And Krugman is correct to an extent. The MBSs on the banks balance sheet can't be de-leveraged. You have a situation w no liquidity because its all tied up in toxic assets. I agree w Bernanke for buying these assets to free up liquidity. But I also agree w Koo that buying long term bonds won't spill the QE into the real economy. Instead, it gets stuck in the financial sector because there are no borrowers. You see things like asset portfolio rotation which inflate the equities markets -- good for investors, but not for the unemployed.
But I also see Koo's point that QE only alleviate short term problems that might be difficult to deal with once the recovery starts. The problem is when the govt buys long term bonds, it makes it difficult to exit QE without affecting sharp rise in long term rates.
Here is an interesting chart of what Koo calls "QE trap"
"The QE "trap" happens when the central bank has purchased long-term government bonds as part of quantitative easing. Initially, long-term interest rates fall much more than they would in a country without such a policy, which means the subsequent economic recovery comes sooner (t1). But as the economy picks up, long-term rates rise sharply as local bond market participants fear the central bank will have to mop up all the excess reserves by unloading its holdings of long-term bonds.
Demand then falls in interest rate sensitive sectors such as automobiles and housing, causing the economy to slow and forcing the central bank to relax its policy stance. The economy heads towards recovery again, but as market participants refocus on the possibility of the central bank absorbing excess reserves, long-term rates surge in a repetitive cycle I have dubbed the QE "trap."
In countries that do not engage in quantitative easing, meanwhile, the decline in long-term rates is more gradual, which delays the start of the recovery (t2). But since there is no need for the central bank to mop up large quantities of funds, everybody is no more relaxed once the recovery starts, and the rise in long-term rates is far more gradual. Once the economy starts to turn around, the pace of recovery is actually faster because interest rates are lower. This is illustrated in Figure 2."
Read more:
http://www.businessinsider.com/koo-says-no-one-can-refute-the-qe-trap-2013-10#ixzz33jos1g1eIn any case its a complex issue and many debates on how to go about it. I disclose that I do follow heterodox economics Post-Keynesian & MMT, and therefore I prefer post-Keynesians like Minsky, Keen & Koo over Krugman. But I do respect Krugman for publicly speaking out against austerity based economics
