Thread: Anyone knows Chinese characters here?

Originally Posted by gunnut

I simply don't understand Krugman's theory. How can spending more money stop a recession? If that's really the case, we should pile on trillions of debt every year to ensure prosperity. If deficit spending should occur, it should be short and targetted. Long term debt is bad.

That is most famous argument but that is not all he has to say -- a coworker of my is a supporter of Krugman (he is also a rockefeller republican, just don't ask, but I am sure some how it all make sense) and two weeks ago, we went back and review what Krugman has to say about Inflation and the value of the dollar and hate to say it, the dollar has been "relatively" stable and so far not much of inflationary pressure yet (and deflation never really kicks in).



Anyways.

It’s a high-stakes debate: Professor Ferguson is arguing that the stimulus package has counterproductively stimulated inflation fears, while Professor Krugman thinks the stimulus has worked as intended by reducing the likelihood of deflation. In fact, Krugman has argued for another dose of fiscal stimulus.

June 15, 2009, 11:54 am
Krugman vs. Ferguson: Letting the Data Speak
By Justin Wolfers

When giants like Paul Krugman and Niall Ferguson start to argue, they both sound compelling. Ferguson says that interest rates are rising because of the deficit, and Krugman retorts that Ferguson has forgotten his first-year economics. Fortunately, the data can speak, and it’s time to give them a voice. This is why I turn to my frequent collaborator, Eric Zitzewitz, who has an incredibly handy knack for getting financial data to speak clearly. Eric’s verdict? You’ll have to keep reading.

Quantifying the Nightmare Scenarios II: Why Have Long-Term Interest Rates Risen?
By Eric Zitzewitz
A Guest Post

There’s no debating that long-term interest rates on government debt have risen. But there’s a pretty fierce debate about what it means. Harvard historian Niall Ferguson interprets this as indicating that the bond market is worried about the U.S. deficit and the prospect of inflation.

Princeton economist Paul Krugman thinks it indicates that worries about deflation have eased.

It’s a high-stakes debate: Professor Ferguson is arguing that the stimulus package has counterproductively stimulated inflation fears, while Professor Krugman thinks the stimulus has worked as intended by reducing the likelihood of deflation. In fact, Krugman has argued for another dose of fiscal stimulus.

So who is right? Standard measures of expected inflation — such as the difference between 20-year nominal and inflation-protected Treasury yields — have risen sharply, from an almost implausibly low 0.9 percent in December to 1.5 percent throughout February and March to 2.25 percent last week. But an increase in expected inflation can come from an increased probability of high inflation (bad news; Ferguson’s story) or a decreased probability of deflation (good news; Krugman’s story).

Resolving their debate requires measuring the likelihood of different inflation scenarios. Let’s do it.

The graph below plots the probability of different outcomes for the yield on 25-year Treasuries on two different dates — late February and the end of last week. I calculated these probabilities using the technique I discussed in my last post, which extracts the probabilities implied by option prices on those dates. (Wonkish detail: I used the January 2011 options on the iShares Barclays 20+ Year Treasury Bond exchange-traded fund (TLT) and converted bond prices to yields using the portfolio average data reported by iShares.)
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The blue line shows that there was a lot of uncertainty about future Treasury yields in February, including a very large chance of very low interest rates, as in Krugman’s deflation scenario. But the green line shows that this deflation risk appears to have receded. In fact, the recent increase in Treasury yields is almost entirely due to a reduction in the probability of the deflationary (low nominal interest rates) scenario. Score this round for Krugman.

While Ferguson wrongly diagnosed the cause of the rise in interest rates, he is right that the markets are spooked about the risk of an inflationary breakout. There’s about a 7 percent chance that 25-year interest rates will exceed 10 percent, although surprisingly, this risk was slightly higher back in February. This is a fairly extreme scenario: long-term interest rates have not been above 10 percent since inflation was tamed in the mid-1980’s. So there’s a chance that Professor Ferguson may be right about the broader issue: now that deflationary worries seem to have eased, it might be time to start turning the fiscal policy battleship around.

Finally, let me suggest that Professors Ferguson and Krugman settle their dispute like gentlemen. No, I don’t mean pistols at dawn, or the modern equivalent. Instead I suggest that Professor Ferguson purchase from Professor Krugman a January 2011 put on TLT (the iShares ETF) at a strike price of 55 (which would profit if future yields were over 8 percent) at the current market price. If the two good profs would put their money where their mouths are, the whole debate may well become clearer, more civil, and more credible than the usual cheap talk, which may be our largest remaining national surplus.

Krugman vs. Ferguson: Letting the Data Speak - Freakonomics Blog - NYTimes.com