Krugman on monetary transmission channels

By: Wolfgang Munchau

There is an interesting post by Paul Krugman in his blog about the monetary transmission mechanisms. He said that US rate cuts in a recession work effectively through the housing market - the Fed creates a housing boom to offset the recession. The other channels, for example the corporate credit channels, are too slow to affect the economy in the short run. But the current downturn/recession is brought upon by a housing slump, which according to Krugman has much further to go. So he questioned whether interest rate cuts will make even the slightest difference. The question he poses: How much would the Fed have to cut interest rates by in order to create another housing boom. He did not answer the question, but implied that cutting rate to zero might the trick, but this is not going to happen.

 

I found this an interesting post, as it appears to break with the US consensus view that this crisis must be solved by monetary policy first and foremost. A housing recession-induced economic downturn is different from other downturns, and the monetary transmission channels, usually ignored by many US economists, suddenly start to matter again.

I am also becoming more gloomy about the US - and even more gloomy about the UK - as this subprime/banking crisis evolves. The house price correction that is necessary to restore some sanity to these markets is so severe that it will either cause a slump (i.e. more than an average recession), persistent high inflation, or some combination of high inflation and low growth. My guess remains that the US and UK will try to inflate themselves out of their troubles.

 

 

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