Addendum to Supply and Demand: What Comes First?

Click here to read the original Cautious Optimism Facebook post with comments

An addendum to the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff's recent post on Say's Law of Markets and supply and demand:

1) "Definition of Demand: the willingness and 𝐚𝐛𝐢𝐥𝐢𝐭𝐲 of consumers to purchase a given quantity of a good or service at a given point in time or over a period in time. In economics, demand is formally defined as ‘effective’ demand meaning that it is a consumer want or a need 𝐬𝐮𝐩𝐩𝐨𝐫𝐭𝐞𝐝 𝐛𝐲 𝐚𝐧 𝐚𝐛𝐢𝐥𝐢𝐭𝐲 𝐭𝐨 𝐩𝐚𝐲."

-Economics Online

2) "Two things are necessary to constitute a demand. These are – A Wish for the commodity, and An Equivalent to give for it. A demand means, the will to purchase, and the means of purchasing. If either is wanting, the purchase does not take place. An equivalent is the necessary foundation of all demand. 𝐈𝐭 𝐢𝐬 𝐢𝐧 𝐯𝐚𝐢𝐧 𝐭𝐡𝐚𝐭 𝐚 𝐦𝐚𝐧 𝐰𝐢𝐬𝐡𝐞𝐬 𝐟𝐨𝐫 𝐜𝐨𝐦𝐦𝐨𝐝𝐢𝐭𝐢𝐞𝐬, 𝐢𝐟 𝐡𝐞 𝐡𝐚𝐬 𝐧𝐨𝐭𝐡𝐢𝐧𝐠 𝐭𝐨 𝐠𝐢𝐯𝐞 𝐟𝐨𝐫 𝐭𝐡𝐞𝐦."

-James Mill, Elements of Political Economy (1821)

3) “In order to demand anything, you can’t just stomp your feet in the colloquial sense of the word demand. You have to have something with which to demand. You 𝐡𝐚𝐯𝐞 𝐭𝐨 𝐡𝐚𝐯𝐞 𝐭𝐡𝐞 𝐟𝐫𝐮𝐢𝐭𝐬 𝐨𝐟 𝐬𝐨𝐦𝐞 𝐩𝐫𝐞𝐯𝐢𝐨𝐮𝐬 𝐩𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐨𝐧 𝐲𝐨𝐮𝐫𝐬𝐞𝐥𝐟 𝐢𝐧 𝐨𝐫𝐝𝐞𝐫 𝐭𝐨 𝐝𝐞𝐦𝐚𝐧𝐝 𝐚𝐧𝐲𝐭𝐡𝐢𝐧𝐠 𝐢𝐧 𝐞𝐱𝐜𝐡𝐚𝐧𝐠𝐞 and so production of course is at the heart of it."

-Economic historian Thomas E. Woods on Say's Law

======

Part 1 of "Supply and Demand: Say's Law of Markets" available for reading at:

http://www.cautiouseconomics.com/2022/08/macroeconomics-15.html

Part 2, the more complicated subject of Keynesian economics' alleged refutation of Say's Law, to come later this week.

Surprise: Stanford's John Taylor Confident 5% Fed Funds Enough to Bring Inflation Down to 2%

Click here to read the original Cautious Optimism Facebook post with comments

The Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff is a bit surprised at Stanford economist John B. Taylor's estimate of a 5% Fed Funds rate target to bring inflation down to its 2% target.

5% is a bit lower than the Correspondent would have thought would be needed.

However the Correspondent has mucho respeto for John Taylor who incidentally was interviewed in 2017 by Donald Trump to head the Federal Reserve as a dark horse candidate.

We got Jay Powell instead.

Even Paul Krugman gives Taylor a wide berth when they disagree, which is often.

Taylor, author of the so-called "Taylor Rule" that takes wild discretion away from Fed officials and sets target interest rate ranges with a formula using objective economic indicators instead, is considered by many to be deserving of the Nobel Prize, but will likely be overlooked due to his strong Milton Friedman-influenced views and association with conservative think tanks like Stanford's Hoover Institution and the free market Mont Pelerin Society.

