1. Paul Krugman is right 2. If you think Paul Krugman is wrong, refer to #1

As DeLong and others have said. Here Krugman points out that Bill Gross has written a letter of apology to PIMCO's investors over being wrong about the end of QE2 this summer. He said interest rates in the bond market would spike, but they didn't and he lost money. As Krugman pointed out at the time, all you needed was an understanding of the IS-LM model to judge that Gross was wrong. Gross is usually good and advocated relief in the mortgage market via Fannie and Freddie to provide stimulus. But Gross wasn't alone with mistaken bet. Ever since the American Recovery and Reinvestment Act was signed into law by Obama, the Very Serious People of Washington and the media have been obsessing over the bond vigilantes and deficit-reduction.

They have been proven wrong again.

Here's Krugman calling it in real time. I remember it very well because up to that point I had some respect for Gross's no-nonsense analytical abilities.

Here's the Wonkish explanation for Krugman's disagreement with Gross.

The Internets are wonderful. Here's a good blog post from Nov. 22 2009, discussing those who warned of a bubble in Treasuries.

Role reversal

Many people on Wall Street are now warning that there’s a huge bubble in government debt, that interest rates will spike any day now; it’s a warning that clearly has the Obama administration’s ear. A good sample is this piece from Morgan Stanley, according to which “Our US economics team expects bond yields to rise to 5.5% by the end of 2010 – an increase of 220bp that outstrips the 137bp increase in the fed funds rate expected over the same horizon.”

Btw: what? Almost everyone expects unemployment in late 2010 to remain close to 10%. Why, exactly, would the Fed funds rate rise sharply?

Anyway, I was wondering: it’s my impression that the same people now warning about the alleged Treasury bubble dismissed warnings about the housing bubble. Is this true?

I think so. Morgan Stanley, September 2006:

The pessimists argue that the bursting of a putative housing bubble means that prices could decline significantly. There is some risk that prices could decelerate faster or even decline in real terms — after all, investment and speculative activity has picked up in the past five years. But the character of housing demand makes the much-feared decline in prices on a nationwide basis unlikely …

Hmmm.

Coincidently Morgan Stanley and Goldman Sachs economists are now calling on the Fed to target nominal GDP. (via DeLong)