Paul Krugman is at it again. (Here's a picture of him with former President Bush) This time, he reassures us of two ideas: 1) all that money the Fed is creating won't push up prices, and 2) the US would never default on its debt obligations by inflating away the debt.
So, for Krugman's first assertion, while he is correct that the contraction in bank lending has counteracted the increase in money created by the Fed, it flies in the face of logic to think that the Fed can create trillions of dollars out of nothing and that this will have zero effect on prices. Doesn't it seem more likely that certain prices are being prevented from falling to their equilibrium level by the Fed's monetary mischief, thus distorting the price mechanism?
See, the thing is, the US is approaching this psychological level, where the debt of the Federal government approaches 100% of GDP. This is only important because people often fail to see that the two can't be compared directly - GDP is a flow, like your yearly income, and debt is a stock, like the value of your stock portfolio (except in reverse!). So just as a person who makes $50,000 a year could owe $75,000, so it is possible that the US debt exceeds GDP, and nothing really changes from debt being 90% of GDP to debt being 100% or more. However, GDP is a good reference point for understanding the level of debt, because it shows our capability for paying back the debt, and also gives us a yardstick which adjusts for changes in the price level and economic growth.
Now there's this thing called denial. When a lot of people say "you don't need to worry about that," they're often saying, "I get why you're worried about that - you should be". Krugman's denial of inflation is similar to his denial of debt default. There's no way the US would default on its debt, he shouts. No way in hell!
In other words, it's extremely likely. All signs point toward default: escalation in borrowing, continued current account deficits, falling dollar, rising yields.
Paul Krugman, I salute you. You're a great economist. You've made important contributions to the theory of international trade. You were right about the war in Iraq. But you're wrong on this: the US will default on its debt, and the method we'll choose is inflation. I'd suppose you have 5 or 10 years before you have to admit your mistake.
I'll be waiting!
3 comments:
J-ECON5 student said...
I feel Krugman's thesis of big new blunt of money will not cause inflation cannot pass the hypothesis test. As you said, the equilibrium will result in a higher price level for the same amount of GDP.
Well, I will give him some credibility on the " U.S will not default debt.". The reason I say so it's that U.S has never default in debt in the history, event when the debt was almost 90% of the GDP in the lat 80's. President Clinton not only cleaned up all the debt, and was able to have surplus. and the new administration are using a very similar economic strategy as the Clinton's day, I am not saying we will do just as well, create surplus, due to the war we are in now, but definitely will not default the debt.
Many people are saying exactly the same. Debt default is unthinkable for the US, the world's premier power. But sometimes unthinkable things happen. If we were to follow the strategy Clinton used, we'd have to rein in spending substantially. We're not doing that. We're doing the opposite.
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