His argument that 5% will be sufficient is based on Robert Lucas' "rational expectations" thesis applied to inflation--that unlike the 1970's and early 1980's consumer and business behaviors have not yet been altered by an expectation that high inflation is here to stay. Such expectations, when engrained in the public psyche, would lead people to spend a greater share of their money and spend it faster, increasing monetary velocity which in turn drives inflation even higher in a cruel spiraling effect. 

Which is what happened in the late 1970's after the public had eaten nearly a decade of the Arthur Burns Fed's high inflation.

So far St. Louis Fed M2 velocity data indicate inflation expectations have not taken hold in the USA (yet) but Taylor also hedged his forecast, adding that:

"It [the Fed Funds rate] could be higher. I wouldn't say absolutely 5%, it may have to be higher"

...right before saying:

"But I think inflation will come down and we can stick to a level like that."

The Correspondent would have thought higher than 5% will be needed but considers Taylor's view, optimistic as it may be, worthy of discussion.

Watch Taylor's Bloomberg interview at:

https://www.bloomberg.com/news/videos/2022-08-23/stanford-s-taylor-says-fed-should-aim-for-5-funds-rate

ps. The Fed Funds rate topped out at 5.25% in 2006 and 2007, bursting the housing bubble and precipitating the Great Recession which officially began in late 2007.

That recession was particularly awful due to government-mandated lowering of lending standards and thinner capital reserve buffers, adding a financial crisis to boot. 

But that doesn't mean a "just less worse recession" isn't possible if the target rate reaches 5.25%, especially given the last two years' pace of Fed money creation which has broken all records going back to World War II.

CNBC's Sorkin to Leahy: Aren't Government Subsidies Just Pushing Up College Education Costs?

Click here to read the original Cautious Optimism Facebook post with comments

(Attached graph: A simple microeconomics supply/demand model depicting a rightward shift in the demand curve. Government arms students with a trillion new dollars to spend thus raising demand from curve D1 to D2. The rightward shift in the demand curve raises the market clearing price from P1 to P2)

======
2 MIN READ - The Cautious Economics Correspondent for Economic Affairs and Other Egghead Stuff heard CNBC host Andrew Ross Sorkin ask a good question today about Joe Biden's latest proposal to forgive another round of student debt.

SORKIN: "To the extent that there's going to be some forgiveness of the [student] debt... ...what does that do towards these spiraling costs? Does it only incent schools to increase those costs? You say they have to look themselves in the mirror. How much does the government have to look itself in the mirror to figure out a new path forward in terms of incenting schools to lower those costs rather than increase them?"

SEN. PATRICK LEAHY (D-VT): "That's a question I keep asking myself and I ask people in higher education. I tell them 'You've got to get these spiraling costs down. We're seeing less young people willing to go on and get the higher education they need and that the country needs to have people who can handle the kind of jobs we really need to fill.'

"And it'd be a terrible mistake for higher education to think 'Oh we can just raise tuition costs because the government will take care of that.' That's not going to happen. I suspect this is a one time thing and higher education is going to look itself in the eye."

Some free advice for Senator Leahy...

No they're not going to look themselves in the eye. That's idealistic, naïve, and frankly the same wishful thinking that's created the college cost crisis to begin with.

Consumers, businesses, investors, and yes... universities respond to incentives. When you subsidize college education, as the federal and state governments have done on a massive scale for decades, universities don't "look themselves in the eye" and lower the price of tuition, room, board, books, etc... out of the goodness of their hearts.

They respond to incentives (i.e. the inflated demand that Congress creates) and raise prices—what freshman microeconomics students learn is called "the demand curve shifts right and raises the market equilibrium price." The fact that you still can't figure that out even after 47 years in the Senate explains why education inflation has been spiraling out of control for decades and won't stop until you stop subsidizing it.

Supply and Demand: What Comes First? Which is More Important? (Part 1 of 2)

Click here to read the original Cautious Optimism Facebook post with comments

6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff addresses a theoretical question that has divided economists for nearly a century and also divided CO readers two years ago in the comments section.

