible because it is embarrassing for policymakers to go back on
their word–they don’t like to lose credibility (for good reasons.)  And
Bernanke, et al, already have reputations very different from the
members of the BOJ.

I don't myself agree with all of Sumner's points (especially his causal account of what happened), but again I don't see that Krugman has responded to the substance of the letter.

I should add that I don't think anyone (I'm not talking about Krugman here) has responded to the claim that quantitative easing, and other monetary reforms, could substitute for a very expensive fiscal stimulus.  (It's much more common to bash "the Treasury view.")  Usually there is simply a brush-off to the effect that we already are trying some monetary innovations.

Addendum: Arnold Kling offers comment.  Sumner responds too.


I thought is was clear (if not justified) that Krugman says that if the Fed could set a higher credible inflation target, that would be stimulative. He just thinks that is "unrealistic". He might want to explain way, but he does specifically address that point.

I think inflation is in fact the only realistic way out of the current situation, and the sooner the better, so I'm not sure why he rejects targeting it.

I'm not saying that Sumner's ideas would work. But if they did hold water, there's too much career risk for Krugman to change his view at this point.

I think this is what Krugman said that Sumner is responding to (of course both can speak for themselves, I'm just hoping they engage):

"I keep seeing economics articles and blog posts that insist that we’re NOT in a liquidity trap (and, of course, that yours truly is all wrong) because the situation doesn’t meet the author’s definition of such a trap. E.g., the interest rates at which businesses can borrow aren’t zero; or there are still things the Fed could do, like buying long-term bonds or corporate debt, or something.

"Well, my definition of a liquidity trap is, purely and simply, a situation in which conventional monetary policy — open-market purchases of short-term government debt — has lost effectiveness. Period. End of story.

"Now, if you prefer a different definition of a liquidity trap, OK; call our current situation a banana, instead. But changing the name does not change the essential fact — namely, conventional monetary policy has lost effectiveness.

"Yes, there are other things the Fed could do — and it’s doing them, on an awesome scale. But they’re controversial, precisely because, unlike conventional monetary policy, they involve picking and choosing among potentially risky investments. And there’s a much stronger case for fiscal policy than in normal times, because we don’t know how well these unconventional measures will work."

Krugman also previously suggested that we needed "a huge fiscal stimulus, unconventional monetary policy, and anything else you can think of to fight this slump. Quite literally, the usual rules no longer apply." By which he apparently meant, we need a huge fiscal stimulus, and anything else proposed isn't worth discussing.

krugman is just being a rigid pain in the X. i don't think he read SS's whole article; he just found something up front that he disagreed with and then stopped reading. two things to note here:

-- a lot of people are going to read SS's blog and make their own minds up independently of PK; this is a good thing.
-- PK is overconfident and admits a 0% probability that he is wrong. even achilles had his heel.

also -- at least he didn't go insulting SS personally or insulting his intelligence; this is a good thing.

For everyone who isn't suckling at the government's teat, there is no liquidity trap. For those who are, there is. It seems to me that the banking sector has become part of the government.

Liquidity trap? I want to borrow at 0%. Will Krugman lend me some of the money from his Nobel Prize?

If bank lending expands and the money muliplier falls, the Fed will need to sell off some of the assets it accumulated. Base money can be reduced just as fast as it increased.

Sumner points out that this could result in losses for the Fed. And that covering such losses will be cheaper than a massive fiscal stimulous.

I think that this should be "easy." The Fed gets weekly figures on the money supply. They still hold hundreds of billions of T-bills that can be sold immediately. The loans the Fed has made are mostly short term.

I am less optimistic about countering the growth in spending as velocity begins to rise from depressed levels, but I am certain this can be done partially.

While it is possible that the monetary base might be adjusted perfectly such that total spending returns exactly to its previous growth path (increases and then decreasing to offset changes in the money multiplier and velocity,) it is unlikely to work out that way in practice. Overshooting or undershooting seem likely. That is, the best we can expect from the Fed in new and unusual circumstances is less than could be expected if nothing much had changed.

But, base money and the money supply have both flucuated a lot. Gone up, but also gone down. The notion that increases in base money are permanent--that is silly.

"Excerpt"? That is the understatement of the month. Your short paragraph is not an excerpt, it is the entire Krugman's reply, besides a non-consequential quote from Scott's letter and a snide remark. Even his NYT blog readers, who I imagine are used to his rude attitude and him ignoring the subject, were appalled.

I guess, once you get the Nobel Prize, you can dismiss and ignore the slow-witted, non-Nobel Prize winner peasants. But my impression is that Krugman began to do that way, way before he got the prize. Was he ever collegial, nice or courteous? Probably not. One more data point confirming my casual empirical observation based on a very small sample size that among the great economists, the more to the right one is politically the nicer one is, and vice versa.

"But explicit targets tend to be more credible because it is embarrassing for policymakers to go back on their word–they don’t like to lose credibility (for good reasons.) And Bernanke, et al, already have reputations very different from the members of the BOJ."

If Prof. Sumner really believes that policy makers can be embarrassed, he really should get out more. Has Bernanke been right about anything through this crisis? Is Greenspan embarrassed? Please.

"I thought George Mason was a free market economics department, and that Tyler Cowen was a libertarian."

For a completely different take, check out Russ Roberts and Don Boudreaux @

As I recall Tyler and Alex were having a bit of a problem maintaining the lid on their Obamaphilia in the fall, telling us about all of his high powered thinkers and Phds and apparently oblivious to the the massive interventionism promised by then candidate Obama.

