Paul Krugman (Jan 1, 2012):

People who get their economic analysis from the likes of the Heritage Foundation have been waiting ever since President Obama took office for budget deficits to send interest rates soaring. Any day now!

…while debt can be a problem, the way our politicians and pundits think about debt is all wrong, and exaggerates the problem’s size.

…nations with stable, responsible governments — that is, governments that are willing to impose modestly higher taxes when the situation warrants it — have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe.

Paul Krugman (March 11, 2003):

…last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.

…we’re looking at a fiscal crisis that will drive interest rates sky-high….But what’s really scary — what makes a fixed-rate mortgage seem like such a good idea — is the looming threat to the federal government’s solvency.

…How will the train wreck play itself out? ….my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.

Now to be fair, Krugman covered himself in 2003 in a credible way he said “unless we slide into Japanese-style deflation, there are much higher interest rates in our future.” Thus, I do not fault Krugman’s forecasting ability. What I do fault is that despite a 180 degree about-face, one thing remains constant in all of Krugman’s writings, anyone who disagrees with him is portrayed as a mendacious idiot. In truth, Heritage today and Krugman 2003 both have legitimate concerns about the long-term debt situation of the United States and it would have been to the credit of Krugman 2012 had he acknowledged that point more fairly.

Addendum: Krugman responds pointing out that he has acknowledged this mistake. Fair enough, although I remain puzzled as to whether we did or did not owe the debt to ourselves in 2003.

The Italian ten-year yield is now over seven percent again.  Italy’s long-term growth prospects, or lack thereof, really do play a major role here (see the picture here).

The pointer is from @FelixSalmon.

In Spain, the carry trade seems to be operating (FT):

However, the success of recent Spanish government bond auctions has raised eyebrows. Spain sold €5.64bn of three-month debt on Tuesday, with the yield paid to investors falling to 1.735 per cent, down from the 5.11 per cent seen in a similar auction last month. Brokers say smaller Spanish banks may be loading up on bills to use as collateral at the ECB operations.

But don’t be too happy, here is from Jed Graham:

Much discussion — and possibly today’s stock market rally — has centered on the notion that the European Central Bank’s new policy of providing ultralow-interest, 3-year financing to banks can serve as a backdoor bailout of over-indebted sovereigns.

But don’t get too excited. This bazooka is actually a bulldozer. Rather than having the potential to flatten sovereign debt problems, it can only make them pile up into an untenable mountain — with far too much maturing within the 3-year life of the ECB program.

…Note that today’s [yesterday’s] Spanish debt sale comprised 3-month and 6-month bills.

As Reuters pointed out, Spain, unlike Italy, has relatively little debt to roll over before April. Thus, the 3-month and likely even the 6-month bills carry little risk.

But as Spain issues more short-term debt to meet new borrowing needs and to roll over maturing debt, the ECB’s backyard bulldozer is bound to produce a growing mountain of short-term funding needs.

Perhaps if Spain’s oversubscribed sale on Tuesday were for 5- or 10-year debt, one might make a case that the ECB policy was a real game-changer. But banks are unlikely to risk damaging their own credibility with investors by loading up on longer-term issuance of at-risk sovereigns.

Here is more.  The optimal policy here of course is time inconsistent. Lend out all the money and somehow forget to ask for it back, but don’t make that clear up front.  On a related note, another possible approach to the eurozone crisis is to have the United States guarantee all (non-Greek) eurozone debt, but if those countries can’t pay up simply void the guarantee, claim Berlusconi or someone blackmailed the U.S. government, and reaffirm the commitment to U.S. Treasury securities.  The market might just believe us.