Krugman vs BoE (or QE bails out the rich)

I like Krugman. He takes a common sense approach to economics and writes clearly for a broad audience.

But, like others, I have to take issue with his insistence that quantitative easing (QE) and low interest rates punish the wealthy and fulfil some progressive distributional objective. In fact they achieve the opposite result.

Here is the crux of his argument:

But I now think that class interests also operate through a cruder, more direct channel. Quite simply, easy-money policies, while they may help the economy as a whole, are directly detrimental to people who get a lot of their income from bonds and other interest-paying assets — and this mainly means the very wealthy, in particular the top 0.01 percent.

He supports his case with this graph in a previous post showing the loss of interest income for the top 10% of households.

Screen Shot 2014-07-15 at 11.11.48 am

But if you are going to all about distributional effects, you have to compare the whole distribution, not just the change over time of one cohort. Because this graph can show the exact opposite point if household in the lower income deciles have had their incomes decrease by more than this about. In this case all it takes is for low income households to have a 5% lower real income in 2011 than 2007 and we end up with a net transfer towards the top 10%.

The simple problem here is that Krugman fails to observe the change in the value of assets and instead focuses merely on the cash-flow. It is a simple fact that any asset that is a promise of future cash flows will increase in price in a low interest rate environment compared to a high interest rate environment (holding all else constant). Even the RBA shows how this effect has been a major contributor to last decade’s Australian house price boom.

More over, low interest rates are even more of a transfer to those who are highly leveraged into asset markets – property, equities and so forth. Since they receive a double effect of lower borrowing costs and supported asset prices.

To be clear, the table below shows a basic example of an asset representing a right to a cash-flow of 5 each year (call is $5, call it $5million, it doesn’t matter for this purpose).

Screen Shot 2014-07-15 at 11.16.57 am

If the asset is purchased in the first time period, assuming for the sake of the argument that risks are perfectly captured in the yield, that there is no net positive return. You buy an asset yielding 5%, it costs you, in risk adjusted terms, 5% to buy it, so there is no economic rent to speak of here.

Then in a later period the interest rate falls, and this asset is traded at a price reflecting a lower yield. That means the price has increased. Over the period when interests rates fall from 5% to 3% in this example, there has been a massive 67% gain in price of this asset, which can all be considered an economic rent.

We can also consider the case where the cash-flow is declines, which probably more accurately reflects the post-crisis situation. Here the cash flows, due to a downturn in real economic activity, are falling, but so are that traded yields (the interest rate), and hence the price is supported and owners of these assets gain from capital appreciation.

Screen Shot 2014-07-15 at 11.11.35 am

This is the exact scenario I see Krugman presenting. The cash-flows from owning particular assets have fallen, so interest incomes will be down for asset owners, but the prices have risen due to the interest rate adjustment. We see evidence of this all around with equities trading at record highs. Imagine what land, equities and other asset prices would be if interest rates were higher?

To be clear, this is not some absurd reasoning I just made up (although it does overlook the expectation of capital growth in prices to make a simpler point). The Bank of England has conveniently published a document outlining their view on the distributional impacts of low rates and their QE program.

Here’s how the Bank of England summarises the effects on wealth from quantitative easing:

By pushing up a range of asset prices, asset purchases have boosted the value of households’ financial wealth held outside pension funds, but holdings are heavily skewed with the top 5% of households holding 40% of these assets.

Which is the exact opposite of Krugman’s point, since he overlooks the prices of assets altogether. And now the BoE’s take on how QE and low interest rates have affected bond holders:

By pushing down gilt yields, QE has reduced the annuity rate. But the flipside of that fall in yields has been a rise in the price of both bonds and equities held in those pension pots. Another way of explaining this is that the income flows from a pension pot (dividends in the case of equities and coupons in the case of bonds) will not be reduced by QE. Indeed, if the pension pot contains equities, then the flows could even be higher as a result of increased dividend payments from the boost to the wider economy from QE.

There you have it. Low interest rates and asset purchases bail out the rich. I hope Krugman reads this and thinks more carefully, because he has a very wide influence in the public debate about these issues.


  1. “The simple problem here is that Krugman fails”. That’s all you needed to write for this article.

  2. Jesus even blind Freddy can see that stimulus has pumped asset prices, what has Krugman been smoking? Is he just a Fed apologist or what?

    • Basically yes, a Nobel-prize-winning Fed apologist. Mish (who, incidentally has been giving hat tips to macrobusiness of late!) regularly rips into Krugman for this kind of garbage.

      • Krugman won prize for work on trade, not macroeconomics. He is straying far from his area of expertise in the misguided notion that he is helping ordinary people and the economy. Basically, Krugman is a moron that doesn’t where money actually comes from.