French Economist Jean-Baptiste Say (1767-1832)

A few years ago a rather heated debate broke out in CO Nation over a question that still divides economists today: What comes first, supply or demand? Production or consumption?

Some argued “Supply is more important. Demand is useless without something to demand.” (ie. production)

Others countered: “Demand is more important. No one will produce or supply anything if it’s not demanded first.”

So who is right?

The Economics Correspondent has been meaning to weigh in with economic theory and evidence for some time and figures now is as good a time as any.

But first off, the Correspondent would like to establish a critical definition: that of demand. 

Supply is a fairly easy concept. It’s goods and services produced by enterprises, be they large corporations down to a sole proprietor.

But in economics, demand is not only the wish to buy a product or service but also the means. 

Anyone can want the latest smartphone, but for “demand” to exist economists have to see consumers not only desire the new phone but also buy it.

In fact, economists talk in terms of the “supply side” and the “demand side,” and there are even “supply side” schools of economics that emphasize the greater importance of production—usually conservative or libertarian—and support government policies that encourage more supply such as lower taxes and fewer regulations.

Likewise there are “demand side” schools that emphasize the greater importance of consumption—usually liberal or socialist—and advocate government policies that encourage more spending such as greater taxation and redistribution to lower and middle classes (who spend a larger share of their income) and regulations that force wages up.

But more on those schools in a future column.

PRODUCTION MUST COME FIRST, BUT…

The Economics Correspondent will establish up front that he leans very heavily, albeit not completely, towards the supply and production side and will explain why, both in simple and more nuanced terms. Then he'll explain why demand-issues can still be important.

After reading, by all means let the discussion continue in the comments.

So the most basic argument for supply and production being both more important than and necessary precursors for demand is intuitive: 

You can’t consume that which has not yet been produced. Or “You can’t even talk about eating apples until you grow them first.”

Seems simple enough.

To which demand-side advocates have their own sophisticated counter: “If no one has the ability to demand/buy the apples, they won't get grown. Demand must come before supply.”

Both arguments seen to have some merit.

SAY’S LAW OF MARKETS

This dilemma was famously studied, discussed, and settled (for a while) by French classical economist Jean-Baptiste Say (1767-1832) in his 1803 book “A Treatise on Political Economy.” 

Say was a contemporary of Thomas Jefferson with whom he corresponded frequently and sent a copy of his book. His ideas also got him into trouble with Napoleon Bonaparte who dismissed him from his post in the French Tribunat. From there Say laid low, working in private business before reemerging as an academic upon Napoleon's defeat at Waterloo.

Say’s book is enormous and, as a treatise, covers a wide range of topics from trade to tariffs to money to taxation, but his most discussed chapter is on supply and demand where he established what economists refer to as “Say’s Law of Markets.”

The Correspondent will provide supporting quotes in a moment, but Say argued that in a market economy one’s ability to demand originates first from supply itself. That is, it’s what you produce that makes your demand possible in the first place.

Thus it’s true that Ford might not produce lots of cars until they see consumers demand them, but for consumers to demand Ford cars they must first produce something of value themselves.

Or in an 1803 example, the baker goes to the market to buy fish, but the money he obtained to demand the fish first came from his production of bread.

Remember that in 1803 Say was talking about a market economy, not money forcibly seized by criminals or governments and redistributed to someone who is unable or unwilling to produce. 

Also an heir may not produce as much as his wealthy retiree parents, but he can still command a lot of demand if the parents will their estate to him. All this means is the parents derived their demand from previous production and transferred it to someone else.

But back to Say who summed up his position writing:

“A product is no sooner created than it, from that instant, affords a market for other products.”

Say is often criticized for stating an economy’s total quantity of supply always and instantly equals the total quantity of demand, something he never claimed. He appreciated that aggregate supply and aggregate demand tend to be in equilibrium but that sometimes there can be a mismatch. 

