Motley Moose – Archive

Geithner versus Krugman has become the new Israel/Palestine debate on the blogs. It’s an Economist’s cage-match, with fervent supporters on both sides, and much hyperbole slung by both camps. Because the economic arguments are so opaque, and because both men are so highly qualified, choosing between their solutions has devolved to questionable character judgments. Krugman is “shrill”, and “never liked Obama”. Geithner is a “crook”, and “is incapable of seeing the problems he helped caused”.

I think we can do better than this. I believe that if we look closely, we can discern some dynamics between the two men, based on objective evidence. Furthermore, this dynamic may serve as a clue to clarifying the debate, and taking us a step closer to deciding who is “right”.

First of all, let’s take it as a given that Dr. Krugman knows his economics. Not only is he a Nobel Prize winner, with a history of fairly prescient predictions, his politics are Progressive. We can reasonably believe that his economics are Progressive. In addition, his viewpoints are echoed by a veritable host of other strong economists.  “Krugman says so” is a strong argument, when Krugman is echoed by Stiglitz, Baker, etc, it’s an overwhelmingly strong argument.

Geithner is, relatively speaking, an unknown. The culture he comes from is suspect, and he does not have a Progressive history. In fact, I think it’s fair to say that were it not for President Obama’s obvious faith in him, all of us would clearly identify him as part of Wall Street. Despite Obama’s backing, Geithner is widely viewed as part of the problem, rather than part of the solution.

What is often missed is that Krugman regarded Geithner as a preeminent expert in the field.

Battle I: THE BANKING CRISIS

Data point: Paul Krugman believed Tim Geithner was an expert

In a Frontline article on the Lehman collapse, Krugman had this to say:

The Fed had, by the time of Lehman, understood that there are a lot of things that aren’t — commercial banks aren’t the Fed’s traditional responsibility — that can nonetheless have the same systemic effects as a bank failure. And in fact, when people ask me, “What can I read to understand the nature of this crisis?,” I actually point to a [then-head of the New York Fed Timothy] Geithner speech from June 2008, before Lehman, about the parallel banking system and how it has become vulnerable to the modern equivalent of bank runs. And that’s the source of our extreme fragility financially right now.

Krugman is saying, “if you want to understand the crisis, read Geithner“. That is a surprisingly strong, and undeniable signal of confidence. As recently as February 17 (the date of the FRONTLINE article), Krugman believed that Tim Geithner’s take on the crisis was not only correct, but even instructive.

When we actually look at the content of the speech, things get more interesting. In his speech Geithner included a section on crisis management, where he laid out his thinking:

No financial system will be free from crises, whatever the design of the regulatory framework or the rules of the game. The framework of lender-of-last-resort policies and the regime for facilitating an orderly resolution of a major non-bank financial institution are critical to our ability to contain financial crises.

In response to this crisis, the Federal Reserve has designed and implemented a number of innovative new facilities for injecting liquidity into the markets. These facilities have played a significant role in easing liquidity strains in markets and we plan to leave them in place until conditions in money and credit markets have improved substantially.

We are also examining what suite of liquidity facilities will be appropriate in the future, with what conditions for access and what oversight requirements to mitigate moral hazard risk. Some of the mechanisms we have employed during this crisis may become permanent parts of our toolkit. Some might be best reserved for the type of acute market illiquidity experienced in this crisis.

It would be helpful for the Federal Reserve System to have greater flexibility to respond to acute liquidity pressure in markets without undermining its capacity to manage the federal funds rates at the FOMC’s (Federal Open Market Committee) target. The authority Congress has granted the Fed to pay interest on reserves beginning in 2011 will be very helpful in this regard. We welcome the fact that Congress is now considering accelerating that authority.

All emphasis is mine. What I wanted to highlight was how central liquidity is to Geithner’s philosphy. It’s the linchpin of his crisis management style, and we are seeing this play out in TALF. Moreover – and this is important – clearly Krugman agreed with this philosophy. He did, after all, refer to this same paper as an illuminating work.

Data point: Krugman and Geither shared a similar “frame” on the crisis.

In fact, as recently as March 17, Krugman was discussing the crisis in terms of liquidity:

How close are we to a liquidity trap?

Here’s one way to think about the liquidity trap – a situation in which conventional monetary policy loses all traction. When short-term interest rates are close to zero, open-market operations in which the central bank prints money and buys government debt don’t do anything, because you’re just swapping one more or less zero-interest rate asset for another. Alternatively, you can say that there’s no incentive to lend out any increase in the monetary base, because the interest rate you get isn’t enough to make it worth bothering

So far so good. But now – now we come to a critical juncture, where the two men diverged. To describe the divergence, I refer to Henry Blodget, who penned a Geithner critique in Business Insider:

Paul Krugman blasts the Obama administration for its startlingly slow and stubborn response to the banking crisis.

