Paul Krugman is making a case that asset prices are not high once you realize that interest rates are not artificially low. So why are interest rates not artificially low? He states…
“Once you accept the possibility that rates belong where they are, or even a bit lower, to correspond to the Wicksellian natural rate, you also conclude that asset prices might make sense; and once you concede that asset prices might make sense, you lose the supposed evidence that rates are all wrong.â€
His logic depends on there being a large output gap. Thus a very low interest rate is required for the economy to get back to potential output. However, I would make a case that the output gap is much smaller than he says due to effective demand being at historically an all-time low since WWII. Does he talk about effective demand? No. Does he even know how to determine effective demand? Who knows?
The time has not quite come for people to see the effects of the effective demand limit. They are showing themselves in bits and pieces, and people are progressively getting concerned.
Basically, everyone has drawn in the sand where they think potential output is… where the natural level of output is. Now we wait for time to show who came the closest. Because there is no changing the course that we are on. Interest rates will stay low, but potential output has its own destiny.
