Paul Krugman (2015): Artificial Unintelligence: "In the e...

Paul Krugman (2015): Artificial Unintelligence: "In the early stages of the Lesser Depression, those of us who knew a bit about the macroeconomic debates of the 1930s... felt a sense of despair...

...Everywhere you looked, people who imagined themselves sophisticated and possessed of deep understanding were resurrecting 75-year-old fallacies and presenting them as deep insights. A lot of water has passed under the bridge since then.... I feel an even deeper sense of despair.... People are still rolling out those same fallacies, even though in the interim those of us who remembered and understood Keynes/Hicks have been right about most things, and those lecturing us have been wrong about everything. So here���s William Cohan in the Times, declaring that the Fed should ���show some spine��� and raise rates even though there is no sign of accelerating inflation. His reasoning:

The case for raising rates is straightforward: Like any commodity, the price of borrowing money���interest rates���should be determined by supply and demand, not by manipulation by a market behemoth. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying...

Oh dear. Cohan���s theory of interest rates is basically the old notion of loanable funds.... [But] loanable funds doesn���t determine the interest rate; all it does is define a relationship between interest rates and income.... What determines where we end up on that curve? Monetary policy. The Fed sets interest rates, whether it wants to or not���even a supposed hands-off policy has to involve choosing the level of the monetary base somehow, which means that it���s a monetary policy choice. And how would you know if the Fed is setting rates too low? Here���s where Hicks meets Wicksell: rates are too low if the economy is overheating and inflation is accelerating. Not exactly what we���ve seen in the era of zero rates and QE....

There are arguments that the Fed should be willing to abandon its inflation target so as to discourage bubbles. I think those arguments are wrong���but in any case they have nothing to do with the notion that current rates are somehow artificial, that we should let rates be determined by ���supply and demand���.... Crude misunderstandings along these lines are widespread even among people who imagine themselves well-informed and sophisticated. Eighty years of hard economic thinking, and seven years of overwhelming confirmation of that hard thinking, have made no dent in their worldview. Awesome.

#noted