And he’s right: Announcing bold change and actually implementing it are two different things.  And so far, with respect to the banks, Obama, Bernanke, and Geithner haven’t done squat.

What they have proposed doing, meanwhile, is based on an incorrect assessment of the problem.

We are not having a “liquidity” crisis in which assets are temporarily worth less than they will be soon.  We are having a solvency crisis: Our mountain of debt is finally collapsing on top of us, and most financial assets are getting crushed.

The answer is almost certainly “pre-privatization”: temporary seizure and restructuring of Citi, et al.  Instead of discussing this option, however, the administration clings to its early assessment of the situation and pretends that seizure means government-controlled banks in perpetuity.

Data point: The administration maintained it’s previously-decided course despite the change in “common wisdom”.

So there we have it. Up to a certain point, presumably late Feb/early March, the common wisdom was that this was a liquidity crisis, that we had to get assets moving. Something changed, and then it became apparent to many that moving assets wasn’t enough, if the assets are worthless. The crit
ique of the Administration was essentially that they did not adapt to the new view.

This latter point is crucial, in my view, for understanding how the two men differ. We’ll revisit it later, but for now let’s examine the second great conflict:

Battle II: THE BUDGET

On Nov 10, a week after the election, Krugman recommended a 600 billion stimulus:

When I put all this together, I conclude that the stimulus package should be at least 4% of GDP, or $600 billion.

That’s twice what the unreliable rumor says. So if there’s any truth to the rumor, my advice to the powers that be (or more accurately will be in a couple of months) is to think hard – you really, really don’t want to lowball this.

Data point: The Administration’s first stimulus exceeded Krugmans advice

As we know now, the Obama Administration seems to have taken Dr. Krugman’s advice. They proposed an $800 billion dollar stimulus, a full 33% larger than Krugman’s recommendation.

On Feb 4, Dr. Krugman critiqued the $800 billion as too small:

I’m still working on the numbers, but I’ve gotten a fair number of requests for comment on the Senate version of the stimulus.

The short answer: to appease the centrists, a plan that was already too small and too focused on ineffective tax cuts has been made significantly smaller, and even more focused on tax cuts.

According to the CBO’s estimates, we’re facing an output shortfall of almost 14% of GDP over the next two years, or around $2 trillion. Others, such as Goldman Sachs, are even more pessimistic. So the original $800 billion plan was too small, especially because a substantial share consisted of tax cuts that probably would have added little to demand. The plan should have been at least 50% larger.

(my emphasis)

Data point: The administration did not meet Krugman’s new recommendation

Now it should be said that the reason for his re-estimate was the new CBO estimates. Both estimates were correct, given the information available at the time.

We should also ask if it’s reasonable for an entire stimulus program to be scrapped, and suddenly upgraded 50%? Those of you who have to put together budgets will understand some of the difficulties involved.

You will note that what we see here is the exact same pattern as the banking crisis fight:

1) Krugman and Geithner start out on the same page

2) Conditions change, and Krugman adapts his advice

3) The administration does not change, or changes insufficiently for Krugman’s taste.

At this point, I think we can make some educated guesses.

CONCLUSIONS: WHY THEY DIFFER

In both cases, what we see is an Administration that agrees with Krugman, but is not as agile as his prescriptions. This does not seem consistent with corruption, or incompetence, or even wildly differing worldviews. In fact, the recent push to acquire receivership powers over AIG indicates that the Administration may indeed still be following Krugman’s path, albeit belatedly.

Krugman is brilliant, and one of the hallmarks of brilliance is the ability to adapt with the times. Perhaps Geithner is highly competent, but simply not as quick-minded as Krugman. Only one of them has a Nobel, after all.

On the other hand, the machinery of a White House administration is not nearly as flexible as the opinions of one mind. There are logistics to any change, and politics involved. Deals that have been struck, and must be reworked. Krugman has long maintained that he prefers to be outside the White House, perhaps it is because he understands how constraining it is. Krugman has a jet-ski, and the White House is stuck with an oil tanker.

In either case it is important to note that both camps agreed on the initial strategies, and only diverged when the environment drastically altered. To my mind, this is the classic tension between the right thing, and the feasible thing.

In an ideal world, the two would always be the same. This isn’t an ideal world, but there is reason to believe that Krugman and the Administration aren’t completely at odds.