"Utter folly": Paul Krugman warns that Very Serious elites threaten economic recovery

What a decision by Switzerland's central bank says about America's economic prospects

Published January 16, 2015 1:45PM (EST)

                                                                                                                                                                (AP Photo/ Francisco Seco)
(AP Photo/ Francisco Seco)

In his New York Times column today, Nobel Prize-winning economist Paul Krugman seizes on the market frenzy sparked by the Swiss franc Thursday to illustrate how Very Serious elites jeopardize the United States' economic recovery.

Here's what happened yesterday: Switzerland's central bank, the Swiss National Bank, announced that it would no longer peg the franc to the euro, and that it would cut the interest rate it pays on bank reserves to negative 0.75 percent, meaning that investors must pay to place their funds in Swiss banks. The drastic steps are a response to a clear and present deflationary threat. Since Greece's debt crisis sent investors fleeing in search of safe havens, Switzerland has seen an influx of funds, leading the Swiss franc to spike in value and undermining Switzerland's commercial competitiveness.

Krugman identifies a crucial lesson in Switzerland's experience, one that the Very Serious policymakers pushing the U.S. Federal Reserve to raise interest rates should heed: It would be foolhardy to raise rates even as inflation remains remarkably low:

What this says is that you really, really shouldn’t let yourself get too close to deflation — you might fall in, and then it’s extremely hard to get out. This is one reason that slashing government spending in a depressed economy is such a bad idea: It’s not just the immediate cost in lost jobs, but the increased risk of getting caught in a deflationary trap.

It’s also a reason to be very cautious about raising interest rates when you have low inflation, even if you don’t think deflation is imminent. Right now serious people — the same serious people who decided, wrongly, that 2010 was the year we should pivot from jobs to deficits — seem to be arriving at a consensus that the Fed should start hiking very soon. But why? There’s no sign of accelerating inflation in the actual data, and market indicators of expected inflation are plunging, suggesting that investors see deflationary risk even if the Fed doesn’t.

And I share that market concern. If the U.S. recovery weakens, either through contagion from troubles abroad or because our own fundamentals aren’t as strong as we think, tightening monetary policy could all too easily prove to be an act of utter folly.

By Luke Brinker

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