But in Say’s view the mismatch is usually the result of businessmen erring in their plans and producing supply that the public doesn’t value very much—ie. the wrong kind of supply, such as producing millions of “Epstein really killed himself” tee shirts.

But he did argue that there can be no long-term *general* overproduction of supply or “glut” in an economy for which he is also criticized. More on that in Part 2.

IS SAY’S LAW CORRECT?

One can test Say’s Law—that demand originates from the ability to first produce something else—using a simple thought experiment:

Imagine a huge freight ship full of BMW’s departs Germany and docks at Manhattan Island. Only it arrives in the year 1500, before western Europeans had colonized the area.

There’s no question the local natives would be fascinated by BMW cars and would instantly want to buy some. But do you think they would command enough demand for the cargo ship to go home empty, or would it return to Germany still full of unsold cars?

Clearly it would go back full. The natives might like BMW’s, but they have little ability to demand them. 

And why do they have so little ability to demand? Because natives in the year 1500 produce so little supply to constitute that demand. The most they might have to offer is a few fish or some corn or squash: hardly enough to trade for a giant ship full of BMW’s.

Now fast forward to the year 2022. The ship arrives in New York City with its stock of BMW’s. Will the ship go home empty or return with its cargo?

Obviously it will go back empty. New Yorkers like BMW’s as much as the natives of 1500 did, but the difference is New Yorkers have a much greater ability to demand BMW’s because they are so much more productive. Their ample demand derives from their greater ability to produce.

Hence yes, demand matters, but since demand originates from the ability to create supply first, supply remains more important.

In fact, one not even need use a thought experiment. Just look at countries today.

What makes some countries rich and other countries poor? How are Americans able to demand cool electronics, cars, and an endless array of other products and luxury goods from around the world, while no one will sell them en masse to the citizens of Zimbabwe?

The answer is Americans’ ability to demand comes from America’s enormous capacity to produce. Zimbabwe can demand very little because it produces so little.

Or just compare one nation to itself, only separated by time.

Fifty years ago the citizens of South Korea would have loved to drive fancy cars, live in high rises with air conditioning, have closets full of designer clothes and handbags, and fly on Boeing jets to faraway vacation destinations.

But very few did. Most South Koreans were poor by western standards and had no ability to demand such luxury goods because their economy was still not very productive in 1972.

Fast forward to 2022 and Koreans’ standards of living have improved enormously. Most have cars. Most live in high rises, have air conditioning, modern appliances, designer clothes, and most fly on exotic vacations.

What changed? The answer is easy. Koreans can demand more and better goods and services because their economies are so much more productive than they were fifty years ago.

As Say himself wrote in 1803:

“It is the capability of production which makes the difference between a country and a desert."

Or as economist Benjamin Anderson wrote in 1949:

“The prevailing view among economists… …has long been that purchasing power grows out of production. The great producing countries are the great consuming countries.”

Conclusion? In a market economy the capacity to demand derives from the ability to supply. If you want to demand, you must first supply. If you wish to consume, you must first produce. Supply comes before demand. Production comes before consumption.

Say would have agreed.

In the concluding chapter we’ll discuss the great academic challenge to Say’s Law of Markets: Keynesian economics.

Left Coast Correspondent: Government "Shoot Up Centers" on Governor Newsom's Desk for Signing

Click here to read the original Cautious Optimism Facebook post with comments

The Cautious Optimism Correspondent for Left Coast Affairs and Other Inexplicable Phenomena predicts this will do wonders for reducing homelessness and drug use in San Francisco, Oakland, and Los Angeles.

And create a bunch more $500,000/year public union government nurse and administrator jobs.

Read "New law could open safe injection sites for drug users in Oakland, San Francisco" at...

https://www.ktvu.com/news/new-law-could-open-safe-injection-sites-in-bay-area-for-drug-users

Peter Schiff Makes a Good Point About Fed Inflation Targeting

Click here to read the original Cautious Optimism Facebook post with comments

The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff is "resolutely ambivalent" about vocal financial commentator Peter Schiff.

Schiff is marvelously right on some points and has been proven dismally wrong on others, and when he’s wrong he tends to stubbornly double down with an intransigent intellectual inflexibility.

