Menzie Chinn is having a dialogue, or something, with the Heritage Foundation. He pointed out that their arguments against stimulus, aside from being primitive and wrong, would also imply that the fiscal cliff is harmless. They respond in part by claiming that all they’re worried about is the incentive effects — yeah, right — and also by claiming that famous economists made the same arguments.There is a very easy explanation for why increased goverment borrowing has not led to soaring interest rates. Like every good Neo-Keynesian, Krugman gets himself in trouble by completely ignoring the credit market, which is a little ironic considering that he's talking about the price of credit.
The latter claim, unfortunately, is completely true. But it doesn’t absolve Heritage; all it shows is that much of macroeconomics, especially but not only at Chicago, has retrogressed intellectually, to such an extent that famous economists repeat 1930-vintage fallacies in perfect ignorance of the hard intellectual work that showed, three generations ago, that they are indeed fallacies.
By the way, Heritage — after totally misrepresenting Keynesian economics (Keynesians never think about investment? Really?) — asks,
When the government borrows a trillion dollars on global financial markets for a stimulus package, does Chinn believe that zero dollars of that is diverted from investment?
I don’t know for sure what Menzie’s answer would be, but mine is, no, I don’t believe that zero dollars are diverted; under current conditions, negative dollars are diverted. That is, stimulus spending would lead to more, not less, private investment. Why? Because we are in a liquidity trap — interest rates won’t rise — and higher sales would induce businesses to invest more, not less.
Oh, and if you go back to what Heritage analysts were writing back in 2009, they were predicting that government borrowing would lead to soaring interest rates. How’s that going, guys?
Government borrowing has soared since 2009. It has exploded from $6.8 trillion to $11.3 trillion. So, with that obvious increase in the demand for credit, why hasn't the price increased? Because government borrowing was only 12.9 percent of the total credit market back in 2009. It is now 20.4 percent of the market. The price of credit hasn't gone up because the OVERALL demand for it has slumped, as I pointed out last week.
This is like asking why the Warcraft servers aren't being overloaded because you're playing twice as much now, even though two other players who used to play a lot more than you did are playing quite a bit less than before.
The Heritage analysts assumed, improperly, that the Household and Finance sectors would continue to expand at their 60-year rates of increase. Instead, both sectors have shrunk, by $1 trillion and $3.3 trillion respectively. Debt disinflation is why interest rates are not soaring.