Krugman call doesn't impress everyone

Nobel winner bats against US rate hike

Krugman call doesn't impress everyone

At a time when stock and money markets across the world are worried about a rate hike by the US Federal Reserve, Nobel laureate Paul Krugman has asked the Fed to refrain from the move. In his latest biweekly column in The New York Times (‘Partying Like it’s 1995’, March 9), Krugman said the Fed was exactly in the same position in 1995, but had held back from raising rates and found that the economy could absorb millions more jobs without inflation going up.

Krugman conceded that the Fed had the dual mandate of achieving price stability and full employment. He noted that for the Fed, full employment  means reaching the Nairu — the non-accelerating inflation rate of unemployment. He attributed the call to raise rates due to the unemployment rate sliding to 5.5 per cent, just within Nairu.

But he argues that in reality, there’s no sign of inflationary pressure now even though Nairu is supposed to be the point at which the economy overheats. His advice? “Don’t yank away that punch bowl, don’t pull that rate hike trigger, until you see the whites of inflation’s eyes….If the Fed moves too soon, we might end up losing millions of jobs we could have had — and in the worst case, we might end up sliding into a Japanese-style deflationary trap....”

His advice doesn’t seem to have come too soon. Markets have been roiled by the likelihood of a US rate hike. On Tuesday, the Sensex ended down 135 points, and the Nifty closed 45 points lower, continuing the slide after more than 2 per cent declines on Monday. Also, the rupee lost 21 paise against the dollar to close at 62.76, continuing from where it had lost 39 paise on Monday. Also on Tuesday, the yen hit a five-year low of 122.02 against the dollar.

Core PCE holds key
But Chetan Ghate, associate professor at the Indian Statistical Institute, New Delhi, said Krugman represents just one side of the debate. He said the puzzle about the US economy is that even though full employment may have been achieved, the core personal consumption expenditure (PCE) is at 1.3 per cent, and trails targeted inflation rate of 2 per cent. “The US Fed doesn’t want to get behind the curve. It may not wait to normalise monetary policy if it thinks wage and inflationary pressures will become a problem later on,” he told Deccan Herald.

He downplayed fears of a US rate hike leading to money being pulled out of India. “There are equity flows and debt flows. Debt flows are arbitrage-driven. But the equity flows are more long-term and driven by India’s growth story. On the debt side, earlier there was a lot of short-term money parked in India. But I think the pendulum has now moved more towards longer term flows.”

On the RBI rate cuts, he thinks monetary policy has become accommodative though it’s still conservative. “If the policy repo rate is at 7.5 per cent and inflation at 5 per cent, then we get a real rate of 2.5 per cent. It’s a little more than the natural rate of 2 per cent, but is coming close to it,” he said.

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