Economics 101
On October 21, Chris Ragan wrote a column for the Globe and Mail titled “In defence of Economics 101.” The link to his column is available here.
On October 24, Marc Lavoie, Louis-Philippe Rochon and Mario Seccareccia replied to him. The link to their response is available here.
This response is silly for suggesting Paul Krugman supports the status quo in economics or espouses the market fundamentalism of Chris Ragan.
First, market economics is broken up into two forms: centrist Keynesian and right-wing neo-classical (which includes the ironically-titled schools, New Keynesian and neo-liberal.) Krugman puts himself squarely in the Keynesian camp. In a column Economics in the Crisis he writes:
“And so we got the division of macroeconomics. On one side there was “saltwater†economics – people, who in America tended to be in coastal universities, who continued to view Keynes as broadly right, even though they couldn’t offer a rigorous justification for some of their assumptions. On the other side was “freshwater†– people who tended to be in inland US universities, and who went for logically complete models even if they seemed very much at odds with lived experience.
“Obviously I don’t believe any of the freshwater stories, and indeed find them wildly implausible. But economists will have different ideas, and it’s OK if some of them are ones I or others dislike.
“What’s not OK is what actually happened, which is that freshwater economics became a kind of cult, ignoring and ridiculing any ideas that didn’t fit its paradigm. This started very early; by 1980 Robert Lucas, one of the founders of the school, wrote approvingly of how people would giggle and whisper when facing a Keynesian. What’s remarkable about that is that this was all based on the presumption that freshwater logic would provide a plausible, workable alternative to Keynes – a presumption that was not borne out by anything that had happened in the 1970s. And in fact it never happened: over time, freshwater economics kept failing the test of empirical validity, and responded by downgrading the importance of evidence.”
In the column How to Get It Wrong where he says the world would be in better shape if we stuck to the lessons of Econ 101, clearly he has different impression of basic economics than Chris Ragan.
He is speaking of the Keynesian interpretation of depression economics: “Low interest rates in the face of big budget deficits, low inflation in the face of a rapidly growing money supply, and sharp economic contraction in countries imposing fiscal austerity” — which are explainable by the Keynesian IS-LM model. Unlike neo-classical economists, Krugman supports government spending to spur an economic recovery and a 4% inflation target (among other things.)
He also says:
“Mammon knows that economics needs rethinking in the wake of a disastrous crisis, a crisis that was neither predicted nor prevented.
“It seems to me, however, that it’s important to realize that the enormous intellectual failure of recent years took place at several levels. Clearly, economics as a discipline went badly astray in the years — actually decades — leading up to the crisis. …
“More damning was the widespread conviction among economists that such a crisis couldn’t happen. Underlying this complacency was the dominance of an idealized vision of capitalism, in which individuals are always rational and markets always function perfectly.”
Krugman has come a long way since his 1996 essay, “Ricardo’s Difficult Idea.” Consider a more recent blog Trade Does Not Equal Jobs where he says tariffs on Chinese exports would create jobs.
Progressive economists should encourage people to read Krugman’s books and blogs. Although they may not agree on everything he writes, he is part of the solution, not part of the problem.
Ron:
Your comment is certainly a good defense of Paul Krugman!
It is true that Krugman and heterodox macroeconomists have quite a lot in common when it comes to Policy recommendations for short-run actions when the economy is in a depression (or in what he calls a liquidity trap). I have myself pointed this out in a review of his most recent book and of that of Joe Stiglitz. I said, that except for a few passages here and there, one could think that Krugman is a closet post-Keynesian! So yes, I would certainly encourage people o read his books and blogs on that account.
However, when we move out of the liquidity trap and out of the realm of Policy, Krugman is no different from the standard representative of the New Keynesian school, which you yourself consider to be part of neoclassical theory. Krugman has also shown quite a lot of disdain for ideas emerging from heterodox authors, such as Wynne Godley, Hyman Minsky, Steve Keen and Randy Wray. So I think it is legitimate to question his views on Economics 101.
Show me where Krugman critiques capitalism itself as a system, and we can talk. Otherwise, you’ll just keep missing the point.
