Why Paul Krugman Doesn’t Understand Bubbles

by Dec 23, 2013Liberty & Economy0 comments

Under the ironically-titled post "Potential Misunderstandings", Paul Krugman profoundly illustrates why he doesn't understand bubbles.

Under the ironically-titled post “Potential Misunderstandings“, Paul Krugman profoundly illustrates why he doesn’t understand bubbles by writing, “If you want to claim that an economy has grown unsustainably above potential, you need to show me the accelerating inflation.”

Krugman didn’t see the dot-com bubble for what it was. He thought the economy was just fine. He even wrote that there was no place for the economy to go but to continue upward, even as the NASDAQ had already started plummeting.

Then, in response to the bursting of that bubble, Krugman advocated that the Fed print money out of thin air to buy government debt to push interest rates down, which fueled the housing bubble. Krugman recognized by 2005 that there was a housing bubble. As early as 2002, even, Krugman wrote of the possibility. And yet he nevertheless still advocated that the Fed print money to fuel the boom in housing.

See, Krugman couldn’t see the dot-com bubble coming because, as he indicated on his blog earlier this month, he doesn’t think the economy can be in an unsustainable boom (a bubble), unless there is “inflation”, by which he means a general rise in prices in consumer goods as measured by the government. (Actually, inflation is an increase in the money supply, as in when the Federal Reserve prints money out of thin air. Rising prices are just the consequences of inflation. So it is useful to differentiate between monetary inflation and price inflation.)

Krugman refuses to see that the high stock prices during the dot-com bubble was price inflation. When the Fed prints money, it isn’t dropped from helicopters evenly to everyone throughout the 50 states. It goes into the hands of privileged sectors first; namely, the government and the financial sector. The privileged classes that receive the new money first are able to spend it into the economy, such as to purchase assets, before the resulting price inflation. In this way, inflation acts as a hidden tax, distributing wealth from the middle class and poor to the wealthy elites who benefit from creating money out of thin air and charging interest for its use.

This means that we shouldn’t necessarily expect the monetary inflation to result in rising prices across a broad spectrum of consumer goods. It can instead find its way into asset classes, like stocks or housing.

And Krugman doesn’t understand — at least, he pretends not to understand — that the Federal Reserve likewise created the housing bubble. Actually, he has acknowledged that the Fed’s low interest rate policy was the cause of the housing bubble, but later on he started denying this for the obvious reason that he had advocated that policy. (Whoops.)

Just last month, Krugman tried to claim that the Fed didn’t cause the housing bubble. He argued that money couldn’t have been “too loose”, meaning the Fed couldn’t have been printing too much money and interest rates couldn’t have been too low. Why not? Because price inflation “was indeed quiescent”, he wrote. But he was deliberately excluding food and energy, which did experience substantial price increases. Moreover, he was excluding housing prices, which, needless to say, were indeed rising significantly.

So Krugman denies that the Fed is inflating any bubbles on the grounds that there is no inflation. But there is plenty of inflation. The base money supply is up. Stock prices are up. Housing prices are up. That’s inflation.

Incidentally, Janet Yellen, who will replace Ben Bernanke as Chairman of the Federal Reserve, also has trouble seeing bubbles.

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About Jeremy R. Hammond

About Jeremy R. Hammond

I am an independent journalist, political analyst, publisher and editor of Foreign Policy Journal, book author, and writing coach.

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