Paul Krugman does believe that an attack of the bond vigilantes would be expansionary

You can read him here.  Keep in mind we are talking about a sudden leap upward in interest rates, a sharp rise in the risk premium, and a sudden fall in bond prices.  In response, I suggest a multi-step program:

1. Read Gary Gorton on how much the decline in the value of mortgage securities — if only as collateral — damaged the global economy during 2008 by causing a credit collapse, including in but not limited to the shadow banking system.

2. Estimate size of said effect for a serious price decline for U.S. Treasury securities, a much larger and more central and otherwise more secure market.  Do not leave out margin call effects or negative effects on the eurozone.

3. Compare said effect to short-run benefits from exchange rate depreciation, taking into account lags and J-curve effects and the relatively closed nature of the American economy and the slowdowns in other countries around the globe.

4. Run a Chicago Booth questionnaire study to see how much of the profession will agree with you.

5. Flee in panic.

6. Start praising the Republican Party for their macroeconomic acumen in damaging the credit reputation of the U.S. government.

7. Declare yourself an “elasticity optimist” when it comes to relative price shifts and lower tax rates.  Team up with the U.S. Chamber of Commerce to write a study calling for the immediate slashing of corporate tax rates, or at least corporate tax rates as applied to exports.  The theory of exchange rate incidence is the theory of tax rate incidence, and furthermore, by happy coincidence, lower tax rates do not involve all of the costs of a financial crisis.

8. Ponder technical questions such as “if I think bad news is more than offset by gains from exchange rate depreciation, do I also think that good news is more than offset by losses from exchange rate appreciation?”

9. Read Thucydides, or perhaps Broadwell, about how a crisis is not always manageable once underway.

Krugman’s is a reckless position, and simply noting that America borrows in its own currency doesn’t come close to defending it.

Addendum: Here are comments from Nick Rowe.  And from Scott Sumner.  And David Beckworth.  And Evan Soltas.  And here is my earlier post on exchange rates and the like.


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