Hey, maybe the government can introduce some kind of wage-and-price anti-controls, or mandatory inflation targets. Raise prices and salaries by 1% per quarter or face fines. Wear a WIN button, citizen (Whip-up Inflation Now).


You suggest that Sumner has proposed alternative ways of quantitative easing.
Really? Reading his piece all I see is the suggestion to use inflation-indexed
bonds "more," along with purchasing some other "riskier" assets. Umm, I am not
sure what their use of inflation-indexed bonds has been lately, but they have been
massively purchasing unbelievable junk in humongous quantities. Their balance sheet
went up nearly tenfold during this past autumn, even as they unloaded Treasuries,
picking up among other things on the order of $600+ billion in totally toxic SIVs
from Europe that the ECB could not handle. They have been engaged in a massive use
of alternative "risky" assets to engage in a massive quantitative easing, the likes
of which I do not think we have ever seen before. This has gone far beyond anything
proposed by Sumner, far far beyond it indeed, and so far it has not gotten us anywhere
(although the TED spread is down from 450 bp to about 100, although that is probably
due more to the much-criticized TARP than to this massive quantitative easing).

And as for setting targets and using credibility, again, the Fed has supposedly
asserted a 2% inflation target, although they have not widely publicized it. But
then, their credibility is in shreds, so this whole argument about using their
credibility, well, just incredible.

Oh, and the glorious "Superheater" is back attempting to impose his ideological
conformity, duuuuh.

If you watch him when he's talking face-to-face with actual people (he pops up on ABC's "This Week"), he's fairly respectful and polite, even to people like George Will,

Comes with experience. As Bill O'Reilly tells it, a few years ago he and Krug were interviewed on TV or something. Krug was exceedingly irritating and, in O'Reilly words, kept lying about O'Reilly.

During break O'Reilly (6'4") grabs Krug (5'3"?) by the lapels and lifts him from his chair while promising to rearrange his face if he continues to lie.
Accordingly to O'R Krug starts shaking and his face pales.
No more problems with Krug during interview, accordingly to O'R.

As a long time observer of O'R and occasionally of Krug, I find the story, coming from O'R, quite believable.

Academic thugs and jerks virtually always are cowards in real life.

Of of SS's responses was:

"5% nominal GDP growth is sustainable forever."

Is this true/possible?

Sorry for repost:

ONE of SS's responses was:

"5% nominal GDP growth is sustainable forever."

Is this true/possible?

Oh, I forgot to mention... doesn't everyone remember from the 70's that inflation doesn't stop recession?

I would have expected nobel prize winning economists to know better by now.

During the 1970s, a) inflation was high and was largely anticipated by the public and b) nominal rates were far above zero -- the Fed funds rate actually broke 10% for periods of time. Today, a) inflation is, well, non-existent at the moment and long-term yields on Treasuries confirm that the market is not anticipating inflation in the near future and b) nominal rates (3-month T-bills and Fed Funds market) are already at 0%.

There's no real comparison and you really ought to read Krugman's paper on the liquidity trap in Japan before characterizing his argument as "inflation stops recession."


I don't know where you get your figures, but I don't see any days with negative federal funds rates. Nor were there any days with negative 90 day treasury bills. It is the 4 week ones that had three days of -.01%. There were several days of zero 3 month and 4 week T-bills. No zero federal funds rates.

I think they should all be continuously slightly less than zero. Maybe -.01 is about as low as possible.

Anyway, reason why the Federal Funds rate is lower than the rate the Fed pays is that some lenders on the market don't receive interest from the Fed.

I don't see why it is relevant. The Fed is paying banks not to lend money.

The Fed borrowed from the Treasury to fund its lending to various troubled financial institutions. It is presumably paying banks not to lend so that they will fund the Fed's loans to troubled financial institutions.

And, of course, the Fed has sold off a lot of its treasury bills to make loans to troubled financial institutions.

Regarless, it isn't quantitative "easing." It is the Fed lending to troubled banks and other financial institutions in ways that prevent an increase in the quantity of money.

If the Fed were maximizing its use of monetary policy, perhaps it wouldn't buy all the treasury bills, but they would all be at or below zero every single day. But I owuld think they would buy them all up.

And, then, they would make loans. And not to especially troubled banks. But rather, to good credit risks, especially.

The Fed's focus is on bailing out finanical institutions that lost money on mortgaged backed securities. I think the rationale is that they were key players in the securitization market. The Fed wants that market to return to "normal."

I guess, they figure that if that is done, then velocity will rise back to normal. And everything will be fine.

They are not using monetary policy to maintain nominal income. Or rather, they are not using it as agressively as possible.

Paying interest on reserves, borrowing from the Tresury, selling off T-bills are all inconsistent with "quantitative easing."

Bill W.,

The first time the federal funds rate ever traded at negative interest rates was during the day on
December 31, 1986, the last day of the old tax code. It may not have gone actually negative in the
last few months, but the target is zero to .15, and it has certainly traded at just about zero.

As for the 90-day T-bill rate, Cumberland Advisors reported on December 10, 2008 that sales of those
securities had traded at negative interest rates.

I would prefer to see the Fed holding Treasuries, but the reports are that their unloading of them was
too allow them to accumulate this much larger pile of junk that they are now holding on their balance
sheets, which certainly involves quantitative easing, even if much of it is directed abroad.

When did Krugman become the target of all this GMU/anarchic libertarian vile?

Especially Russ Roberts of cafe hayek(anyone sense a little jealousy about the Nobel?). When Eugene Fama rederived the "treasury view" didn't see anyone in the free markets camp go after him in such a vitriolic fashion.

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