Believe those who are seeking the truth. Doubt those who find it. Andre Gide


Sunday, May 23, 2010

On Krugman (Again)

I seem to have hit a nerve with Mark Thoma in my previous post (see his comments). Apparently, he took issue with my suggestion that Paul Krugman's theoretical contributions to macroeconomic theory are close to nil. Mark goes so far to suggest that if we had all just read Krugman's work on Japan's liquidity trap, that we could have all been spared reinventing the wheel. Really?

In fact Mark, I had read his thoughts on the liquidity trap (and I thought they were pretty good, which shouldn't be confused with I thought they were original). Indeed, during my visit at the BOJ in 2002, I offered some of my own speculations on the matter (see here). Here is a quote from that piece:


I conclude with some thoughts on the potential role for fiscal policy. Some economists, notably Krugman (1999) and Eggertsson (2002), have advocated the use of fiscal policy as a means of “stimulating” the economy when it finds itself in a “liquidity trap” scenario. The model that I present below is consistent with this idea. In particular, by increasing the rate of expansion of nominal government debt, the fiscal authority can drive down the expected real rate of return on government securities (by increasing the expected inflation rate), thereby inducing asset substitution from government securities into capital investment. However, whether such a policy is likely to have a quantitatively important effect and whether such a policy would even be desirable in terms of economic welfare are still questions open to debate.

Open to debate, that is, as far as I was concerned. Not to (the post Nobel prize) Krugman, or any of his devout followers.

So Krugman "discovered" the liquidity trap in 1999? He discovered the proposition that a swap of two zero-interest bearing securities (money and government debt) is not likely to have a significant impact on the wealth portfolios of individuals? Well done (but wasn't this known already?).

What I find insufferable about the man is not that he is necessarily incorrect; it is the manner in which he proclaims things to be absolutely true (something that I don't detect in his earlier writings). Even worse is the faint, but unmistakable hint that the reader is a moron for not capitulating at his alter of higher wisdom.

What do I mean by this last statement? Well, take a look here, for example. That's for all of you stupid PhDs who cannot understand how a sticky price model works. You see, just assume that free markets do not work well (prices are sticky). Then you assume that the government works really well. Homework: deduce the correct policy implications.

Another irritating aspect of the man is the way he likes to label the assumption of sticky prices as a Keynesian construct. What is irritating is not so much that he does this (as do almost all NK types); it is that he frequently berates others (notably Barro) for not reading the General Theory properly (or at all). Well, here's a quote from the General Theory for all you NK fans:
In this summary, we shall assume that the money-wage and other factor costs are constant per unit of labour employed. But this simplification, which we shall dispense later, is introduced solely to facilitate the exposition. The essential character of the argument is precisely the same whether or not money wages are liable to change. (Chapter 3, Part II)

In other words, the assumption of sticky prices/wages has absolutely nothing to do with Keynes' theory. In fact, he would argue later on that to the extent that prices/wages are sticky, that this would be good thing (it would prevent a further fall in incomes that would serve to exacerbate any demand deficiency).

Mark pointed me to this Krugman piece, which I had not seen before (thanks, Mark). Evidently, one thing that has really been "bothering" Paul is the absence of "fully worked out models." In light of his history of coming down hard on one side of this debate, I can hardly believe that he is being sincere. But maybe he is, and maybe I've been wrong about the guy.

I'll have more to say once I finish reading it carefully.

13 comments:

  1. The main focus of Keynes was not sticky wages, but the failure of credit markets to balance saving and investment - in modern term it would probably be better to describe it as a failre to generate a sufficiently high level of private borrowing.

    Since private borrowing depends not only on nominal interest rates and business/consumer confidence, but also on inflation expectations, collateral prices, and bank credit policies, the government has many policy options Keynes simply did not think about.

