Noted: Blanchard’s response to Krugman’s Mundell Fleming lecture

Just a short note to record a few of Olivier Blanchard’s
comments in response Paul Krugman’s recent IMF lecture.
Krugman’s paper included a ‘scratching pad’ analysis using an IS-MP
model, an inter temporal model and supporting evidence. It provided
a very convincing case that economies like the US, the UK and
Japan, with their floating currencies and independent central
banks, would not conceivably experience a Greek style crisis. Seen
in the video of the presentation and a follow up vox post, Olivier
Blanchard raised a few interesting points that are worth

1. The term premium on longer term sovereign bonds. In
his lecture Krugman spoke of the expectational view of interest
rates, where market participants expect low short rates to continue,
then this would translate in low long rates as well. Blanchard
subsequently raised the point that if investors lost confidence
then they would require a higher premium on longer term bonds, thus
pushing up these longer rates. I would presume that Krugman could
respond to this by stating that the Fed could perform QE or
Operation Twist type programs to offset this increase in the term

2. For Blanchard, it is a puzzle as to why rates on
Japanese Government bonds are so low. And he asked Krugman to show
him the model for that.

3. Krugman’s key point was that economies
with independent central banks and floating currencies can absorb
the loss of investor confidence and sell off in government bonds by
a depreciating currency. One of Blanchard’s points from the vox
article was that a large depreciation could be disruptive for both
the real economy and the financial markets.


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