Krugman Vs. Feldstein on Interest Rates and the Fed

Bruce Krasting's picture


Paul Krugman has been taken shots at Martin Feldstein over this article (Link). Feldstein made the case that the Fed is keeping interest rates artificially low - and sooner or later this will cause a problem. The issue is whether the Fed is creating a new bubble. Feldstein says, "Yes". Krugman says "N0". A few lines from PK on this topic:


I really don’t understand how Marty Feldstein can look at these facts and conclude that the only way to explain low interest rates is to imagine that the Fed is imposing massive market distortions.


(Feldstein) then grabs hold of an answer to his imagined puzzle — it must be the quantitative easing! — that assigns vastly more importance to Fed bond purchases than I think can be justified by any evidence I see.


The notion that rates are low only because the Fed is holding them down by “gobbling” up debt is clearly refuted by international evidence, clearly refuted by the behavior of rates over time, and logically flawed.


This is a very important debate. Either Krugman is right, or Feldstein is. IMHO Krugman is ignoring the laws of supply and demand, and also the laws of gravity. The Fed's ZIRP policy anchors the short end of the curve at 2% below the rate of inflation. The long end of the curve is a function of the base cost of money, adjusted for supply from Treasury of new paper, and the demand that the Fed is creating with $85b a month of POMO.

If Feldstein can't convince Krugman, I doubt my thoughts will either. But I'll try.


Krugman provided a chart in this post (Link) that he maintains proves his point - QE has little consequence on the shape and level of the yield curve. PK's comments and the chart:


You can see a couple of pauses in the Fed’s expansion of its holdings — and no relationship at all to rates.





A different way to track the relationship between the Fed's balance sheet and interest rates comes from the folks at BMO Capital. Read the full report here. The author, Dimitri Delis, looks at the Fed's POMO buys (QE) under a different light than PK. BMO measures the Fed's purchases based on the 10-year equivalent duration (If the Fed buys 3 year bonds it has less "consequence" than an equal $ amount of 30-year bonds) and looks at real interest rates as opposed to PK's nominal. Delis concludes that the relationship between QE and real interests rates line up nearly perfectly (.94 correlation).





Krugman compared apples to oranges to make his point. BMO's look of the same data, makes an apples to apples comparison, and comes to a different conclusion.

So Mr. K, whatdaya think of those apples?




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just a dude's picture

At some point during the rest of my life, assuming the Fed continues to exist, "Dr." Paul Krugman will become a governor on the Federal Reserve Board of Governors.

withglee's picture

Proper management of any Medium of Exchange (MOE)
Money is “a promise to complete a trade”. This is obvious by studying its genesis as an efficient improvement over simple barter. Look at barter. At that instant when a good moves from one hand to another there is a promise to complete a trade. The instant before, it is a trading promise in the making. The instant after it is a promise kept.
All that money does is allow that promise to occur at different times; over different periods; at different places; and for intermediate goods. These promises are “certified” and then take on value themselves. The certificates are freely traded and called money.

When the trade is completed, the trading promise is extinguished. The certificates (money) representing it are returned and extinguished with it.

Again ... money is "a promise to complete a trade".

Characteristics of a properly managed MOE:
  o INFLATION is zero at all times and in all places
  o Money circulates freely and is universally accepted
  o Money is always in free supply at all times and in all places
  o Supply and demand for money are always in perfect balance
  o Responsible traders enjoy zero INTEREST
  o DEFAULTERS pay INTEREST ... it's an actuarial issue
  o There are no runs on banks
  o There is no business cycle
  o There are no bubbles
  o No capital what-so-ever is required
  o Saving has no effect on the economy at all
  o No cascading effects
  o No marking to market

To properly manage any Medium of Exchange (MOE), the controlling relation is:


Proper management entails:
  o measuring DEFAULTS of trading promises
  o collecting INTEREST equal to DEFAULTS
  o thus maintaining INFLATION at zero for all time and in all places
  o assuring a free supply of certificates for trading promises at all times in all places

It is the marketplace, not capital, that backs money (promises to complete trades). And it is precise management of interest collections that give the responsive negative feedback assuring stability and integrity in the marketplace.

Money is debt, that is true… but that is not a bad thing any more than making a trading promise is a bad thing. Gold, silver, and any other good is not money. It is simply a good exchanged in simple barter.