But the Economics Correspondent listened to a recent Schiff podcast where he made a golden point.

First the background.

During the early stages of the Covid pandemic the Federal Reserve subtly changed its policy inflation target from 2% per year to an “average of 2%” per year. 

The official rationale was that if inflation remains under 2%, as it had from 2013 to 2016, the Fed should run slightly higher than 2% inflation for several years going forward to pull the longer-term "average" rate up to 2%.

So Schiff has asked a logical question:

Q. Now that the country is experiencing far, far higher than 2% inflation and will probably continue to do so as the Fed works to lower it back to 2% over the next couple of years, will they deliberately aim for under 2% inflation in the years after that? 

Using a hypothetical example: If the official inflation rate over four years is, say, 8%, then 6%, then 4%, and then 2%, then to achieve an average target of 2% over a decade the remaining six years’ inflation target must be zero.

Under those conditions does anyone expect the Fed will deliberately pursue a zero inflation policy for six years in order to achieve its own stated long-term target of 2%?

Thanks to Peter Schiff for his insight.

Who Has Taiwan Traditionally "Belonged" To?

Click here to read the original Cautious Optimism Facebook post with comments

4 MIN READ - Other than the dismal science, the Cautious Optimism Correspondent for Economic Affairs and Other Egghead stuff is a modest student of Chinese history. The following is a brief history of Taiwan’s official relations with China.

No matter what one thinks of Nancy Pelosi’s recent visit to Taiwan or the U.S. government’s position on Taiwan independence here are some interesting facts about who Taiwan has “belonged to” over the centuries.

As most people know Chiang Kai-Shek’s Nationalist government retreated to Taiwan in 1949 after losing the Chinese civil war against the communists. 2 million Chinese crossed the strait to live among 5.9 million native Taiwanese, most of whose ancestries were rooted on the island for centuries. 

Taiwan has subsequently been governed from Taipei for the last 73 years.

Meanwhile the Chinese Communist Party emphasizes that Taiwan is still “an inalienable part of China,” and Chinese state-run media repeatedly reports Taiwan has been part of China going back to the dynastic period.

Of course we know Taiwanese don’t want to live under communist rule, but given Beijing’s version of history how could those stubborn islanders not at least recognize that Taiwan is part of China?

Let’s go back a little further in time.

PRE-CIVIL WAR AND THE DYNASTIES

Before the Chinese civil war broke out in 1945, Taiwan had been a Japanese colony for 50 years (1895-1945), only having been handed to the Nationalist government upon Japan’s World War II surrender.

During the 19th century, when the rising Japanese military crushed a larger Chinese imperial force in the first Sino-Japanese war, the Treaty of Shimonoseki (1895) ceded both Korea and Taiwan to Japan which in turn modernized the island.

So the initial math says for 123 of the last 127 years Taiwanese have had a pretty good reason to think they are not part of China. Because they’ve been governed by someone other than China.

Going back further across two thousand years of Chinese dynastic rule, none of the dynasties ever showed interest in conquering, ruling, or governing Taiwan until the very last one: the Qing dynasty (1644-1911, pronounced “ching”). 

The Qing were actually not even Chinese but rather Manchurians who successfully invaded China from outside (hence they are also referred to as the Manchu dynasty) and were hated by native Chinese as alien rulers for their 267 year reign.

The Qing only reluctantly went to Taiwan to eliminate the last vestiges of holdout loyalists from the previous dynasty, the Chinese Ming (1368-1644), who had retreated to the island upon defeat.

Even the great Qing emperor Kangxi himself (pronounced “kahng-shee”), who sent his forces to Taiwan to wipe out Ming loyalists, declared Taiwan was "a ball of mud beyond the pale of civilization.” 

In 1683, the year the Ming loyalists were defeated, Kangxi stated “Taiwan is outside our empire and of no great consequence,” and later tried to sell it back to the Dutch who refused.

Before the Qing the Ming also didn’t recognize Taiwan as Chinese territory and told Dutch traders to “go beyond our territory,” kicking them off the mainland to establish a base on the island.

