Paul Krugman: Interest Rate Follies


Interest Rate Follies, by Paul Krugman, in NY Times:

I don’t have time to do all the references, but here’s a quick summary of what Very Serious People have been saying over the past 2 1/2 years:

May 2009: Interest rates have risen on hopes of recovery, but lots of people claim that we’re seeing crowding out by government borrowing; the WSJ announces that the bond vigilantes, the “disciplinarians” of US policy, have arrived.

Fall 2009: Although rates keep refusing to soar, the story I hear is that it’s all because hedge funds are borrowing short and lending long, and that it’s going to end in grief any day now when this “carry trade” collapses. Obama goes on Fox and says that we have to cut the deficit or we’ll have a double dip.

May 2010: A slight rise in rates due to renewed optimism about recovery is described in news reports — and this is reported as a fact, not a speculation — as a sign of worries about US debt. Meanwhile, the OECD calls for immediate rate hikes.

Fall 2010-present: Despite the persistence of low rates, politicians and pundits state — again, as a fact, not a hypothesis — that we’re going to have a terrible crisis within 2 years if the deficit isn’t slashed.

Meanwhile, some us worked with a very different story: the Fed will determine short rates, and the long rate reflects expected future short rates. And the Fed will keep short rates near zero as long as the economy remains deeply depressed. So the long rate reflects beliefs about prospects for recovery, and hence of an eventual move off the zero-rate policy. According to this view, a weaker economy will push rates down even as it raises the deficit.

And right now, with the 10-year rate at 2.19% — 2.19%! — the market is basically signaling that it doesn’t care a bit about the deficit, but that it’s terrified about growth prospects.

But I’m not a Serious Person.

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