Monday, December 1, 2014

Sequester and vortex redux.

I posted this last week, but I was unaware at the time of the Paul Krugman's "Keynes is slowly winning" post; Tyler Cowen's 15-point response, documenting not only Keynesian failures but more importantly how the policy world is in fact moving decidedly away from Keynesian ideas, right or wrong (that was Krugman's point); and Krugman's retort, predictably snarky and disconnected from anything Cowen said, changing the subject from Keynesian ideas are winning to the standard what a bunch of morons they're not Keynesians though I keep telling them to be. (I like Krugman's chart though. I see a glass half full -- look at all those nominal wage cuts, even in Spain! And look how many people got raises.)

In that context, I added two "Facts in front of our noses." Keynsesians, and Krugman especially, said the sequester would cause a new recession and even air traffic control snafus. Instead, the sequester, though sharply reducing government spending, along with the end of 99 week unemployment insurance, coincided with increased growth and a big surprise decline in unemployment. And ATC is no more or less chaotic than ever. Keynesians, and Krugman especially, kept warning of a "deflation vortex." We and Europe still don't have any deflation, and even Japan never had a "vortex."  These are not personal prognostications, but widely shared and robust predictions of a Keynesian worldview. Two strikes. Batter up. 

The original: (This is a re-post if you saw it the first time around, but easier to copy and paste than link.) 
Multiplier? What multiplier? 
Wall Street Journal, November 26 2014:
The economy expanded at its fastest pace in more than a decade during the spring and summer,... Gross domestic product...grew at a seasonally adjusted annual rate of 3.9% in the third quarter... combined growth rate in the second and third quarters at 4.25%, affirming the best six-month pace since the second half of 2003." 
The upward revision to overall growth, driven by [sic] stronger consumer and business spending and a smaller drag from inventory investment, surprised economists... 
Paul Krugman, February 22 2013, "Sequester of Fools"
The sequester, by contrast, will probably cost “only” around 700,000 jobs.
New York Times, Februrary 21 2013, "Why Taxes Have to Go Up"
Democrats and Republicans remain at odds on how to avoid a round of budget cuts so deep and arbitrary that to allow them now could push the economy back into recession. The cuts, known as a sequester, will kick in March 1 [my emphasis]
Paul Krugman, March 10, 2013: "Sequester Cuts Will Be Felt in Time" will start to build, and it won't just be White House tours, it will be air traffic delays, the effects kick in, it will remind people why we actually need a government that does its job.
(Actually,  manifest failures of government to do its job lately are pretty depressing. But not for lack of money.)

Meanwhile back in the worryzone

Deflationary Vortex?
Paul Krugman Sept 4 2014 "The Deflation Caucus"
Europe, which is doing worse than it did in the 1930s, is clearly in the grip of a deflationary vortex,
Really, "worse than the 1930s???" We're watching different versions of the History Channel.

Paul Krugman, undated,
... if the economy ... has excess capacity, and also ...i = 0 ...- it cannot get out. The output gap feeds expectations of deflation, and since the nominal interest rate cannot fall this implies a rising real interest rate, worsening the output gap. The economy, in short, falls into a deflationary spiral.
This prediction of a "deflation spiral" once we hit the zero bound with huge "output gaps" has to stand as a stark failure of Keynesian economics, on a par with its grand failure to predict inflation in the 1970s. Only, predicting a catastrophe that did not happen doesn't attract quite as much attention as failing to predict one that did.

If you're not getting the point, look at the graph. Let me remind you "deflation" means numbers less than zero, a lot less than zero. And "spiral" or "vortex" means getting steadily more negative, not asymptoting to zero. And if you patch a model ex-post and ad-hoc not to produce a spiral, then that model no longer predicts that inflation is a danger.

To be sure, I am being inconsistent today -- I have staunchly maintained that "models" must exist on paper or in computers, in objectively verifiable forms, with "predictions" that any operator can make, not in soothsayer's heads.  I have staunchly maintained that evaluating economic theories by pundit prognostication is completely meaningless.

But I also don't make it my business to vilify other people from misquoted opinions on current dangers. (Though I'm indeed pulling Paul's leg a bit, please notice the absence of "evil," "vile," "mendacious idiot," "corrupt," "stupid," "doesn't know economics," and so on from this post.)

So just this once I will give in to grumpy temptation.


  1. I am sort of neutral between you and Krugman since I think you are both wrong. :-)

    It does seem to me that your writing has a "grumpier" edge to it than Krugman's does. You come across as being openly contemptuous of people who disagree with you and that tone permeates your writing. Your contempt is pre-emptive: your writing communicates a hostility to anyone who might dare to disagree with what you have written.