We can go further back to 221 BC, or the establishment of the Qin dynasty (pronounced “chin”) under China’s first unified emperor Qin Shi Huang. Since the time of the Qin emperor Taiwan has been administered by China, usually reluctantly, only in 1683-1895 and 1945-1949, or 216 of the last 2,243 years.

Or stating the inverse, Taiwan has not been governed or even officially “part of China” for 2,027 of the last 2,243 years.

Perhaps one can see how Taiwanese, particularly the majority whose bloodlines are native to the island, don’t see themselves as part of China and many don’t even consider themselves Chinese.

THE COMMUNISTS

But what about the Chinese Communist Party? They’re the ones in charge of China today. So haven’t they felt more kindred affection for their Taiwanese countrymen than the old imperial dynasties?

The Correspondent remembers reading twenty years ago that Mao Zedong, the founder of the People’s Republic of China, never once called Taiwan part of China in any of his writings or speeches up until the civil war, but can’t remember the book he read it in.

But no matter. Historical records easily obtained today confirm Mao’s position. 

The Chinese Communist Party was founded in 1921 and quickly merged into the larger Nationalist Party. 

Suspicious (and later proven correct) that the communists were operating under orders from the Soviet Union to subvert the Nationalist Party from within and rule China themselves, Chiang Kai-Shek violently purged the communists in 1927. 

Those CCP members who escaped the purge formally split off and officially rewrote the new communist political platform:

From 1928 to 1943 the CCP’s official position on Taiwan recognized the island as a distinct “nation” and “nationality.”

In a 1937 interview with American journalist and communist sympathizer Edgar Snow, Mao Zedong (then hiding from Chiang Kai-Shek’s forces) stated “…we will extend them (the Japanese-occupied Koreans) our enthusiastic help in their struggle for independence. The same thing applies for Taiwan.”

For many years after future Chinese Premier Zhou Enlai reiterated the CCP’s position on granting independence to Taiwan, writing as late as 1941 that "We should sympathize with independence-liberation movements of other nation-states" of which he named "Korea or Taiwan," "the Balkan and African nations," and "India and various South Asian countries."

These historical quotes of Communist Party founding giants eagerly supporting Taiwan independence are undoubtedly *not* reported on Chinese state-run media today.

It was only near the end of World War II, when it became clear civil war was about to break out again, that the Communist Party changed its position and declared Taiwan to be part of China.

Today, cynical Taiwanese and observers outside China theorize that Beijing is concerned far less with Taiwan’s legal status or a fraternal union with the islanders than its strategic value, and the Economics Correspondent agrees.

Beijing wisely views Taiwan as an “unsinkable aircraft carrier” that they don’t control—and therefore view as a threat—even though China has an enormous army and nuclear weapons. 

Also as has been widely reported Beijing has claimed the entire South China Sea as its own territory, building artificial islands with military ports and airbases while its coast guard and navy harass, hose down, ram, and even sink non-Chinese commercial vessels and fishing boats for infringing on Chinese sovereignty.

It's not lost on the world that 40% of all global commercial shipping passes through the South China Sea which Beijing wishes to control. And seizing Taiwan would allow Beijing to also push its claims out into the Philippine Sea lanes that connect Japan, South Korea, and eastern Russia to the 85% of the world’s population not living in the western hemisphere.

Bank of England Tightens, Warns of Long Recession

Click here to read the original Cautious Optimism Facebook post with comments

2 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff believes the Bank of England is being more forthcoming with the British public about the potential repercussions of suppressing inflation than the Federal Reserve has been.

That said, there are some slightly different circumstances at play in the UK.

1) The UK's official reported inflation rate is slightly higher than the USA’s at 9.4% (June). During the pandemic the Bank of England expanded money just as aggressively as the Federal Reserve and also kept its policy rate too low well into 2022 (see M1 chart).

