Essay on Macroeconomics: Where Krugman Fails 23 comments
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By Kindred Winecoff
Everyone should read the Krugman essay on the state of macroeconomics, if only to see where the faultlines lie. The piece is basically Krugman's victory lap: he thinks that he and the other paleo-Keynesians have been vindicated, the Chicago school has been vanquished once and for all, and the New Keynesians have been forced to take a side: you're with Keynes or you're against him. No more trying to have it both ways.
He has good reason for thinking this: the Chicago School's strong-form belief in markets as efficient price aggregators has been tempered, if not refuted, by the current crisis*.
But as Krugman notes, this is nothing new: financial crises happen with alarming regularity all over the globe, and only a fool or ideologue would suggest that these manias, panics, and crashes are efficient.
In short, the current crisis tells us nothing about the truthiness of the Efficient Markets Hypothesis (EMH) that the Asian financial crisis, or the Argentinian depression, or the collapse of LTCM didn't tell us. All financial crises have very significant costs, and it takes a very brave person to argue that bubbles are good for an economy.
Krugman is also right to question economists' faith in the Fed. To be sure, the Fed had a great run during the "Great Moderation" from 1982-2008, where recessions were generally brief and mild. Perhaps such successes lulled economists into a "In Fed We Trust" mentality, and Krugman claims that this is the fundamental failing of the New Keynesians: the Fed can do quite a lot to stabilize the economy, but it is not omnipotent. In such circumstances where the Fed's normal tools of management fail to gain traction -- when the Funds rate reaches its zero bound -- the New Keynesians have no answer (according to Krugman). Krugman proposes paleo-Keynesianism.
But Krugman fails to acknowledge the weakness of his own position, and paleo-Keynesianism certainly has its faults. Not only is the academic literature on the effectiveness of fiscal policy mixed**, the justification for it seldom holds. In order for fiscal expansionism to succeed where monetary expansionism has failed, Krugman must model individuals as holding contradicting expectations. Second, actual incidents of Keynes' "paradox of thrift" are very rare, and maybe non-existent. Without these theoretical supports, the Keynesian view of fiscal stimulus is severely weakened.
Perhaps worse for Krugman's case is our actual experience over the past year. It is now clear that the Fed was effectively able to fight the recession and stave off deflation, and that bumping against the zero bound does not necessarily involve getting snared by the liquidity trap.
As Krugman himself acknowledges, the U.S. economy is most likely already out of recession despite very little stimulus spending (something like $100bn). Unless you believe that $100bn in stimulus spending was enough to shock a $14tn economy out of recession, you must conclude that monetary policy was effective (if unconventional) and thus the main justification for stimulus advanced by Krugman and other paleo-Keynesians was wrong.
Score one for the faith of New Keynesians in the efficacy of the Fed.
Never mind, says Krugman, fiscal stimulus is still justified to fight a "jobless recovery" in which GDP growth is positive but high unemployment persists. In fact, the data seem to show that this is happening in the U.S. at present. It's possible that Krugman is right and stimulus could have a positive effect in fighting unemployment.
But employment is often a lagging indicator and the recovery is barely underway. It is more likely that employment would improve without stimulus over the next year than that it wouldn't. Moreover there is no theoretical tradition that believes in the persistence of high unemployment during economic expansion. The case for stimulus doesn't look all that strong at the moment, so Krugman is on very shaky ground. But even if he's right, this sort of "mission creep" is worrisome.
All of that said, Krugman's main point stands -- economic theory is not as sound as it appeared a year ago -- and is in fact stronger than he believes since he exempts his own theoretical tradition from criticism. As I said, the whole thing is worth reading to get up to speed on the arguments.
But keep in mind the source: Krugman has a strong interest in denigrating any school of thought but paleo-Keynesianism; he has plenty at stake in this debate. There is more of benefit in the Chicago and New Keynesian schools than Krugman acknowledges, and less in the paleo-Keynesian school. So if there is to be a "New Economics" it should combine the best from all three traditions and others besides.
