Paul Krugman was dead wrong

On Friday, Paul Krugman wrote:

I wish I could believe in this Macroeconomic Advisers claim that there is a zero chance of a double-dip recession. But when they say that this probability

is estimated as a function of the term slope of interest rates, stock prices, payroll employment, personal income, and industrial production

I immediately lose all confidence.

When short-term interest rates are up against the zero lower bound, a positive term spread tells you nothing; as I explained a year and half ago, it’s something that has to happen given the fact that short rates can go up, but not down.

Failure to understand this point led to excess optimism in late 2008. I’m a bit surprised to see Macroeconomic Advisers falling into the same fallacy now.

In the second to last paragraph, he is referring to a previous blog post of his from December 27, 2008, in which he wrote:

I see that economists at the Cleveland Fed are taking some comfort from the positive slope of the yield curve. Long-term interest rates are higher than short-term rates, which is usually a sign that the economy will expand.

Not this time, I’m afraid. It’s all about the zero lower bound.

The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.

But here’s the thing: the Fed can’t cut rates from here, because they’re already zero. It can, however, raise rates. So the long-term rate has to be above the short-term rate, because under current conditions it’s like an option price: short rates might move up, but they can’t go down. ...

So sad to say, the yield curve doesn’t offer any comfort. It’s only telling us what we already know: that conventional monetary policy has literally hit bottom.

Paul Krugman may have been right in theory, but he was completely wrong in fact. As Frederic Mishkin has pointed out, the yield curve forecasts economic expansion or contraction roughly four quarters advance. Four quarters after Paul Krugman gave his "Not this time, I’m afraid" argument above, Real Gross Domestic Product showed economic expansion as shown here:

So, Paul Krugman was dead wrong. The economy returned to expansion exactly as the yield curve predicted. Furthermore, the yield curve is significantly steeper now than it was in December 2008. That means year-ahead prospects are even brighter now than they were then.

Paul Krugman is a natural economic pessimist. He's such a pessimist that when the economic data shows economic expansion, he tries to confuse his readers by implying that it doesn't.

No matter how Paul Krugman tries to spin it, the yield curve in December 2008 predicted mild economic expansion, and mild economic expansion is what we got. The yield curve is much steeper today.

Economy continues to slowly improve

The economy continues to slowly improve, but today's payroll numbers were not as good as expected:

A flood of temporary Census workers in May led to the biggest jump in jobs in ten years, the government reported Friday.

Employers added 431,000 jobs in the month, up from 290,000 jobs added in April. It was the biggest gain in jobs since March 2000.

But Census hiring was responsible for 411,000 of May's increase in employment. Private sector employers also added 41,000 jobs in the period, well below the 218,000 private sector job gains in April. Government payrolls other than Census declined by 21,000 jobs in May, due largely to job cuts by state and local governments.

It was a disappointing number for private sector hiring, as economists surveyed by Briefing.com had forecast an overall gain of 500,000 in May. U.S. stocks traded sharply lower on the report, with the Dow Jones industrial average down more than 200 points in midday trading. ...

Despite the spike in hiring, the unemployment rate declined only modestly, to 9.7% from 9.9% in April. Economists had forecast it would decline to 9.8%.

Here is the year-over-year percentage change in payrolls:

Here is the year-over-year percentage change in aggregate weekly hours worked:

Here is the year-over-year percentage change in initial jobless claims:

Here is the official unemployment rate:

Individual liberty vs. states' rights

The ideal relationship between personal freedom and states' rights in a nutshell:

For those who believe in limited government, state’s rights is a fundamental mechanism of keeping power decentralized. But even constitutionalists should recognize that our Founding Fathers never intended for state sovereignty to triumph individual sovereignty.

In short, personal freedom should always take precedence over states' rights, but states' rights play an important role in preventing the concentration of power.