Todd Marshall
Plantersville,T X

Ned Zeppelin's picture

Krugman is High Priest of the Sanhedrin Fed.

Decimus Lunius Luvenalis's picture

For some reason, whenever I read Krugman's comments, I picture Steve Buscemi in Billy Madison with his list of "People to Kill." 

StarTedStackin''s picture

What HASN'T the Obowel Movement Lied about?

The Alarmist's picture

Apples to oranges, or apples to moon-rocks?

jomama's picture

I only read Krugman if I need to throw something up.

jon dough's picture

Yeah, I get you, he moves me...

My bowels, anyways...

jonjon831983's picture

Remember that talk of Money Market Funds and "Breaking the Buck"?  It seems they've already been doing it for EUR MMFs thanks to low rates and doing cosmetic changes like cancelling shares in order to maintain the 1EUR price point.

"Money Funds Meet Zero Yields by Breaking Buck Taboo: Euro Credit"

buckethead's picture


From investopedia: The buying and selling of government securities in the open market in order to expand
or contract the amount of money in the banking system.

From Urban Dictionary:

Short for Permanent Open Market Operations.

The mechanism by which the Federal Reserve manipulates the stock market.
It is no secret that the Federal Reserve, and its now semi-daily interventions in market liquidity via POMO, is rather hell bent on creating the illusion that the economy is alive and well courtesy of a ramping stock market.

The court jester has long been the most accurate reporter of truth.

Herdee's picture

Krugman always does his best to avoid the big question which is:How does the FED tell the Markets that it's time to start to unwind?And how can it do it safely?That's why he'll always compare apples to oranges because he knows that when that day comes,it'll be the start of the washout of all the bad debt worldwide.And you can be guaranteed that Krugman is just as ignorant as to how and where those trillions of dollars in derivative bets are positioned for that coming day.

lotsoffun's picture

i spent many years on wall street and i met many sociopaths - i could drop some big names.  but i'm really ignorant on this.  seriously.  what motivates bennie and timmie and kruggie?  that they didn't take a job at goldman?  bill dudley did that and been there - so i know him. he's moved on to being mouthpiece.  

.but the others?   i guess they really are just second-stringers.  bennie - you see this?


CHX's picture

Krugman seems quiete tonight... I wonder why.

AmenRa's picture

How come " The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2012" winners  Alvin E. Roth and Lloyd S. Shapley stay out of the news yet your mug is everywhere? You're a 2011 winner and old news.

Dan Conway's picture

Now that the destroyer in chief wants people with bad credit to buy homes, what could possibly go wrong?  I thought obbumer said we don't want to go back to the failed policies of the past?  Let's see what has changed since the last time this terrible idea was tried:  lower interest rates, the fed is a desperate buyer of all mortgage paper, lower incomes generally, and a weak economy.  Why do thoughts of matches, dynamite, and mushroom clouds keep appearing in my head?

pbppbp's picture

The problem goes WAAAAAAY beyond Obama, or any President for that matter. What, you think Bush was better? How about McCain/Palin. That would have been awesome. They are just the errand boys.

newengland's picture

Feldstein is correct, honorable, trying to talk about the dangers, honestly.

Krugman is a lowly paid media  shill, an 'educated fool'. So long as he gets paid, he's happy to spew any line, the Internationale.

bunnyswanson's picture!

History of Federal Reserve by DecideChange

10 min

It describes the use of media to falsely exclaim a major US bank was about to fail, that it was bankrupt, resulting in bank run in 1907, consequences of which marginal calls, loans called in and people selling stock to pay their loans as I understand it.


Fix-ItSilly's picture

If Krugman is right, and that international evidence says the Fed is not distorting the interest rate curve, then there is no socially proper justification for the Fed's actions (crony capitalism doesn't qualify).  Therefore, Krugman should issue a cease and desist order to the Fed!

Panafrican Funktron Robot's picture

This is a solid point, we hear all the time on the government radio that they're doing QE to lower interest rates in order to stimulate the economy.  If there is no strong correlation between QE and dropping interest rates, then that kind of blows a giant hole in the government radio's claims here.

Mototard at Large's picture

Artifically low interest rates are forcing a restructuring of the economy up here in Canada and not in a good way.