P.S. After I wrote all this, I saw that Scott Sumner addressed some of the same concerns and came to some of the same conclusions, albeit in a different way. Sumner, like me, sees Krugman's dismissal of monetary policy as premature and therefore sees his core argument in favor of paleo-Keynesian fiscal stimulus as a non sequitur. Please read his post.
*The weak-form belief in markets as most efficient price aggregators has not, I think, been refuted by the crisis. It simply states that markets reflect all information about the prices of a good, and thus represent the best estimate of a good's value. It is possible for the best estimate to be very wrong and still be better than even-more-wrong "other" estimates of value. Or fluctuations in financial markets reflect changes in information, and thus be rational. Tellingly, neither Krugman nor any other critic of EMH even propose an "other", much less defend it, which is why some version of the EMH has persisted for so long and will continue to persist: markets may not be infallible, but they are better than anything else. The Chicago school might not be quite dead after all.
**Yes, I know about Romer/Romer, but all other studies are less positive. And as this Brookings report states, the negative consequences of debt accumulation and deadweight loss from implied future tax increases must be weighed against any positive benefits from stimulus.
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Krugman is harmless since he lives among the socialists at Princeton who as a group favor any government action, and criticize any private actions in the market. It is the mantra of the economics department. At root the department harbor deep fears that private capitalists may actually have gotten something to work better than the Fabian socialists of 1850. They waste no time attempting to prove that government and people like themselves are better than any market for the important social decisions. And they are wrong. That is all.
How about 1.6T?
On Sep 07 01:45 PM Roger Knights wrote:
> "very little stimulus spending (something like $100bn)"
>
> How about one trillion in QE to hold down interest rates and thereby
> bolster the stock market and real estate market?
Krugman's whole defense of paleo-Keynesianism rests on the liquidity trap argument, and QE basically disproves that.
Debt <> Growth
Consumption <> Prosperity
Globalism <> Prosperity
Planet Earth <> "Externality"
Capitalism <> Democracy
Democracy ("Keep the government away from my SSA and Medicare") <> Intelligence
But some (16 decade) "old" rules do still apply:
“The need for a constantly expanding market for its products chases the [capitalist] bourgeoisie over the whole surface of the globe, paving the way for more extensive and exhaustive crises.” – Karl Heinrich Marx, The Communist Manifesto
The markets aren't efficient because they have been manipulated.
CDS's and bailouts and HFT do not a market make.
I suppose the only wake up call some people hear is the klaxon of the incoming nuclear warheads - ooops - too late.
Let's see, DOW 12,000 minus 86% = DOW ~ 1,700.
Y'all prepared for that? In nearly identical circumstances in 1929-1932 we survived. I'm not sure we would this time around...
On Sep 07 02:56 PM whidbey wrote:
> Nobel Krugman makes a point that economics has too many schools which
> dictate the views of those in the school. Krugman has made a name
> for himself as a political economist who beards presidents (usually
> Bush) and flirts with the Nobel Committee which hated Bush, and shockingly
> selected Krugman as the nearest to direct political action it could
> effect.
>
> Krugman is harmless since he lives among the socialists at Princeton
> who as a group favor any government action, and criticize any private
> actions in the market. It is the mantra of the economics department.
> At root the department harbor deep fears that private capitalists
> may actually have gotten something to work better than the Fabian
> socialists of 1850. They waste no time attempting to prove that
> government and people like themselves are better than any market
> for the important social decisions. And they are wrong. That is
> all.
I thought that doing the same thing and expecting a different result than all previous attempts was the very definition of insanity. In this case, I guess it is the very definition of ideology. One of the things I found most compelling about the recent (and lengthy) Krugman piece, was that it was relatively free of his usual ideological spiel. For that alone it was worth reading, and it possibly demonstrates that even for those long married to an ideological view, there is hope. Perhaps there is hope for the author of this post too.
