Scott Sumner has a recent post about two types of economists; economists that predict with models, and economists that infer predictions from markets. Tim Fernholtz picked up on it, but I don’t think that he grasps the gravity of what Scott was trying to say. Here is Tim’s conclusion:

But more than that, I think that when stimulus proponents cite these market indicators, is less an attempt to promote their strategy than to undercut the arguments of deficit hawks. Every time interest rates have bumped up at all, breathless fear-mongering ensues, but challenging those claims by pointing out the trending historic rate lows (and deflation) isn’t so much an endorsement of the indicators as a challenge to deficit hawks: Come up with serious arguments to justify your calls for austerity, since the human price we pay for waiting is to high for arguments that don’t even work in your own model.

This conclusion is kind of convoluted, but that is no matter. The point Scott was trying to make is that when Krugman makes correct predictions, they come from current market indicators…which means that policy lags don’t matter. In that respect, the $787 billion stimulus bill was never going to be successful, because it didn’t have any impact on inflation expectations within the first few days after it passed. You don’t need a fancy new Keynesian model for this — the information is contained in asset prices. Read that again: the $787 billion stimulus would have been just as effective if it had not passed as it was in the reality in which it did pass.

Krugman knows that fiscal and monetary policy “work” by changing expectations of future NGDP. Using this knowledge, he (correctly) predicted that fiscal stimulus would be less-than-effective, even though everyone else was making predictions based on when the money is going to be spent, how it’s going to be spent, etc. Yes, quite a few people were saying that it was going to be too small, and then making numeric predictions — like “it should be $2tn”. I bet that if expectations didn’t change in the immediate trading days of a $2tn stimulus, Krugman would have still been saying that the it was too small. I have much less faith in fiscal stimulus than Krugman does, but the thing is that Krugman’s models weren’t giving him any more intuition that markets were giving me (and I infer market predictions).

Scott Sumner is clearly looking for trouble.

P.S. See this post for my views on fiscal stimulus.