Those who were going to retire from 2008 onwards are discovering that their 401K/RRSP retirement money is now making one or two percent rather than 6 or 7.

The Royal Bank of Canada became suspicious of government figures claiming good rates of job creation.  RBC was not seeing the results in in terms of young clients getting new car loans etc.  etc.

Once they did their homework, however, they found out the government was more or less correct.  Jobs were being created, but they were mainly being taken by people over 50.  These older folks are either not retiring or are re-entering the workforce in order to keep up their retirement incomes.

ZIRP is forcing this restructure and it hurts everyone from youth looking for jobs up to wanna-be retirees.

Thanks for that Central Bankers!


angel_of_joy's picture

Krugman proved to be nothing more than an economic snake-oil peddler. Countless times, that is...

Why is everybody so obsessed with his daily utterances ???

shovelhead's picture

Because everyone loves the Krugman 'Shock and Awe Bullshit Bazooka' being fired at random targets of opportunity?

web bot's picture

The way to answer the question is follow the money... Where are the QE dollars parked? In what? Then... what are the factors that would cause this money to start to move (velocity). What sort of crisis or panic would cause this. There... you'll have your answers.

Downtoolong's picture

There's a much simpler way to resolve the argument with hard empirical evidence. Let the Fed come out with a surprise announcement tomorrow and say that it is stopping all bond purchases indefinitely. They can always start it up again after we see what happens and Krugman is embarrassed into oblivion.

The best part of being an economist isn’t that you might be proven right on rare occasions; it’s that you can never be proven wrong.


WhiteNight123129's picture

John Fullarton 1844:

The process by which the redundant issues of inconvertible government paper (fiat system) act upon prices is exactly analogous to that which is set in motion by an increase of the productive power of the mines (large discovery of Gold in a metallic money system). It is in the discretion of the issuing authority, either to limit the employment of the notes which it sends out to the purposes of a temporary advance in anticipation of taxes, or to issue them for all purposes of state expenditure without making any provision to secure their return. In the former case, there will be no permanent addition to the circulation, nor any power of purchase obtained through taxation alone. In the latter, the issuing authority will be place nearly in the same position with the merchant returning with his double cargo of gold and silver from El Dorado.
        [In that case] the market would take off at part merely such proportion of the importation as had hitherto sufficed for the purposes of consumption, and the rest would all be sent to the mint for coinage, yielding an enormous accession to the importers, who, to the extent of the means thus placed in their hands, would immediately become competitors for every description of productive investment in the market, as well as for all the material which contribute to human enjoyment. But as the supply of such objects of desire is always limited, and would in no way be augmented by this great inundation of circulating coin, the inevitable results would be,
–First a decline of the market-rate of interest
–Next a rise in the value of land,
–And of all interest-bearing securities
–And lastly, a progressive increase in the prices of commodities generally “

Krugman knows very well this sequence, he is just lying to try to admit reality at the latest moment.

The money printed still is hoarded in cash like instruments and bonds, but eventually it will move to the real economy and stop shuffling around between financial assets and idle cash and bonds, at that point we will have the last leg of Gold rally (the last phase described by Fullarton), but the most powerful one. The Fed will not print when money goes into the circulation, that would put gasoline, instead they will have to raise rates agressively on the short end as Soros mentioned in his latest interview.


orez65's picture

The Fed is checkmated, if they then raise interest rates the bond market will collapse.
Bond holders will panic sell their bonds, the Fed will then buy all bonds to try to keep interest rates from overwhelming interest payments on the debt and over $10 Trillion will appear in the market looking for a safe place to park.
Voila, hyperinflation!

infiniti's picture

I disagree. If they raise short-term interest rates, long-term treasury yields would plunge with the treasury yield curve nearly becoming flat. Stocks and commodities would plunge and the economy would go from shitty to totally fucking shithouse wrecked. There are trillions of dollars out there that would love to find a home in M0 treasury paper yielding 1%, at the expense of housing, stocks, etc. That is why the Fed is forcing negative real yields on everybody - because if they went positive, this economy would absolutely implode.

Roandavid's picture

I've said it before, I'll say it again, Krugman is to economics what Obama is to peace.

A fraud.

Clowns on Acid's picture

Not tha Feldman is that much better ...but "Krugman compared apples to oranges to make his point", I compare Krugman to a dishonest douche bag, low l;fe make my point.

little buddy buys the dips's picture

...but we compare krugman to road apples to make our point.

