Equitable Growth Focus: In Which I Am Once Again Puzzled by Martin Feldstein
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DeLong Smackdown Watch: Paul Krugman Accuses Me on Inventing an Imaginary and Idealized Bill Gross...

Now that's more like it, internet!

You all are going to have to wait at least a week more for my to continue my death-march close reading of chapter 11 of David Graeber's Debt: The First 5000 Mistakes--a chapter which I think whose bankruptcy goes well beyond chapter 11 into chapter 7.

For today we have Paul Krugman:

Paul Krugman: Bill Grosses, Idealized and Actually Existing: "Brad DeLong tries at some length to rationalize Bill Gross’s insistence in 2011 that interest rates were about to spike...

...But while it’s nice to be charitable, to attempt to put the best face on someone else’s arguments, it’s also important to look at the argument someone was actually making. And the reasoning of Gross and others was much cruder and a lot more foolish than Brad acknowledges.... Gross wasn’t arguing that rates would rise sharply once people understood that the economy would normalize.... He was arguing that rates were being suppressed right now by the Fed’s purchases of Treasuries, and would spike as soon as those purchases ended.... Not only did it ignore the fundamental reasons rates tended to stay low in a deleveraging world, not only did it overestimate the impact of QE, but it also assumed that the rate of Fed purchases--the flow of QE--was what mattered, when sensible people argued that the stock of assets the Fed held mattered. I wrote all about this at the time. If you find it hard to believe that such a smart guy could make such a poor argument, well, that’s the world we’re living in.

Let me try to rephrase my rational reconstruction of Gross's argument back at the end of 2010-start of 2011, as something like this:

  1. Just as in every other recession episode since World War II, the economy Will quickly normalize.

  2. Forward-looking 10 and 30 year bond yields ought to already be pricing in that normalization.

  3. They are not. Why not? Well, the only possibility is that the Federal Reserve is in the market bigtime making non-fundamental trades--trades that do not reflect a desire to make money in the context of a rational assessment of fundamentals.

  4. The Fed will no more be able to maintain its position if my peers and I bet heavily against it than the Bank of England was able to maintain its non-fundamental position when George Soros and company bet heavily against it back in 1992.

As Krugman correctly says, Gross was wrong.

As Krugman correctly says, Gross was wrong in thinking that most bond holdings were inertial and only the narrow flow mattered--smarter and more-sensible people understood that a lot of the stock was in play via rebalancing. As Krugman correctly says, Gross's belief that normalization would be rapid was wrong--and paid no attention to the example of Japan in front of his face. As Krugman does not say but would if we gave him an extra moment, there is a huge difference between a central bank which intervenes by spending the small quantity of harder-currency reserves it has to diminish and a central bank which intervenes by printing cash to expand the money stock. As Krugman says, Gross fundamentally misread the world. As Krugman does not say but would if we gave him another moment, he had correctly diagnosed this situation as a possible and indeed likely scenario when back in the mid-1990s he took a hard look at Japan, Mexico, and East Asia, and wrote The Return of Depression Economics.

Have I tried too hard to impose coherence in constructing my rational account of what Gross and company were (or should have been) thinking? Perhaps. But it also feels inadequate to me to say: "He just didn't do his homework on this." Why didn't he--and so many other people--fail to do their homework? What did they think their homework was? They did do something, after all...

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