When Someone Denies Paul Krugman Called for a Housing Bubble, They Are Either a Fool or a Liar

Paul Krugman describes it as a “canard” and Dean Baker accuses anyone who points it out of being “either a fool or a liar”, but the truth is that, yes, Krugman did in fact call for the Fed to create a housing bubble in 2002. The best Dean Baker can do is to quote Krugman doing so, but then deny that he actually meant it by asserting that Krugman was being “sarcastic”, adding “So let’s cut the crap.”

Yes, let’s cut the crap, indeed. All we have to do to see that Krugman did in fact mean it is to look at the quote Baker refers to in its context. Since I addressed Krugman’s denials already in Ron Paul vs. Paul Krugman: Austrian vs. Keynesian economics in the financial crisis, I’ll paste the relevant excerpt from the book (with the key portion Baker quoted in bold):

On August 2, 2002, Krugman wrote an article in which he said that what the Fed needed to do in order to prevent a recession was to create a housing bubble. His statement, quoted in its full context, was as follows:

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 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.

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.

Curiously, he commented that Alan Greenspan needed a recovery “to avoid awkward questions about his own role in creating the stock market bubble”, but didn’t elaborate on what that role was. He closed by saying, “But wishful thinking aside, I just don’t understand the grounds for optimism. Who, exactly, is about to start spending a lot more?”

It is important to be clear on what Krugman was saying here. His earlier record on the housing bubble is unambiguous. He had repeatedly advocated that the Fed should lower interest rates for the explicit purpose of creating a boom in housing as a route to economic recovery. Here, he was implicitly acknowledging that the numerous interest rate cuts that had already been made had not solved the problem. The reason he offered was that people were still not spending enough, and his argument had been that the Fed should cut interest rates even further. He attributed the view that the Fed “needs to create a housing bubble” to Paul McCulley, but there can be no mistake, reading his remark in context, that Krugman was in agreement. This is evident in his prefacing the remark by saying that people warning of a double-dip recession “made a lot of sense”, by his own (not McCulley’s) comment that to “fight the recession” the Fed “needs” to do so, and by his expressed pessimism that the Fed could “pull that off”.

So there you have it. It is perfectly evident from the quote’s actual context that Krugman was not being “sarcastic”. But that’s not all. There is a broader context to consider, as well. While the above quote from his August 2002 article is the most infamous example, Krugman in fact repeatedly and consistently advocated a Fed policy of lowering interest rates specifically in order to create a housing bubble.

To cite a few examples, following the bursting of the dot-com bubble, in August 2001, Krugman argued that the Fed should cut long-term as well as short-term interest rates in order to create “a boom” in the housing sector.

In September, he again advocated that the Fed buy long-term government debt in addition to short-term Treasury securities in order to spur a housing boom.

In October, he advocated this once again, saying that a housing boom spurred by the Fed’s low interest rates were “the main answer” to fixing the U.S. economy.

In December, he again advocated cutting long-term rates in order to “conjure up another dramatic boom”, this time in housing (emphasis added).

In August 2002, Krugman wrote the above column calling explicitly for “a housing bubble to replace the NASDAQ bubble”.

In July 2003, he praised the Fed’s historically low interest rates for fueling “the home-buying and refinancing boom”.

That October, he acknowledged that the housing boom “can’t go on” forever, but he maintained his advocacy for the Fed policy that was fueling it.

By May 2005, Krugman was explicitly acknowledging that housing was in a bubble. “Now the question is”, he wrote, “what can replace the housing bubble.” His answer was for the Fed to create yet another bubble. The problem, however, was that “the Fed does seem to be running out of bubbles”.

In August 2005, he acknowledged that the bursting of the housing bubble would result in unemployment, but continued to advocate for low interest rates nonetheless.

In January 2006, he complained that interest rates couldn’t get much lower in order to inflate the bubble even further.

In August 2006, he acknowledged that, “A snarky but accurate description of monetary policy over the past five years is that the Federal Reserve successfully replaced the technology bubble with a housing bubble” — just as he had advocated. Rather than reconsidering the wisdom of having advocated for this policy, Krugman instead wondered, “But where will the Fed find another bubble?”

In May 2009, Krugman said in an interview with a Spanish TV channel, “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 [The Onion] in the U.S. last summer that said, ‘The nation demands a new bubble to invest in’. And that’s pretty much right.”

For full documentation and additional examples, please see my book Ron Paul vs. Paul Krugman: Austrian vs. Keynesian economics in the financial crisis.

So, yes, Paul Krugman and Dean Baker, let’s please cut the crap and stop being so foolish and dishonest as to deny that Krugman advocated a Fed policy of pushing down interest rates in order to fuel the housing bubble.