On Sep 07 12:59 PM LKofEnglish wrote:
> Krugman has his Nobel but Lord know he ISN"T a Nobel. In other words
> he hasn't innovated and indeed appears to have done nothing more
> than regurgitated. (Or is it that other thing guys do?) Productivity
> happens and is happenning BIG TIME now. How can one argue with the
> market? It collapses, government intervenes MASSIVELY and the government
> claims to be powerless to prevent double digit unemployment for the
> forseeable future? What do we pay the Federal Government for? I
> don't see how any rational person cannot see this as a "victory"
> (for all the wrong reasons) for the monetarists. THEY GOT THE PRIZE
> AND THAT ISN'T OIL. The prize, of course, is TO BE THE GOVERNMENT.
> The only thing that happened this past year is that the American
> people have been awakened to the (isn't it always?) obvious fact
> that Washington DC could care less about "the people's" livlihood
> but sure do care about their own. "Moral hazard." Only Wall Street
> could have such a "ready reserve" of terminology. "Here, we'll help
> you Mr. Scaredy Cat Politician." THEY DON'T HAVE ANY MONEY TO BEGIN
> WITH UNCLE SAM! STARVE 'EM TO THEIR LAST PENNY AND YOU MIGHT EVEN
> GET REELECTED. I can't believe it. AND THEY CALL THEMSELVES DEMOCRATS
> NO LESS!!!!
That's one definition of insanity, but not a very good one. Quite frequently doing the same thing has different results. Of course I'm not advocating doing the same thing, I didn't say anything about regulation (neither did Krugman), and since I'm a political scientist (not an economist) I don't have any dog in the fight over economic ideologies (unlike Krugman). If you think the Krugman piece was "free of his usual ideological spiel" then you didn't read it properly. That was the entire point of that piece.
But while we're at it, in many ways our regulatory structure now is *much* stricter than it was from 1945-1987. Our capital adequacy standards are higher, our accounting rules were standardized by Sarbanes-Oxley, we have the Basel protocols, etc. Not even Krugman argues that regulation is weaker than in the past. What changed was the nature of the financial industry.
It may be true that regulation has not kept up with the times, but that's a very different argument.
On Sep 07 04:45 PM American in Paris wrote:
> Anyone who calls Krugman a socialist reveals themself to be a Neanderthal
> right winger.
Solution? Hang and/or draw and quarter those who gamble and steal with the hard earned retirement and savings of a nation.
Quit wasting the same hard earned tax money on the black hole that is government spending.
Let me keep what I earn.
Take the power away from equivocating politicians, lawyers, and money-grubbing bankers who don't give a shi* about their country or fellow citizen.
This happens sooner or later, it's called "civil war" or "revolution" or "collapse of empire" after "war".
On Sep 07 08:27 PM Robert A. Weigand wrote:
> Sounds like more of the same: Many words devoted to attacking Krugman
> and Keynes; few words devoted to proposing an alternative path to
> economic recovery. Are you implying that we should cut taxes and
> . . . then what? Your comparative intellecutal advantage is supposed
> to be providing insights into the connection between economics and
> politics. Reaganomics blew up because, even when Republicans controlled
> Congress, no one could get them to reduce of even slow federal spending.
> Thus the $14 trillion deficit. Now that the Dems are in charge (thanks
> to a huge anti-Bush turnout at the polls) . . . they're not going
> to cut spending, either -- tax cuts are therefore out of the question.
> That leaves Keynesian solutions. Lets just hope the fiscal stimulus
> works and we don't wind up stuck in a Japanese-style liquidity trap,
> or slow-growth stagflation scenario. Additionally, the reaction from
> European and Asian financial markets today was telling. Their governments
> announced continuation of the stimulus programs and stocks rose on
> the news. So the market obviously likes stimuli.
Nice straw man, but I'm not "implying" anything. I said quite clearly that Fed policies (including QE) have so far been sufficient to arrest the downturn and begin the recovery. So far as I know, no one disputes this. So any case for fiscal stimulus (including tax cuts, which I oppose) has been severely weakened. That doesn't mean that fiscal stimulus can't have positive effects (i.e. the multiplier is probably greater than 1), but it does mean that it is probably unnecessary, so the negative aspects of stimulus (inflation, the debt burden, deadweight loss from future taxation) should be given greater weight.
