Why Paul Krugman is no real Keynesian
March 26, 2015
from Lars Syll
Keynes’s insights have enormous practical importance, according to Lance Taylor and Duncan Foley (who jointly received the Leontief Prize for Advancing the Frontiers of Economic Thought at Tufts University’s Global Development and Environment Institute on Monday.)
But isn’t Keynes now mainstream? No, say Foley and Taylor. The mainstream still sees economies as inherently moving to an optimal equilibrium … It still says demand causes short-run fluctuations, but only supply factors, such as the capital stock and technology, can affect long-run growth.
EVEN PAUL KRUGMAN, a self-described Keynesian, Nobel laureate, and New York Times columnist, writes in the 2012 edition of his textbook: “In the long run the economy is self-correcting: shocks to aggregate demand affect aggregate output in the short run but not in the long run” …
Krugman does point to one exception: If interest rates are nearly zero, as during the financial crisis, markets lose restorative force. But, Taylor asks, what’s the logic?Keynes saw capitalism’s general state as allowing almost arbitrary unemployment: hence his “General Theory.” Full employment was a lucky exception.
To Taylor, calling full employment the general state and allowing one unlucky exception turns Keynes upside down. And look where this confusion has brought us, he adds. Take the current eurozone disaster. For two decades, the European Union bureaucracy in Brussels, the German Council of Economic Experts, and a chorus of others, branded Germany, the “sick man of Europe,” as suffering from a sclerotic supply side: rigid labor unions, impediments to layoffs, a burdensome welfare state. But German labor costs to produce output sank steadily, and Germany generated huge trade surpluses — hardly signs of a sclerotic supply side. Yet growth has barely averaged 1 percent a year since 2000.
I can’t but agree with Taylor and Foley here. To a large degree one does get the impression that Krugman thinks he is a Keynesian because he is a stout believer in John Hicks IS-LM interpretation of Keynes. In a post on his blog, self-proclaimed “proud neoclassicist” Paul Krugman has argued that “Keynesian” macroeconomics more than anything else “made economics the model-oriented field it has become.” In Krugman’s eyes, Keynes was a “pretty klutzy modeler,” and it was only thanks to Samuelson’s famous 45-degree diagram and Hicks’s IS-LM that things got into place. Although admitting that economists have a tendency to use ”excessive math” and “equate hard math with quality” he still vehemently defends — and always have — the mathematization of economics:
I’ve seen quite a lot of what economics without math and models looks like — and it’s not good.
However, being a student of Hyman Minsky, yours truly very much doubt that IS-LM is an adequate reflection of the width and depth of Keynes’s insights on the workings of modern market economies.
Almost nothing in the post-General Theory writings of Keynes suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thought. In Keynes’s canonical statement of the essence of his theory — in the famous 1937 Quarterly Journal of Economics article — there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. John Hicks, the man who invented IS-LM in his 1937Econometrica review of Keynes’ General Theory — “Mr. Keynes and the ‘Classics’. A Suggested Interpretation” — returned to it in an article in 1980 — “IS-LM: an explanation” — in Journal of Post Keynesian Economics. Self-critically he wrote that ”the only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better — is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate.”
IS-LM is typically set in a current values numéraire framework that definitely downgrades the importance of expectations and uncertainty — and a fortiori gives too large a role for interests as ruling the roost when it comes to investments and liquidity preferences. Reducing uncertainty to risk — implicit in most analyses building on IS-LM models — is nothing but hand waving. According to Keynes we live in a world permeated by unmeasurable uncertainty — not quantifiable stochastic risk — which often forces us to make decisions based on anything but “rational expectations.” Keynes rather thinks that we base our expectations on the “confidence” or “weight” we put on different events and alternatives. To Keynes expectations are a question of weighing probabilities by “degrees of belief,” beliefs that often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modeled by “modern” social sciences. And often we “simply do not know.”
IS-LM not only ignores genuine uncertainty, but also the essentially complex and cyclical character of economies and investment activities, speculation, endogenous money, labour market conditions, and the importance of income distribution. Most of the insights on dynamic coordination problems that made Keynes write General Theory are lost in the translation into the IS-LM framework.
