Krugman on David Stockman

Criticizing David Stockman's "screed," Paul Krugman writes in today's NYT:

Now, the fact is that these ranters have been wrong about everything, at every stage of the crisis, while the Keynesians have been mostly right. Remember how federal deficits were supposed to cause soaring interest rates? Never mind: After four years of such warnings, rates remain near historic lows — just as Keynesians predicted. Remember how running the printing presses was going to cause runaway inflation? Since the recession began, the Fed has more than tripled the size of its balance sheet, but inflation has averaged less than 2 percent.

Well, of course interest rates have remained low! That's because the Fed has been artificially depressing them by buying up the majority of Treasury issuance for a couple of years now.

And, since the market knows that the Fed will continue to buy Treasuries for as long as the economy sputters, the market buys more Treasuries, too, thereby depressing interest rates even more. What happened this morning is a great example of this latter dynamic. The unemployment report revealed that only 88,000 new jobs were created last month. This is a terrible number and it suggests that Mr Bernanke will not be willing to put an end to quantitative easing any time soon. As a result, the US 10 year is off 7 basis points, as hedge fund managers and other speculators pile into Treasuries. Who can blame them? As Stockman has pointed out in his book, their strategy is to borrow short term at near 0% interest rates and use those borrowings to buy the 10 year and shear off the approximately 1.75% yield. Since Bernanke has promised that he will not stop buying Treasuries and raise interest rates until the economy recovers, this strategy is guaranteed to be a money maker. In other words, as Stockman has argued, the Fed's policies have done nothing to stimulate the economy, but have created an environment in which the 1%, by investing in the Treasuries that Mr Bernanke is propping up, are making windfall profits.

So, the fact that interest rates have remained at near all-time lows is not, as Krugman claims, proof that the Keynesians are right. Rather, it is an indicator of how enormously the Keynesians have distorted the market, creating an enormous bubble in Treasuries that will eventually pop with catastrophic effects.

As for Mr Krugman's other point about inflation remaining under control, I can only laugh. The whole purpose of Mr Bernanke's policy is to create inflation. Just yesterday, BOJ chairman Kuroda described the purpose of his quantitative easing as follows: "We took all available steps we can think of. I'm confident that all necessary measures to achieve 2 percent inflation in two years were taken today." The Fed itself has announced that it won't end quantitative easing until inflation reaches 2.5%:

In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

[4/17/2013: If you are not convinced that the purpose of QE is to increase inflation, consider this recent news story from Forbes: "St. Louis Fed President James Bullard spoke in New York on Wednesday, warning that inflation remains too low and suggesting he’d be ready to increase the rate of asset purchases, or QE, to defend their target “from below.”]

In other words, the Fed is trying its damnedest to goose the economy and create inflation, but, even after all Mr Bernanke's stimulus, the economy continues to sputter and inflation remains low, likely because all these monetary manipulations do not represent any real economic activity. How this represents the triumph of Keynesianism is beyond me.