  3. I’m with you on Krugman, Rumples.

    US taxpayers saved their banks at great individual cost and are being rewarded in the usual manner.

    QE and ZIRP have inflated conventional asset values and got us to here – where assets are expensive and earnings uncertain, a setting discouraging entrepreneurial risk-taking and pretty well everything else.

    • Are you with Rumples on his first sentence – he likes Krugman – or on the rest of his piece?

      I despise Krugman and I hope Rumples is seeing the guy’s feet of clay too. This example that Rumples has spotted is just typical of Krugman, not an aberration.

      At some point in his career, Krugman sold his soul. He was still OK back at the time he wrote “That Hissing Sound” – August 2005. That was brilliant. He picked the difference between “flatlands” and “the zoned zone” in housing market bubbles.

      Since then? On that subject? Since the crash that made this all the more important? Since the resumption of price bubbling in the same old same old parts of the USA? Nada, Zip, Zilch from Krugman just as surely as if he had been paid to say nothing more on it.

      • +many.

        He takes a common sense approach to economics

        Anything but from what I have read from him. I think he tries to push a supposed common sense approach to fit his narrative.

        Having said that, I think he knows and understands a whole lot more than he lets on…

  4. Very good!

    “QE for struggle street” is however a different kettle of fish.

    Though a bit like a Japanese Puffer Fish – toxic if not prepared with care by a trained chef.

  5. QE should be (and often is) reviled by both the wealthy and the working classes.

    The biggest problem is that it papers over the cracks in the economy without resolving them. Lacking the bravery for real reform, government has put all the pressure on central banks to resolve structural problems.

    QE is just a delay tactic, not a solution.

  6. Of course anyone who sitting on a 10yr coupon from 2006 for example is doing very nicely. Great cashflow and all that capital gain. Krugman is really only focusing on recent market entrants.

  7. migtronixMEMBER

    What exactly are you saying here Rumples? What about the opposite side of that coin, is the loan NOT an asset to the bank? Does the loan NOT decrease in value as rates plummet?

    Where are these fairies coming from? Is it purely from the appreciating asset by which the loan is backed? If it is then isn’t it always in the interest of both the borrower and the bank to lower interest rates? And IF IT IS shouldn’t interest rates ALWAYS be 0%!?!

    • You’re right here mig. But the muppet Keynesians “running” the financial system always believed they were controlling the economy via interest rates. The rates must come to zero, albeit taking three and a half decades. Their fate was sealed the day they decided to use credit and fiat to “manage” the economy. Now they can’t admit the mistake but I think Ben knows, hence why he resigned. No doubt, the financial system is royally screwed.

  8. Actually, i’m staggered that Krugman and others actually think that QE doesn’t benefit the richer (who are often proportionally cash poorer and asset richer!).


    • I think Krugman is simply pushing his luck with his economically illiterate liberal-lefty following further and further because so far, gaining the idolisation of these people has only been good for P. Krugman.

      • Ronin8317MEMBER

        Krugman has a huge following because he has a model which explains the problem the US is facing. He advocates more deficit spending to solve the unemployment problem, which will work, but the deficit spending will have to continue forever. (e.g.. Japan). Austerity, in contrast, cannot work for a country running a current account deficit since you cannot defy the law of arithmetic.

        The truth, which no main stream economist dares to voice, is that the global trade and capital flow imbalance is the real reason for US unemployment. The money created by QE is producing a lot of jobs and wealth.. in China.

      • hmmmm…… a lot depends on the policy settings within each country that is involved in the capital flows. China has an urban land price bubble that is even worse than the US one, and even more so when you consider that China has no regions like the US does where the easy credit actually DOESN’T increase land values.

        If anything, I can see the big winners out of all this are going to be the parts of the global economy that manage to minimise the asset inflation but still capture the orders for actual products produced locally. The urban land price inflation in particular ends up as a cost pressure for the productive sector, and if you don’t have that cost pressure, then you are going to clean up your competitors for export business and for footloose industry and entrepreneurs.

        I think everyone knows what part of the world I am talking about. The longer time goes on the more undeniable this gets. “Experts” make a big mistake when they assume something doesn’t matter because it “only” imposes a disadvantage to productivity growth of a few percent per decade…… after 3 decades this is pretty noticeable stuff, and after a century this is “total change in global or regional pecking order” stuff.

    • The real irony is that Krugman believes he is the conscience of the liberal, and that he is helping ordinary people by encouraging more debt based spending. In truth, rich people have taken advantage of low interest rates to further speculate on asset price appreciation and thus reintroducing leverage risk into the financial system. In other words, Krugman is a moron who can’t admit he is wrong.