The rest of your comment makes even less sense. We have debt problems... so we should engage in more deficit spending? Fiscal stimulus (in the form of tax cuts) doesn't work... so we should enact more fiscal stimulus? We face deflation... AND stagflation? Financial markets are all screwed up... so we should set public policy based on day-to-day market fluctuations in Europe and Asia? These are all non sequiturs.
You're right about one thing: my comparative advantage is in examining the links between politics and economics, and most of my posts are oriented towards that nexus. But that requires having an understanding of basic economic theory; apparently that's not a prerequisite for finance professors.
Great comments. I am also an admirer of Minsky (and before him, Wicksell), but I read him maybe a bit differently. The Minsky I know was a strong backer of the Fed as regulator and lender of last resort, and was less sanguine about ad hoc fiscal policy (though he favored automatic stabilizers). This is basically my view, and I think it has been borne out by this crisis. Meanwhile, it's instructive that Krugman is underwhelmed by Minsky (or any of the other post-Keynesians or New Keynesians); he prefers old-school Keynes, which I called "paleo-Keynesianism" but is really just "true" Keynesianism:
krugman.blogs.nytimes..../
In short, I'm quite happy to accept Minsky's advice, at least in part; Krugman is not. He prefers actual Keynes. So we're not quite in the same boat.
The scary thing is, I start noticing this trend among economists , too, recently.
But then again, why should those people who didn't see the debacle coming in the first place (though they are paid exactly to anticipate this stuff) now succeed in anticipating it's end? And yes, that includes Krugman, who is just another example in a long list of economists getting a Nobel price for essentially, crap.
I agree that I’m drawing assumptions from Minsky’s analysis that were not explicit and central to that analysis. The same might be said of Minsky’s take on Keynes. As others have noted, Keynes’s seminal 1936 work contains many asides and inferences that he does not explain and Keynes himself, because of his health and role during WW II, did little to interpret, reject or develop these themes. I suggest, therefore, that the ‘real Keynes’ is elusive but that his ‘General Theory’ is a fruitful starting point leading in many, sometimes conflicting, directions. With Keynes, Marx and Schumpeter as influences, Minsky is also a complex and interesting thinker whose work can lead in many directions.
On Sep 08 03:45 AM Kindred Winecoff wrote:
> Bob -
>
> Great comments. I am also an admirer of Minsky (and before him, Wicksell),
> but I read him maybe a bit differently. The Minsky I know was a strong
> backer of the Fed as regulator and lender of last resort, and was
> less sanguine about ad hoc fiscal policy (though he favored automatic
> stabilizers). This is basically my view, and I think it has been
> borne out by this crisis. Meanwhile, it's instructive that Krugman
> is underwhelmed by Minsky (or any of the other post-Keynesians or
> New Keynesians); he prefers old-school Keynes, which I called "paleo-Keynesianism"
> but is really just "true" Keynesianism:
>
> krugman.blogs.nytimes..../
>
>
> In short, I'm quite happy to accept Minsky's advice, at least in
> part; Krugman is not. He prefers actual Keynes. So we're not quite
> in the same boat.
One gripe about your comment above:
"But while we're at it, in many ways our regulatory structure now is *much* stricter than it was from 1945-1987. Our capital adequacy standards are higher, our accounting rules were standardized by Sarbanes-Oxley, we have the Basel protocols, etc. Not even Krugman argues that regulation is weaker than in the past. What changed was the nature of the financial industry."
Leverage ratios were relaxed for the large banks, SIVs hid exposures, the entire shadow banking industry was unregulated - how can you say that capital adequacy ratios were adequate? Regulation in terms of having rules will always have loopholes. Minsky had the best prescription for this. Quoting him below. Btw, I only know of Minsky from the PIMCO link below and it made a lot of sense. Note that Minsky mentions fringe banks - anticipating shadow banking.
“In a world of businessmen and financial intermediaries who aggressively seek profit, innovators will always outpace regulators; the authorities cannot prevent changes in the structure of portfolios from occurring. What they can do is keep the asset-equity ratio of banks within bounds by setting equity-absorption ratios for various types of assets. If the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions, they are in a better position to attenuate the disruptive expansionary tendencies of our economy.”
www.pimco.com/LeftNav/...