Given the BoE only raised its policy bank rate (similar to the Fed’s discount rate) from 1.25% to 1.75% last week, there’s an argument to be made that its policy rate still remains too low even eight months into the year (see bank rate chart), that it's even further behind the curve than the Fed, and that it's more motivated to risk recession in order to stop inflation.

2) Bank of England officials are publicly forecasting inflation to reach 13.3% later this year. Central bank rate hikes can influence price movements faster than the real economy, taking several quarters before their effects are fully felt on growth and employment—what Milton Friedman called "long and variable lags"—another risk Americans should consider since the Fed's recent 150 basis points in rate hikes have only occurred in the last 50 days. 

3) The Bank of England may be trying to prepare the British public for a “worst case scenario” in the hopes of exceeding lower expectations in the future.

The Fed, on the other hand, may be opting for a different political path: talking down any major recession risks in the hope it can still engineer a “soft landing.” 

While there's no guarantee an inflation-suppressing tightening will create a recession a year later, history has shown that soft landings are nearly impossible to achieve when attempting to stop any inflation above mid-single digits... as the Economics Correspondent has previously written about (see attached article).

http://www.cautiouseconomics.com/2022/06/monetary-policy-24.html

Read more on the Bank of England's warning on CNBC at:

https://www.cnbc.com/2022/08/04/bank-of-england-launches-biggest-interest-rate-hike-in-27-years.html

A Look Back at Two Decades of Paul Krugman Predictions

Click here to read the original Cautious Optimism Facebook post with comments

6 MIN READ - With New York Times columnist Paul Krugman recently telling CNN that the USA is not in recession and the word doesn’t matter, the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff feels now is a good time to look back on some of the Nobel laureate’s previous predictions... with a little color analysis.

While this list is comprehensive enough to illustrate Krugman's batting average it’s far from complete. At first the Economics Correspondent did try to gather more of Krugman’s career mistakes but received an email from Facebook’s data center staff complaining it was draining too many exabytes of storage capacity from their main campus servers.

So about two dozen quotes will have to do.

1) RECESSION

Brian Stelter: “Are we in a recession and does the term matter?"

Krugman: “No we’re not and no it doesn’t… …What does it matter whether you use the ‘r’ word or not?”

-CNN interview. July 31st, 2022

2) THE INTERNET

"By 2005 or so, it will become clear that the Internet's impact on the economy has been no greater than the fax machine's."

-Red Herring Magazine, June 10, 1998

https://web.archive.org/web/19980610100009/http://www.redherring.com/mag/issue55/economics.html

3) 2000-01 RECESSION: THE FED STIMULATES HOUSING

“During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn’t you lower interest rates?”

-New York Times, May 2001

"It’s still not clear that Mr. Greenspan has caught up with the curve—let’s have at least one more rate cut, please—but the interest-rate cuts do, cross your fingers, seem to be having an effect."

-New York Times, July 2001

“Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer.”

-New York Times, October 2001

“The good news about the U.S. economy is that it fell into recession, but it didn’t fall off a cliff. Most of the credit probably goes to the dogged optimism of American consumers, but the Fed’s dramatic interest rate cuts helped keep housing strong even as business investment plunged.”

-New York Times, December 2001

“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.”

-New York Times, August 2002

4) THE HOUSING BUBBLE

(Correspondent comment) History now records the Fed inflated a historic housing bubble which burst and took the banking system down with it, precipitating the Great Financial Crisis of 2008 and the Great Recession.

So when some people went back and found Krugman’s many columns urging the Fed to inflate and stimulate housing even more he responded: 

"Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened."

-"And I Was On The Grassy Knoll Too," July 2009

Sure, all those quotes from 2001 and 2002 weren't "policy advocacy." Krugman just wrote again and again that the Fed should cut rates further to stimulate housing but never really meant it (smh).

And all topped off with…

"To be honest, a new bubble now would help us out a lot even if we paid for it later. This is a really good time for a bubble… …There was a headline in a satirical newspaper in the US last summer that said: 'The nation demands a new bubble to invest in' And that’s pretty much right.”

-Spanish television interview, May 2009

5) U.S. BANKS DURING THE CRISIS

In early 2009 Krugman called for the federal government to take over much of the U.S. banking industry Sweden style.