    Which means that countercyclical government policies can be designed in many different ways to achieve difefrent objectives, for example:

    1) It could be used to replace private borrowing with public borrowing - the original Keynesian proposal currently advocated by most modern Keynesians

    2) Or it could be used to increase inflation and/or inflation expectations

    3) Or it can be used to support collateral prices

    4) Or it can be used to recapitalize banks in order to change bank credit policies

    and so on and so forth.

    The right policy mix depends on the underlying causes of the credit market failure and how persistent they are. If for example, we expect the ZLB to remain binding for another decade (as in Japan), then it is not a good idea to simply continue attempts to replace private borrowing with public borrowing - we have to try higher inflation or some structural changes (change in trade policies, social security reform or tax reform).

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  2. "[Mark Thoma] took issue with my suggestion that Paul Krugman's theoretical contributions to macroeconomic theory are close to nil."

    Is that what you suggested? I thought you were suggesting something else: "Where is the evidence that Paul Krugman has ever thought deeply about the theoretical foundations of Keynesian theory?"

    Isn't that something different?

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  3. "So Krugman "discovered" the liquidity trap in 1999?"

    Where did Mark Thoma say that? He said some people reinvented the wheel instead of reading Krugman about Japan's liguidity trap. Maybe some people did. But that's different from claiming that Krugman "invented" liquidity traps; and Krugman himself never claims that. In fact, one of his most famous pieces was clear about this starting with the seventh word of its title: "It's baaack: Japan's Slump and the Return of the Liquidity Trap."

    "Return". See the word? Not convinced? OK, let's start from the first paragraph:

    "In the early years of macroeconomics as a discipline, the liquidity trap - that awkward condition in which monetary policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes irrelevant because money and bonds are essentially perfect substitutes - played a central role. Hicks (1937), in introducing both the IS-LM model and the
    liquidity trap, ....."

    OK, let's not.

    Now, you might naturally protest that you were never accusing Krugman of claiming to "invent" the idea of the liquidity trap, just that you thought Mark Thoma meant to say something like that. Well, Mark Thoma is not that stupid or ignorant about macro.

    So what did you mean?

    It's interesting how little you use direct quotes from the people you're attacking. Are you sure you aren't putting words in their mouths, with your paraphrases?

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  4. "Another irritating aspect of the man is the way he likes to label the assumption of sticky prices as a Keynesian construct."

    Eh? Where does he say that? I've read a lot of Krugman, and I haven't seen that. If he'd say it anywhere, he'd certainly say it in his introduction to the General Theory. But he doesn't. Here's what he does say:

    "So the crucial innovation in The General Theory isn’t, as a modern macroeconomist tends to think, the idea that nominal wages are sticky."

    In other words, if Krugman is saying anything about how assumptions of wage or price stickiness are labeled, he's saying, "DON'T assume this is a Keynesian construct -- that's a bad habit of some economists."

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  5. "Even worse is the faint, but unmistakable hint that the reader is a moron for not capitulating at his alter of higher wisdom."

    Actually, I didn't really get interested in economics until I read his The Accidental Theorist. And it was precisely because I felt he *wasn't* condescending to the general reader.

    "What do I mean by this last statement? Well, take a look here, for example."

    Been there, read that.

    "That's for all of you stupid PhDs who cannot understand how a sticky price model works."

    He makes it clear he's run across econ PhDs who didn't know this stuff. He doesn't say it's all of them.

    "You see, just assume that free markets do not work well (prices are sticky)."

    You didn't get to the point in the essay where he says he justifies that assumption from overwhelming empirical evidence?

    "Then you assume that the government works really well."

    He leaves the role of government to a quote from Keynes, which itself says nothing about how effective the government would be; if anything, Keynes' "green cheese" is a suggestion that it's not so great, but better than any alternative anyway.

    "Homework: deduce the correct policy implications."

    You didn't see where he said that the holes in this oversimplified model were the subject of decades of recent economic research?

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  6. "In light of his history of coming down hard on one side of this debate, I can hardly believe that he is being sincere."

