Paul Krugman, the Fed, and the housing bubble

Paul Krugman seeks to clarify comments he made in 2002 about the Fed "needing" to create a housing bubble.

Today Paul Krugman responded to his, as he put it, “haters”:

“others are using that out-of-context remark about the Fed “needing” to create a housing bubble.(…)

So did I call for a bubble? The quote comes from this 2002 piece, in which I was pessimistic about the Fed’s ability to generate a sustained economy. If you read it in context, you’ll see that I wasn’t calling for a bubble — I was talking about the limits to the Fed’s powers, saying that the only way Greenspan could achieve recovery would be if he were able to create a new bubble, which is NOT the same thing as saying that this was a good idea.”

Since Mr. Krugman insists on using his New York Times soapbox to distort the public record, we must, once again, look at his 2002 bubble quote (in two full paragraphs of context):

A few months ago the vast majority of business economists mocked concerns about a ”double dip,” a second leg to the downturn. But there were a few dogged iconoclasts out there, most notably Stephen Roach at Morgan Stanley. As I’ve repeatedly said in this column, the arguments of the double-dippers made a lot of sense. And their story now looks more plausible than ever.

The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble. (Emphasis added.)

As I wrote last July, context is not Krugman’s friend in this matter…

“…the first paragraph introduces the “double-dipper iconoclasts”, and then clearly states that he, Krugman, agrees with them. The second paragraph then outlines the “basic point” of the double-dippers, which again, he agrees with. And the basic point in question is that to “fight this recession the Fed…needs soaring household spending.” Krugman then continues to say how the Fed would need to accomplish this goal, which again, he supports; he says that the recession needs to be fought with soaring household spending, which Alan Greenspan needs to induce by creating a housing bubble to replace the Nasdaq bubble. By writing, “as Paul McCulley of Pimco put it”, Krugman is not “merely” quoting another person; he is using someone else’s phraseology to express his own opinion.

Another protestation is that Krugman was saying the housing bubble won’t work, since later in the editorial he wrote:

“Judging by Mr. Greenspan’s remarkably cheerful recent testimony, he still thinks he can pull that off. But the Fed chairman’s crystal ball has been cloudy lately; remember how he urged Congress to cut taxes to head off the risk of excessive budget surpluses? And a sober look at recent data is not encouraging.

But this protestation completely ignores the fact that when Krugman wrote in the editorial…

‘Despite the bad news, most commentators, like Mr. Greenspan, remain optimistic.

and…

But wishful thinking aside, I just don’t understand the grounds for optimism. Who, exactly, is about to start spending a lot more? (Emphasis added.)’

…he was clearly characterizing a housing bubble as an object of optimism, whether or not he thought it was possible. In other words, at best, Krugman could be interpreted as saying that it would be great if Greenspan could pull off a housing bubble, but that he, Krugman, doubts whether he’ll be able to accomplish such a worthy feat.

So it should be clear that the Fed causing a housing bubble in order to bring about “soaring household spending” was Krugman’s optimal situation, whether or not he thought it was do-able at the time. Given the consequences of the housing bubble that did ultimately happen, that alone should be enough cause for the public to stop listening to this fellow.

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