Sure, “New Keynesian” economists like Krugman — and their forerunners, “Keynesian” economists like Paul Samuelson and (young) John Hicks — certainly have contributed to making economics more mathematical and “model-oriented.”
But if these math-is-the-message-modelers aren’t able to show that the mechanisms or causes that they isolate and handle in their mathematically formalized macromodels are stable in the sense that they do not change when we “export” them to our “target systems,” these mathematical models do only hold under ceteris paribus conditions and are consequently of limited value to our understandings, explanations or predictions of real economic systems.
The kinds of laws and relations that “modern” economics has established, are laws and relations about mathematically formalized entities in models that presuppose causal mechanisms being atomistic and additive. When causal mechanisms operate in real world social target systems they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it (as a rule) only because we engineered them for that purpose. Outside man-made mathematical-statistical “nomological machines” they are rare, or even non-existant. Unfortunately that also makes most of contemporary mainstream neoclassical endeavours of mathematical economic modeling rather useless. And that also goes for Krugman.
In recent blogposts Paul Krugman has come back to his idea that it would be great if the Fed stimulated inflationary expectations so that investments would increase. I don’t have any problem with this idea per se, but I don’t think it’s of the stature that Krugman seems to think. But although I have written extensively on Knut Wicksell and consider him the greatest Swedish economist ever, I definitely – since Krugman portrays himself as “sorta-kinda Keynesian” – have to question his invocation of Knut Wicksell for his ideas on the “natural” rate of interest. Krugmanwrites (emphasis added):
Start with the very simplest view of how Fed policy affects the economy: the Fed sets short-term interest rates, and other things equal a lower rate leads to higher output; the “natural rate” of interest … is the rate at which output equals potential, that is, at which there are neither inflationary nor deflationary pressures …
What does this tell us? First of all, that there is nothing “artificial” or “unnatural” about low interest rates; they’re low because demand is low, and the Fed is responding appropriately. If anything, the “unnatural” situation is that rates are too high, because they’re constrained by the zero lower bound (rates can’t go below zero, except for some minor technical bobbles, because people can always just hold cash).
Second, the Fed’s inability to get rates as low as they should be justifies a search for policies that can fill this policy gap. Fiscal stimulus is one such policy; unconventional monetary policies of various kinds are another. Actually, the natural policy — natural in a Wicksellian sense, and also the one that in terms of standard economics should produce the least distortion — would be a credible commitment to higher inflation.
Now consider what Keynes himself wrote in General Theory:
In my Treatise on Money I defined what purported to be a unique rate of interest, which I called the natural rate of interest¾namely, the rate of interest which, in the terminology of my Treatise, preserved equality between the rate of saving (as there defined) and the rate of investment. I believed this to be a development and clarification of Wicksell’s ‘natural rate of interest’, which was, according to him, the rate which would preserve the stability of some, not quite clearly specified, price-level.
I had, however, overlooked the fact that in any given society there is, on this definition, adifferent natural rate of interest for each hypothetical level of employment. And, similarly, for every rate of interest there is a level of employment for which that rate is the ‘natural’ rate, in the sense that the system will be in equilibrium with that rate of interest and that level of employment. Thus it was a mistake to speak of the natural rate of interest or to suggest that the above definition would yield a unique value for the rate of interest irrespective of the level of employment. I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.
I am now no longer of the opinion that the [Wicksellian] concept of a ‘natural’ rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such.
Paul Krugman has on his blog tried to explain why we should still use the neoclassical hobby horse Aggregate Supply-Aggregate Demand model:
So why do AS-AD? … We do want, somewhere along the way, to get across the notion of the self-correcting economy, the notion that in the long run, we may all be dead, but that we also have a tendency to return to full employment via price flexibility. Or to put it differently, you do want somehow to make clear the notion (which even fairly Keynesian guys like me share) that money is neutral in the long run.
Actually, this is the same unsubstantiated stuff you find in all of the “fairly Keynesian” Greg Mankiw’s textbooks.
Well, THIS “fairly Keynesian” guy is not impressed. And I doubt that Keynes himself would have been impressed by having his theory being characterized with catchwords like “tendency to return to full employment” and “money is neutral in the long run.”