    1. I think you are wrong. Charitaby and respectfully, yours.

    2. Absalon- are you being sarcastic? Otherwise I completely disagree with you on that point.

      A more serious question (for Cochrane or anyone else): I understand the concept of a deflationary spiral, but what are the best historical examples of this actually happening?

    3. Zack,


      There have been several fairly recent periods of deflation in the U. S.
      1921-1923, 1930-1933, and even the slight period 2008-2009.

      The most persistent deflation was what occurred from 1930-1933.

      The simplistic story of a "spiral" - inflationary or deflationary - is a demand story about expectations. People expect prices to fall (forever?) and so delay purchases - deflationary "spiral". People expect prices to rise (forever?) and so move consumption forward - inflationary "spiral".

      The story misses what happens to the expectations of producers, it misses technological changes, it misses all of finance (debt / equity), and a lot more.

    4. @Zack - No, I am not being sarcastic.

    5. Frank,

      Thanks, I agree that the theory behind it is very simplistic. I guess my real question is why professional economists were so worried about it. Japan always gets mentioned when it comes to deflation, but even this hardly fits the "spiral" story. They have had about two decades of either very low inflation or very low deflation. From what I can find, even when Japan has had deflation it has almost always been less than 1% and never averaged 2% for a given year- certainly nothing that would qualify as a deflationary spiral.

    6. Zack,

      "I guess my real question is why professional economists were so worried about it."

      Pick your answer:
      1. Because professional economists get paid to worry
      2. Because professional economists take the view that deflation "unfairly" favors creditors at the expense of debtors
      3. Because economists are under the delusion that deflation negatively affects a government's fiscal position

  2. I think the relative success of the American economy post -2008 is due to a mildly expansive central-bank policy.

    Would that the Fed be more aggressive and show more resolve in targeting nominal GDP growth, or even in selecting and effectively targeting a moderately higher inflation target, perhaps a 2-3 band, ala Aussie's central bank.
    3% inflation in not TEOTWAWKI--indeed that is about the average CPI 1982-2007, not a bad run.

    1. Targeting nominal GDP growth or a higher inflation rate seem to amount to the same thing.

      I do not understand the mechanism by which Krugman and others think that inflation will somehow stimulate the economy:

      First. Having lived through the 1970s it seems to me that one mechanism might be that fear of inflation stampeded the middle class into over-investing in housing temporarily stimulating the economy. That mechanism is both undesirable and a spent force.

      Second: Inflation provides some measure of universal debt relief but it operates indiscriminately. If debt relief is appropriate for some it should be targeted, perhaps through amendments to the bankruptcy laws. In the meantime low interest rates are a huge cash flow benefit to most borrowers.

      Third: Anyone who believes that inflation is needed to address wage "stickiness" must believe:
      1) there is some materially large group which is materially overpaid to the point where a drop in real wages for that group would materially benefit the general economy; and
      2) The overpaid group does not have the political or economic leverage to protect their real incomes in the face of inflation.
      My question for Krugman, Delong etc is: "who are these overpaid, but powerless, people and how many of them are there that they can move the whole economy?"

    2. Krugman's claim is it any different than conventional monetary expansion in a country with positive interest rates, right? The market clearing rate is negative, and negative deflation is - inflation? And you're worried about runaway 1970s inflation for what reason now?

  3. " your writing communicates a hostility to anyone who might dare to disagree with what you have written."

    Not anyone. Only as a response to *someone* who actually does what you indicate, i.e. Krugman who attacks the person, condescends, attacks motive.

  4. I am tired of the absurdity of the keynesian thinking! How can we still believe in the multiple fallacies of the General Theory about 80 years after its release! The Keynesian system is really "the economics of illusion" (to paraphrase a book by L. Albert Hahn in 1949).

    1. 80 years, OMG! So centuries old Newton fallacies must be oh so wrong!!!

    2. See Albert Einstein - General Relativity.

  5. Jose Romeu RobazziDecember 2, 2014 at 1:57 PM

    Hum, who claims that the other side "has been wrong about everything" ?! I don't think professor Cochrane has that kind of attitude. Having said that, I do think the entire gospel of "deflationary spiral" and "vortex" a total absurd. There has never been a deflationary spiral anywhere in time or space. But what really amazes me is not that keynesians have gotten a lot of things wrong without admitting either. Is that they managed to convince a lot of people that inflation is not only good, but it should be higher, so that "we" (the economy as seen by policymakers, I assume) stay away from the zero lower bound, and therefore policy makers retain control over the economy. Notice that the objective of higher inflation is not to have a healthier economy, but "be able to control it better". How not democratic and not alined with a democratic country that is I leave to the other readers to assess...

    1. Economists suffer from a pathology called "Hero Syndrome":


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