Paul Krugman: Fatal Fiscal Attractions


 

Oh, my. David Greenlaw, James Hamilton, Peter Hooper, and Rick Mishkin have published an op-ed in the WSJ (where else?) based on their recent paper on debt, deficits, and interest rate spreads. They really shouldn’t have — the argument in that paper collapsed under scrutiny almost the moment it was released.

Matt O’Brien sums it up. Greenlaw et al start by saying that they’re going to restrict their analysis to advanced countries, because developing countries generally can’t borrow in their own currencies, and this lack of monetary independence makes them vulnerable to shocks in a way advanced countries historically haven’t been. But the authors then proceed to offer statistical results in which the majority of their sample consists of euro area countries, which by definition can’t borrow in their own currencies — because they no longer have their own currencies.

And even a quick pass at the numbers shows that all, yes all, of their claimed result comes from troubled euro area nations:

O’Brien does a more careful takedown, doing the same regressions they do but separating non-euro from euro countries, and confirms that their result is euro-exclusive. He also finds that the really strong relationship within the euro is between interest spreads and current account deficits, which is in line with the conclusion many of us have reached, that the euro area crisis is really a balance of payments crisis, not a debt crisis.

This leaves us with a puzzle: what were the authors thinking? Particularly when one bears in mind the fact that there is, let’s say, a bit of history (from 2010) here:

Morgan Stanley Issues a Mea Culpa on Treasuries Forecast That Was `Wrong’

Morgan Stanley had forecast that a strengthening U.S. economy would lead to private credit demand, higher stock prices and diminish the refuge appeal of Treasuries, pushing yields higher. David Greenlaw, chief fixed-income economist at Morgan Stanley, said in December that yields on benchmark 10-year notes would climb about 40 percent to 5.5 percent, the biggest annual increase since 1999. The New York-based firm reduced its forecast to 4.5 percent in May and to 3.5 percent last week.

Maybe a bit of caution, indeed a willingness to bend over backwards to avoid once again crying wolf about interest rates, would have been in order?

But there’s something about fiscal scare stories that makes economists who have done good work elsewhere careless, all too ready to jump on results that seem to reinforce fiscal fears without engaging in self-reflection and self-criticism. Maybe it’s the morality-play aspect; maybe it’s the realization, conscious or not, that you can’t go wrong with the Very Serious People by playing deficit scold.

Whatever the reason, it’s very disappointing to see economists feeding fiscal fears with work that is so obviously flawed.

Fatal Fiscal Attractions – NYTimes.com

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