Monday, March 3, 2014

We should all be so quick

Saturday, in CBO Mix-And-Match, Paul Krugman considered

the relationship between “r”, the real interest rate, and “g”, the economy’s long-run growth rate. The extent to which public debt is a problem depends a lot of this relationship.

He added:

As Floyd says, we should expect lower g to lower r too. In fact, I think there’s good reason to believe that a fall in g will reduce r more than one for one, so that slow projected growth actually reduces the urgency of doing anything about debt.

Slow growth makes debt less of a problem, he said. Pretty surprising, coming from Krugman. But he was back next day with Growth and Interest Rates: I Appear To Be Wrong. He showed a graph of the interest rate minus the rate of GDP growth, which I have duplicated because it caught my eye:

Graph #1: Interest Rate "r" less GDP Growth Rate "g"
Before 1980 the growth rate was higher than the interest rate, making interest relatively easy to bear. Since 1980 the interest rate has mostly been higher than the growth rate, making interest harder to bear. Krugman pointed out that, and:

I also offered a hypothesis: that interest rates fall more than one-for-one with slower growth...
So I’ve taken a quick and dirty look at US history, and it doesn’t seem to bear my hypothesis out.
I still think that a fall in g leads to a fall in r ... But lower growth does appear to make debt harder, not easier, to carry.

Lower growth makes debt more of a problem, Krugman says. Yup. But he knew that already. He had a momentary lapse of reason, that's all. Back in March 2010, in Debt And Transfiguration he wrote:

What I think I’m seeing, although I haven’t tested this carefully, is that the causal relationship largely runs from growth to debt rather than the other way around. That is, it’s not so much that bad things happen to growth when debt is high, it’s that bad things happen to debt when growth is low.

Bad things happen to debt when growth is low: Slow growth makes debt more of a problem. Krugman knew that four years ago. But then he read something he liked, and briefly adopted the notion that slow growth makes debt less of a problem. But he fixed it the next day.

We should all be so quick to think things right.

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