    If he's irritated by a lack of very detailed models, that's not inconsistent with a concurrent desire to be (pace Keynes) "vaguely right" than "precisely wrong", and to come down hard on people who are being precisely wrong.

    "But maybe he is, and maybe I've been wrong about the guy."

    Given that you've managed to be wrong about the guy in just about every paragraph of the above blog post, it wouldn't surprise me a whole lot.

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  7. “What I find insufferable … is the manner in which he proclaims things to be absolutely true… Even worse is the faint, but unmistakable hint that the reader is a moron for not capitulating at his alter [sic] of higher wisdom.”

    “… I have come across no evidence that …[DeLong] has any deep understanding of modern macroeconomic theory. I'm not sure how he passed his macro core exam.”

    Yes, much better to proclaim that the objects of your spleen are morons. That is not insufferable—in fact, it's a mark of a wide-open mind. Now I understand!

    Thanks for pointing out that our Emperors have no clothes in the most useful way possible.

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  8. It's almost always a silly move to take on Krugman and I'm afraid this was no exception...

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  9. Seriously David.. Did you actually read your last post? You just screw it up big time. Normally you accept it and apologize... but no.. that would be so...elegant. No, better to say "No I actually did not say that, oh boy you are so rude, oh and by the way you still suck altough I do not have anything to prove it"

    Do you have a PhD? In dishonesty?

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  11. "What I find insufferable about the man is not that he is necessarily incorrect; it is the manner in which he proclaims things to be absolutely true (something that I don't detect in his earlier writings). Even worse is the faint, but unmistakable hint that the reader is a moron for not capitulating at his alter of higher wisdom."

    I disagree with basically everything you've written on Krugman, but I find the above to be especially weird. I've read a lot of him, and one of the things I like best about him is the way he seems so much more intellectually self-aware than everyone else. (See for example http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html , which did a lot to convince me that he was different. It helps that I already agreed with him, and you clearly won't, but I suspect a careful read will reinforce my point.)

    Perhaps there's something to your claim, but I'll note two relevant things about his current role as a public intellectual: (1) He's trying to make headway against a persistent perception that conservative economists (and conservative noneconomists) are somehow more 'realistic,' whereas the opposite is too often true. In this context subtle epistemology is simply out of place. If he were able to engage with his opponents on a more equal footing in the public sphere, he could dispense with much of his flattening stridency. (2) In general when trying to change the world in 700 words or less, subtle epistemology isn't what's going to come across. Contrasts must be emphasized, distinctions clarified, and sophisticated abstractions rendered in terms that everyone can understand; again, sophisticated epistemology is simply out of place.

    Much of his earlier work took the form not of honed instruments of social change, but rather of a playful professor geeking out in print. In this context subtle epistemology is emphatically not out of place, and he engages in as much of it as he can get away with. As his role changed, I haven't detected any change in the quality of his understanding; at worst, there's a corresponding change of emphasis.

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  12. Well it sure looks like you're taking a beating, but I suppose it's healthy in a way. I left the following comments at Mark Thoma's blog because imho some of the commentators are missing the point:

    What I don't understand is why Andolfatto's sarcasm is being positioned as an attack? For example, consider that he thinks Economists (and other academics) should show some humility, like Greg Mankiw: See http://andolfatto.blogspot.com/2010/05/greg-mankiw-on-fiscal-policy.html

    What is particularly strange is Prof. Sethi's implication that Andolfatto is not showing humility. I would say he is more likely to show humility and academic honesty than most dogmatic economist-cum-public intellectuals out there. You just gotta get his sense of sarcasm.

    So what does this mean for commentators like Krugman? It means prefacing his written works for mass consumption with the acknowledgement of the assumptions and limitations of the models he's "translating". As per Prof. Sethi final point, Krugman should also not smoke the public by presenting macro theory as an understanding of the macro-economy. At best his writing should ask readers to read with a critical eye and consistently question one's own pre-conceptions. Otherwise, the crisis would be over now, we wouldn't be having this discussion, and there would be no more macroeconomics to study!

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