by Lars Syll edited by O Society October 26, 2019
Paul Krugman never suffered fools gladly. The Nobel Prize-winning economist rose to international fame—and a coveted space on the New York Times op-ed page—by lacerating his intellectual opponents in the most withering way. In a series of books and articles beginning in the 1990s, Krugman branded just about everybody who questions the rapid pace of globalization “a fool” who didn’t understand economics very well. “Silly” is a word Krugman uses a lot to describe pundits who raise fears of economic competition from other nations, especially China. Don’t worry about it, he said: Free trade will have only minor impact on your prosperity.
“Now Krugman comes out and admits, offhandedly, his own understanding of economics is seriously deficient as well. In a recent essay titled “What Economists (Including Me) Got Wrong About Globalization,” adapted from a forthcoming book on inequality, Krugman writes he and other mainstream economists “missed a crucial part of the story” in failing to realize globalization would lead to “hyperglobalization” and huge economic and social upheaval, particularly of the industrial middle class in America. Many of these working-class communities are hit hard by Chinese competition, which economists made a “major mistake” in underestimating, Krugman says.
It is quite a “whoops” moment, considering all the ruined American communities and displaced millions of workers we see in the interim. A newly humbled Krugman must consider an even more disturbing idea: Did he – and other mainstream economists – help put a protectionist trickle down supply side mercantilist – called Donald Trump – in the White House with a lot of bad advice to the public about free markets?”
Michael Hirsh The Economist
We’ve complained about Krugman on this issue for years, so of course, it’s great he finally admits he is wrong!
Another issue on which we a beef with Krugman is his view his hobbyhorse IS-LM interpretation of Keynes is fruitful and relevant for understanding monetary economies. Is it time for Krugman to come out on this also and admit he is wrong?
My own view is IS-LM is not fruitful and relevant and it does not adequately reflect the width and depth of Keynes’ insights on the workings of monetary economies.
The workings of a monetary economy is especially important as Krugman’s warmed over Neo-Classical explanation of money ‘as a veil over the economy’ and his denial of endogenous money, insisting on ‘loanable funds’ – as in his embarrassing fairly recent dust up with Steve Keen – helped prop up the bankrupt Neo Classical view of monetary economics, as opposed to the growing support for the ‘Modern Monetary Theory’ view of money as being created endogenously by banks.
The difference is crucial to a progressive solution to government fiscal policy; at least in countries which have their own sovereign currencies. MMT and Post-Keynesian Economics provides policy space for spending by currency issuing governments not available to countries on the gold standard or to countries in currency unions, such as the EuroZone in the EU. MMT provides an answer to the omnipresent objection to any progressive fiscal policy: “How are you going to pay for it?!”
Another issue on which Krugman is wrong is the climate crisis.
“In pure economic terms the required action shouldn’t be hard to take: emission controls, done right, would probably slow economic growth, but not by much.”
~ Paul Krugman New York Times Interests, Ideology, and Climate
The USA has an aging and fragile electrical distribution system predicted by the Pentagon to fail under the stress of expected global warming. With US Mainstream Economic views such as The Samuelson Synthesis the question is: “How are you going to pay for it?”
With MMT and Post-Keynesian Economics, the answer is it will mostly pay for itself. If financed partly by deficit spending, the increased deficit to the federal budget becomes income to the private sector, causing increased economic activity, the increased tax revenue from which will partly offset the deficit while the improved system is being built. Once finished, the increased reliability and reduced cost of electricity from the project will provide long term greater productivity. In the USA the same argument will support Medicare for All and other aspects of a Green New Deal.
1 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 Economicsarticle — 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 1937 Econometrica 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.” What Hicks acknowledges in 1980 is basically that his original IS-LM model ignored significant parts of Keynes’ theory. IS-LM is inherently a temporary general equilibrium model. However — much of the discussions we have in macroeconomics is about timing and the speed of relative adjustments of quantities, commodity prices and wages — on which IS-LM doesn’t have much to say.
2 IS-LM forces to a large extent the analysis into a static comparative equilibrium setting that doesn’t in any substantial way reflect the processual nature of what takes place in historical time. To me, Keynes’s analysis is in fact inherently dynamic — at least in the sense that it was based on real historical time and not the logical-ergodic-non-entropic time concept used in most neoclassical model building. And as Niels Bohr used to say — thinking is not the same as just being logical …
3 IS-LM reduces interaction between real and nominal entities to a rather constrained interest mechanism which is far too simplistic for analyzing complex financialised modern market economies.
4 IS-LM gives no place for real money, but rather trivializes the role that money and finance play in modern market economies. As Hicks, commenting on his IS-LM construct, had it in 1980 — “one did not have to bother about the market for loanable funds.” From the perspective of modern monetary theory, it’s obvious that IS-LM to a large extent ignores the fact that money in modern market economies is created in the process of financing — and not as IS-LM depicts it, something that central banks determine.
5 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. In this regard, it is actually as bad as all the modern microfounded Neo-Walrasian-New-Keynesian models where Keynesian genuine uncertainty and expectations aren’t really modelled. Especially the two-dimensionality of Keynesian uncertainty — both a question of probability and “confidence” — has been impossible to incorporate into this framework, which basically presupposes people following the dictates of expected utility theory (high probability may mean nothing if the agent has low “confidence” in it). 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 modelled by “modern” social sciences. And often we “simply do not know.”
6 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. And as Axel Leijonhufvud so eloquently notes on IS-LM economics — “one doesn’t find many inklings of the adaptive dynamics behind the explicit statics.” Most of the insights on dynamic coordination problems that made Keynes write General Theory are lost in the translation into the IS-LM framework.
The IS-LM approach is not fruitful or relevant for understanding modern monetary economies. And it does not capture Keynes’ approach to the economy other than in name. If macroeconomic models — no matter of what ilk — make assumptions, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypotheses of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. A gadget is just a gadget — and brilliantly silly simple models — IS-LM included — do not help us working with the fundamental issues of modern economies any more than brilliantly silly complicated models — calibrated DSGE and RBC models included.