"The case for nationalization [of US banks by the federal government] rests on three observations... ...There’s a reasonable chance — not a certainty — that Citi and BofA, together, will lose hundreds of billions over the next few years. And their capital, the excess of their assets over their liabilities, isn’t remotely large enough to cover those potential losses…"

“…Still, isn't nationalization un-American? No, it's as American as apple pie.”

-"Banking on the Brink." New York Times, February 22, 2009

(Correspondent’s comment) Two weeks after his column Citigroup and Barclays announced surprise profits and bank stocks soared, never looking back. A few months later Krugman wrote a column complaining that bank profits were too large and creating too much wealth inequality.

6) EUROPE

(Right before the financial crisis)

“… tales of a moribund Europe are greatly exaggerated. … The fact is that Europe’s economy looks a lot better now—both in absolute terms and compared with our economy.”

-“The Comeback Continent.” January 11, 2008

(After the financial crisis and during the ensuing eurozone crisis)

“'Greece will leave eurozone within 12 months"

-“The Independent” interview. May 30, 2012

“The Euro collapse is imminent”

-At least 11 times from April 2010 to July 2012

https://www.huffingtonpost.com/niall-ferguson/paul-krugman-euro_b_4060733.html

(Correspondent’s comment) Of course Greece didn't leave the eurozone and the Euro didn’t collapse.

“I think I can say without false modesty, a huge win; I (and those of like mind) have been right about everything.”

-"A Mythical Anniversary." June 18, 2012

7) UK AND IRELAND RECOVERIES

“Britain will continue on a death spiral of self-defeating austerity.”

-“Cameron’s Remarkable Achievement” April 25, 2012

(Correspondent’s comment) In the four years after Krugman’s column the UK’s real GDP grew by 2.4% per year and unemployment fell 3.1 points to full employment.

Not stratospheric growth but clearly not a death spiral, and better than the USA’s real GDP growth rate of 2.1% during the same period under Barack Obama (whose policies he credited for the U.S. recovery).

“The repeated invocation of Ireland as a role model has gotten to be a sick joke.”

-“Ireland is the Success Story of the Future, and Always Will Be.” August, 2013

“This is a ‘bright spot’? …True, [European economist Jean] Pisani-Ferry doesn’t actually say that Ireland is recovering, only that it is ‘set to recover’. But we’ve heard that before, and before, and before.”

-“The Neverending Irish Success Story.” May 2013

(Correspondent's comment) In the six years following Krugman’s 2013 barrage of articles criticizing Ireland's economic policy its real GDP grew by 91% or 11.4% per year compounded—easily the highest in Europe and probably the world.

Unemployment fell from 14.4% to 4.9% (ie. full employment) down nearly 10 points in six years.

8) TRUMP

"If the question is when markets will recover, a first-pass answer is never."

-Eve of Donald Trump election victory. November 8, 2016

(Correspondent’s comment) One year after Donald Trump's inauguration the S&P 500 index had gained 32.7% from Krugman’s election night doomsday prediction. When Donald Trump left office in January 2021 the S&P had gained 80.0%.

9) INFLATION

"And we really should have some patience... ...pronouncements that inflation can’t be transitory because it has persisted for a number of months are just silly."

-"History Says Don't Panic About Inflation." November 2021

"There wasn’t anything in the report suggesting that inflation is rapidly spiraling upward... ...That said, the headline number is highly likely to come down over the next few months."

-December 2021

"Look underneath the hood and it does not look like, we don't really have a 7% inflation economy out there."

-Mercatus Center interview, January 2022

(Correspondent’s comment) For what it's worth, Krugman has come out officially and admitted he was wrong on inflation.

10) SELF-CRITICISM

“But can the debate really be as one-sided as I portray it? Well, look at the results: again and again, people on the opposite side prove to have used bad logic, bad data, the wrong historical analogies, or all of the above. I’m Krugtron the Invincible!”

-“Knaves, Fools, and Me.” April 28, 2013