Must-Read: Paul Krugman: Strangely Self-Confident Permahawks: “An odd thing about permahawks…

…They are, by and large, free-market acolytes who insist that markets know best; yet they also insist that we ignore financial markets that have been telling us that inflation is quiescent and the U.S. government is solvent…. It’s OK to conclude that markets are currently wrong, although if you believe that they make huge errors that should influence your views on policy in general. But your confidence in your dismissal of market beliefs should bear some relationship to your own track record. If you’ve been warning about inflation, wrongly, for six or so years, and markets current show no worries about inflation… I would expect some diffidence….

But I’m not Martin Feldstein.


Marty Feldstein: A Federal Reserve Oblivious to Its Effect on Financial Markets: “The sharp fall in share prices last week was a reminder of the vulnerabilities created by years of unconventional monetary policy…

…t was inevitable that the artificially high prices of U.S. stocks would eventually decline. Even after last week’s market fall, the S&P 500 stock index remains 30% above its historical average. There is no reason to think the correction is finished. The overpriced share values are a direct result of the Federal Reserve’s quantitative easing (QE) policy…. The strategy worked well. Share prices jumped 30% in 2013 alone and house prices rose 13% in that year. The resulting rise in wealth increased consumer spending, leading to higher GDP and lower unemployment. But excessively low interest rates have caused investors and lenders, in their reach for yield, to accept excessive risks…. As the Fed normalizes interest rates these prices will fall. It is difficult to know if this will cause widespread financial and economic declines like those seen in 2008. But the persistence of very low interest rates contributes to that systemic risk and to the possibility of economic instability….

Moreover, the Fed is planning a path for short-term interest rates that is likely to raise the rate of inflation too rapidly…. The danger is that very low interest rates in this environment would lead to a higher rate of inflation and higher long-term rates. The Fed could prevent that faster rise in inflation by increasing the federal-funds rate more rapidly this year and next. Fed officials also make the case that stimulating the economy by continued monetary ease is desirable as protection against a possible negative shock—such as a sharp fall in exports or in construction—that could push the economy into a new recession. That strategy involves unnecessary risks of financial instability. There are alternative tax and spending policies that could provide a safer way to maintain aggregate demand if there is a negative shock. The Fed needs to recognize that its employment goals have essentially been reached and that the inflation rate will reach its target of 2% in the foreseeable future. The economy would be better served by a more rapid normalization of short-term interest rates.