As Taylor and Foley convincingly argue — Krugman is no real Keynesian.
Here is another take at this question I put out a couple of weeks ago. False advertising, indeed, Paul. You should know better, having written the preface to the last edition of The General Theory! Do not miss the comment section, either, where I use Paul’s own words to demonstrate he (and his so called New Keynesian brethren) is at best and Old Fisherian, at worst, at New Friedmaniac.
http://www.nakedcapitalism.com/2015/03/robert-parenteau-the-large-fly-in-krugmans-new-keynesian-soup.html
“We do want, somewhere along the way, to get across the notion of the self-correcting economy,,,”
And why, in Keynes name, would we ever want to do that? “Is the Economic System Self-Adjusting?” asked John Maynard K. in a 1934 BBC broadcast.
http://ecologicalheadstand.blogspot.ca/2011/02/self-adjusting-economic-system.html
“No,” was his answer.
Indeed Krugman is no real Keynesian
Links. The value of assets, Worldbank rhetorics and an answer. Two graphs.
1) Do we know how rich we are? One of the problems with the (invaluable) work of Piketty is how to value assets. GDP accounts basically use transaction prices – but many assets are not traded and we have to use other values or prices like book value, assessed market prices, rebuilding value or something like that. Think of the valuation of natural reserves of oil or dikes (the discounted value of assessed future streams of income is not used by statisticians, as this measure is too fickle – if measurable at all, as in the case of dikes). This means that assessed asset values can be quite volatile – as shown by the estimated value of Dutch net international assets (graph) – using another assessment method of the stock value leads to a 100 billion difference – even though estimated current account surpluses (a flow) stayed basically stable. Not that despite decades of current account surpluses in 2008 the Netherlands had a negative international investment position (the ‘Dutch black hole’, caused by bad investments…). The large change in the net position is also caused by the fact that it is… a net position. A relatively small change in total assets or liabilities can show up as a relatively large change in the net position. Even then, 100 billion is a lot…
2) Does she sing like a bird (spoiler: yes)? Does she roar like an Antonov plane? Also. Frances Coppola about the recent default of the Austrian government:
“Greece has been roundly criticized for behavior that caused trust to break down, threatening to tear the union apart. And now it seems Austria may join Greece in the naughty corner….the new head of the German regulator BAFIN, Felix Hufeld, regards Austria’s behavior as tantamount to sovereign default:
“It was “indeed a challenge for European countries” when a core EU member decides not to honor its debts, Hufeld said.
And he went on to observe that sovereign debt cannot be regarded as risk-free any more. Though of course it never was risk-free, was it? Amusingly, the architect of this “default”, Austrian Finance Minister Schelling, is critical of Greece. He says that Eurozone countries can’t trust Greece. No doubt Heta bondholders – and perhaps the German government – would say that they can’t trust Finance Minister Schelling.”
3) A magnificent New Left Review article about the changing rhetorics of the Worldbank:
“In the case of ‘the reduction of poverty’, to keep using that example, if you know what the individual words mean, you also know what the expression means: the whole is just the sum of its parts. But ‘poverty reduction’, like ‘disaster prevention’, or ‘competition policies’, is not just the sum of its parts; as we have seen, it is an expression in code—the code of ‘management discourse’—whose meaning has more to do with ‘approaches’ and ‘frameworks’ than with ‘employment’ and ‘income’. … And the point is, the World Bank wants to communicate in code … there were 1,198 occurrences of ‘poverty reduction’, and only 38 of ‘the reduction of poverty’. Which … makes perfectly clear that for the World Bank pre- and post-modification are notequivalent, and that its preference goes unabashedly to the more cryptic of the two constructions … How could such a tortuous form of expression become a leading discourse on the contemporary world? … The key move, write Latour and Woolgar, consists in ‘freeing’ a statement from ‘all determinants of place and time, and all reference to its producers’ …> Figures 10–11 show how decisively the World Bank has dealt with such ‘determinants’.”
4) (In German) Norbert Häring got an answer to his questions to the ARD (A German state broadcasting organization) about their misconceptions about Greece. He’s not entirely satisfied with their answer (my summary: “it doesn’t matter, as we have programs which show the truth, too”).