Wednesday, August 18, 2010

Why I like Krugman ...

I like Krugman because he makes testable predictions ...
Liquidity Preference And Loanable Funds, Revisited - Paul Krugman Blog - 
A brief revisiting of the issues I raised more than a year ago regarding alternative views of interest rates.

This was never a question of simply forecasting what was going to happen to rates. It was about what would drive rates.

The view of Ferguson and others, back then, was that government deficits would drive up interest rates, choking off recovery. I and others argued that this was bad macroeconomics: interest rates would rise if and only if recovery took place. More specifically, short-term rates would stay near zero as long as the economy was deeply depressed; long-term rates would depend on expectations about the future of short rates, and hence on prospects for recovery.

So the key point is not the fact that rates are now considerably lower than they were when that debate took place; it’s the fact that rates have fluctuated very much with optimism about recovery, never mind the deficits.

In fact, if you had a naive loanable funds view, you’d expect the recent downgrading of expectations to drive rates up, not down — after all, a weaker economy means bigger deficits. But the opposite has, in fact, been happening.

The bottom line is that events have utterly confirmed one view, utterly rejected the other. Too bad such things don’t count in politics.
Testable predictions are a fundamental distinction between science and mere scholarship.

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