Tuesday, September 21, 2010

In Krugman v. Rajan, I Side with Rajan

Paul Krugman has a book review on three books about the causes of the financial crisis and/or ways to get the economy going again. One of the books is by Rajan, Fault Lines, a book I commented on favorably in an earlier post. As might be expected, Krugman is critical of Rajan whereas I was not. Rajan has a response to Krugman also. Rajan's criticisms of Krugman's review I think are exactly right.

Krugman discusses four causes of the housing bubble that economists and others have identified. The first is the low interest rate policy of the Fed through most the the 2000s. Second, the "global savings glut." Third, financial innovations, and finally government programs.
Rajan cited government policy and the low interest rates in particular. Krugman rejects both, and argues instead for financial markets and a "Minsky moment."

Krugman's arguments that Fed policy and government policies were not responsible are specious, as Rajan shows. Krugman says the Fed couldn't be responsible because there were housing bubbles in Europe also and the European Central Bank was not pursuing low interest rates like the Fed. But, as Rajan notes, the Fed pushed the interest rate to 1% and the European Central Bank to 2%, so both were low by historic standards. Krugman aruges that Fannie and Freddie were not responsible for subprime mortgages, but they were part of the overall government emphasis, regardless of political party, to extend homeownership.

This review by Krugman is further evidence that Krugman has ceased to be an economist and is a political columnist instead. The evidence he cites to back his claims or refute other claims would not be accepted by most teachers if offered by their students. Krugman is so obsessed with showing that Republicans are at fault for all the ills and Democrats are not, that he seems to be identifying and interpreting evidence through biased eyes. As Rajan notes, government officals of both the Clinton and the Bush administrations were involved in policies that help bring about the bubbles and the crisis.

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