Arbysauce's picture

Hit Krugman again and again. You can never hit him enough while has a pulpit.

Confundido's picture

Anyone showed Krugman the ZH posts tracking Tsy purchases by CUSIP by the Fed, after settlement of auctions? What can be more telling than that???

NoTTD's picture

What a douche.  Krugman, that is.

HD's picture

Krugman is a shill and a zealot. I can't wait for him to start backpedaling when it all implodes.

Doug Eberhardt's picture

Feldstein wasn't a gold fan either. In 2009 when gold was selling for $1,087 an ounce, he called it a "high risk investment."


He also said this in Feb. of 2011: "There is no reason to expect the stock market to keep rising at the rapid pace of 2010. Quantitative easing is scheduled to end in June 2011, and the Fed is not expected to continue its massive purchases of Treasury bonds after that."

Notarocketscientist's picture

And he was right re the stock market.   IF the Fed had not continued it would not have continued.  How can anyone make an accurate prediction unless they have inside info from the Fed?  Because the Fed is the only fundamental driver of the economy.  Only the Fed knows how much money will be printed going forward.  The Fed IS the economy

orangegeek's picture

The prime rate follows the 3 month T Bill rate - always has.  The 3 month T-Bill rate fluctuates and is set by the market.  The Fed is a big player in this market, so it can influence rates.


If demand for US Dollars increases, rates will likely rise.  If risk for holding this debt increases, rates may increase to entice buyers.


Until then, rates should remain low.

Kayman's picture

So... if rates are market driven, let Bernanke start selling Treasuries.  Oh, maybe that isn't such a good idea...

sgt_doom's picture

Seriously, guys, do you really believe this is anything other than political theater for the cattle? I mean, an argument among the ranks of the Group of Thirty?

Puuuhlease, Marty Feldstein, a director at the place that brought us the largest insurance swindle in US history, AIG Financial Products***?

Marty Feldstein, a director at Eli Lilly when it incurred the largest criminal penalty in US history?

Marty Feldstein, a director at HCA, when they were fined with that stupendous out-of-court penalty/settlement for Medicare/Medicaid fraud?

Really, guys. . . .

***AIG FP sold almost one-half trillion dollars worth of unregulated insurance, i.e., credit default swaps and most especially naked swaps, with no capital reserves on hand to support the potential $20 trillion to over $40 trillion insurance payouts --- which was the cause of the global economic meltdown and necessity for the so-called bankster bailout and TARP funds (and the Fed pumping out $16.1 trillion during the 2007-2009 period, thanks to that FOIA request from Bloomberg News, etc.

Kayman's picture

AIG paid out $13 billion to Goldman. Of course, Goldman cleverly bought re-insurance through Hank.

NeedleDickTheBugFucker's picture

"How can you be so obtuse?"

Andy Dufrense


"People will believe what they want to believe."

Henry Louis Mencken




Mercury's picture

The notion that rates are low only because the Fed is holding them down by “gobbling” up debt is clearly refuted by international evidence,...


Are we supposed to be impressed by the term  International evidence? Is that on par with International Coffees ? because that stuff tastes like shit. 

OK, just to pick a Fed bond buying program at random.....what was the stated purpose of Operation Twist again?

Oh it is: (warning: this is domestic evidence!)

"Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative. "


eclectic syncretist's picture

Krasting is the the Cramer of Zero Hedge

MortimerDuke's picture

Nice "international coffees" reference.  Very funny.

sgt_doom's picture

Great points, Mercury, International Coffees suck royally.

And, speaking of "international" . . .

(And, not directed at you, Mercury, but some other commenters here:  anybody ever hear of "ELX Futures" ???)

Kayman's picture

" international evidence,..." as supplied to Kruggy by the Council on Foreign Relations. Get me another spritzer will ya, dawling....

disabledvet's picture

"only providing what the market will bear." the Fed was being front run for this entire time...good luck getting a buyer's strike with what's going on in Japan, Europe and the Middle East. "if Ben Bernanke's causing all this then surely Wall Street is driving the getaway car." so why are those asset prices re-inflating again?

G_T_A_44's picture

Wait until the mass of global creditors Treasuries come circling back to the Fed for regurgitation.


Chew on that.