Hi Ron,
Krugman is an anti-austerian in neoclassical dress. In essence, he and Larry Summers and other salt water economists subscribes to all the traditional IS-LM analysis but concludes that, in times of crisis, when monetary policy is ineffective because interest rates are at their lower bound (because of a so-called natural rate being negative), you need fiscal policy activism. In some ways, this is precisely what the early Keynesians used to defend, namely that fiscal policy is relevant but only for “depression economics†when the IS curve intersects the LM curve in its horizontal range. Yet Krugman still believes that interest rates are set in the market for loanable funds with the existence of a natural rate of interest, that bank deposits are a precondition for bank loans, etc. This is hardly revolutionary thinking! Indeed, we have the same problem with Piketty (and friend of Krugman). Piketty says and addresses some of the same things that interest progressive economists, but he does so in neoclassical dress just like Krugman, by making their policy views somewhat incoherent in our humble opinion!
For what it’s worth, here are my two cents. Of course I agree with my colleagues and co-authors. I always liked Krugman’s policy and have always been uneasy of the severe criticism against him, precisely because I thought that on the policy level, he was part of the solution. Indeed, he was one of the strongest voices against austerity, and we should allow welcome that. Beyond that, however, Krugman remains very much a defrocked priest of neoclassical economics.
Like Mario said, since the natural rate is negative, the central bank is ineffective because it cannot bring its rates below 0, so we must therefore rely on fiscal policy. This is not the same theoretical argument proposed by, say, Post-Keynesians.
WHat I find funny is that Krugman casts himself as a “radical”. In a column, he refers to Summers and says: “He laid down what amounts to a very radical manifesto. And I very much fear that he may be right.”
Summers and Krugman as radicals? Someone bring me a copy of Webster’s now!!
But in the same column, he says this: “we are an economy in which monetary policy is de facto constrained by the zero lower bound (even if you think central banks could be doing more), and that this corresponds to a situation in which the “natural†rate of interest – the rate at which desired savings and desired investment would be equal at full employment – is negative.”
Once you accept the natural rate hypothesis, then you are far from being a radical. Post-Keynesians reject the natural rate and with good reasons. Logically, if you accept the natural rate, then your conclusions will draw you in very traditional terrain.
The real test, of course, is once the economy is back to growth and prosperity. There, Krugman’s conclusions will be very traditional, indeed.
See Krugman’s column:
http://krugman.blogs.nytimes.com/2013/11/16/secular-stagnation-coalmines-bubbles-and-larry-summers/?_r=0
All criticisms about Krugman seem perfectly valid. But the problem is not a right-leaning Keynesian. It’s the outright neoclassical ideologues who are still calling the shots. The Canadian media is polluted with such “experts”: Andrew Coyne, Jack Mintz, Stephen Gordon, Kevin Milligan, etc.
Although I haven’t read Piketty yet, it seems his neoclassical “story telling” (as Krugman puts it) worked in his favor, giving his work legitimacy. What was the point of the book? That inequality produces an inefficient, unstable economy (when r > g) and has to be remedied with redistribution of wealth through progressive taxation. That is the very antithesis of neoclassical ideology.
So I think we need more practical thinking than revolutionary ideas that are unlikely to see the light of day.
Take the Great Moderation, which turned out to be the Great Flop. Instead of stabilizing the economy it brought back boom-to-bust bubble economic cycles that eventually collapsed in Great Slump.
What was the real cause of this failure? The inflation rate was tilted in favor of bondholders over workers. The 2% target was completely arbitrary and forced on the economy too abruptly. When Greenspan lowered interest rates to 1% in the early 2000s, that was not loose monetary policy. It was evidence of an economy already in freefall.
Back in the Keynesian era, all government tools were used countercyclical to the businesses cycle: fiscal, monetary and regulatory. Clearly more tools used in tandem are better than one alone. So that’s the kind of system we need to return to: a democratic economy rather than another failed attempt to run it on ideological autopilot.
So the real revolutionary work, in my opinion, is showing how the pseudo technocrats got is so wrong: the flaky physics-aping mathematical models, the absurd assumptions about human behavior, and the corrupt self-serving biases that all caused the economy to collapse.
Like Friedman revived classical economics by finding an alternative cause for the Great Depression — monetary policy — the Keynesians will have to come up with an alternative solution for 1970s inflation other than the Volcker Shock (as well as explain all the damage it caused: massive recession, skyrocketing unemployment and government debt, third-world debt crises, etc.)
Since nothing has changed, the economy will collapse again in another boom-to-bust business cycle. Economists who predict how it will collapse will have a lot of credibility when the inevitable reforms are brought in.