Paul Krugman Tells the Right Story


…but I think he has the wrong emphasis. It’s nice to hear him state the case this clearly though. I could be narcissistic and claim that he is responding to my request, but I won’t.

Here Krugman:

So how do we think about this problem? Here’s my take. Japan has pretty much spent the past 20 years in a liquidity trap; as I’ve been explaining for years, one way to understand such traps is that they happen when, even at a zero real interest rate, the amount that people would want to save at full employment exceeds the amount they would be willing to invest, also at full employment:

Which is a sure head scratcher to me. 20 years in a liquidity trap? At what point do we stop calling it a “trap”, and call it what it really is: a self-imposed monetary regime whose stated goal is price stability come hell or high water. Indeed, the price stability is a popular central bank goal, and the BoJ has certainly delivered the most stellar performance in the world over the last two decades.

In the real world, there should be no pretention that Japan has been in a “liquidity trap”; as soon as Shinzo Abe won the election on promises to force the BoJ to raise its inflation target this happened:

Japan’s CPI has shown a mild turnaround from -0.5% to -0.1%, so it would seem the policy is boosting real growth — what all economists (even those that advocate higher inflation!) would prefer to see for any given NGDP growth rate!

The odd thing about this is that later in the article, Krugman admits that there was no “liquidity trap”:

But Japanese policy has never sought to achieve this. Deficit spending has put part, but only part, of the excess desired private saving to work; this has mitigated the slump, but not produced a booming economy, except perhaps briefly circa 2007. And the Bank of Japan has always pulled back on monetary policy when the economy looks better, instead of doing what it should, which is to keep the pedal to the metal until the inflation rate is solidly into positive territory.

I agree, above is the monetarist critique of Japan. Minus the fiscal policy stuff, which is a side show, the BoJ has decided for the last two decades to target inflation at zero percent, allowing for undershoots — surprise! The price level is lower today than it was in 1990. Krugman is certainly right that you can wedge an IS/LM model in there, and that fiscal stimulus did not backfire. Fiscal and monetary policy both affect AD (NGDP). Unless the central bank ignores its target, fiscal policy will have no traction beyond it.

Finally, I want to turn to demographics. As it turns out, there is reason to believe that the global population is soon to begin falling. More poignantly, US birth rates have been in decline for the past decade (accelerated with the recession):


[Really, Japan is the hipster of world populations.]

These facts suggest that real interest rates will face secular decline into the foreseeable future, making a scenario of near-zero interest rates a real — and frequently recurring — possibility. Every time this happens, are we going to have a large swath of the profession throw their hands up, cry “liquidity trap!”, and lazily advocate fiscal stimulus?

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