Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
A Simple Way to Preserve Your Wealth Amid Uncertainty - 11th Aug 20
Precious Metals Complex Impulse Move : Where Is next Resistance? - 11th Aug 20
Gold Miners Junior Stcks Buying Spree - 11th Aug 20
Has the Fed Let the Inflation Genie Out of the Bottle? - 10th Aug 20
The Strange Food Trend That’s Making Investors Rich - 10th Aug 20
Supply & Demand For Money – The End of Inflation? - 10th Aug 20
Revisiting Our Silver and Gold Predictions – Get Ready For Higher Prices - 10th Aug 20
Storm Clouds Are Gathering for a Major Stock and Commodity Markets Downturn - 10th Aug 20
A 90-Year-Old Stock Market Investment Insight That's Relevant in 2020 - 10th Aug 20
Debt and Dollar Collapse Leading to Potential Stock Market Melt-Up, - 10th Aug 20
Coronavirus: UK Parents Demand ALL Schools OPEN September, 7 Million Children Abandoned by Teachers - 9th Aug 20
Computer GPU Fans Not Spinning Quick FIX - Sticky Fans Solution - 9th Aug 20
Find the Best Speech Converter for You - 9th Aug 20
Silver Bull Market Update - 7th Aug 20
This Inflation-Adjusted Silver Chart Tells An Interesting Story - 7th Aug 20
The Great American Housing Boom Has Begun - 7th Aug 20
NATURAL GAS BEGINS UPSIDE BREAKOUT MOVE - 7th Aug 20
Know About Lotteries With The Best Odds Of Winning - 7th Aug 20
Could Gold Price Reach $7,000 by 2030? - 6th Aug 20
Bananas for All! Keep Dancing… FOMC - 6th Aug 20
How to Do Bets During This Time - 6th Aug 20
How to develop your stock trading strategy - 6th Aug 20
Stock Investors What to do if Trump Bans TikTok - 5th Aug 20
Gold Trifecta of Key Signals for Gold Mining Stocks - 5th Aug 20
ARE YOU LOVING YOUR SERVITUDE? - 5th Aug 20
Stock Market Uptrend Continues? - 4th Aug 20
The Dimensions of Covid-19: The Hong Kong Flu Redux - 4th Aug 20
High Yield Junk Bonds Are Hot Again -- Despite Warning Signs - 4th Aug 20
Gold Stocks Autumn Rally - 4th Aug 20
“Government Sachs” Is Worried About the Federal Reserve Note - 4th Aug 20
Gold Miners Still Pushing That Cart of Rocks Up Hill - 4th Aug 20
UK Government to Cancel Christmas - Crazy Covid Eid 2020! - 4th Aug 20
Covid-19 Exposes NHS Institutional Racism Against Black and Asian Staff and Patients - 4th Aug 20
How Sony Is Fueling the Computer Vision Boom - 3rd Aug 20
Computer Gaming System Rig Top Tips For 6 Years Future Proofing Build Spec - 3rd Aug 20
Cornwwall Bude Caravan Park Holidays 2020 - Look Inside Holiday Resort Caravan - 3rd Aug 20
UK Caravan Park Holidays 2020 Review - Hoseasons Cayton Bay North East England - 3rd Aug 20
Best Travel Bags for 2020 Summer Holidays , Back Sling packs, water proof, money belt and tactical - 3rd Aug 20
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Krugman's Keynsian Economics, End This Nonsense Now!

Economics / Economic Theory Jun 18, 2012 - 05:37 AM GMT

By: David_Gordon

Economics

Best Financial Markets Analysis ArticleEnd This Depression Now! By Paul Krugman. Norton, 2012. Xii + 259 pages

Supporters of Keynesian economics sometimes claim it to be a crude caricature of the Master that he thought the government has only to spend more money to get us out of a depression and that getting us into debt doesn't matter because we owe it to ourselves. Keynes, it is alleged, was a vastly more sophisticated thinker than this caricature portrays him to be. These defenders may find End This Depression Now! disconcerting. Krugman, who whatever his faults certainly is not lacking in technical sophistication, defends pretty much the cartoon version of Keynesianism that we are told is oversimplified.


He makes unmistakably clear the lesson he intends to convey: the government needs to spend a great deal of money to extricate us from our depressed economic conditions.

But the essential point is that what we really need to get out of this current depression is another burst of government spending. Is it really that simple? Would it really be that easy? Basically, yes. (p. 39)

To those who worry that spending on the scale he has in mind would add to the already huge government deficit, he says,

It's true that people like me believe that the depression we're in was in large part caused by the buildup of household debt, which set the stage for a [Hyman] Minsky moment in which highly indebted households were forced to slash their spending. How, then, can even more debt be part of the appropriate policy response? The key point is that this argument against deficit spending assumes, implicitly, that debt is debt – that it doesn't matter who owes the money. Yet that can't be right; if it were, we wouldn't have a problem in the first place. After all, to a first approximation debt is money we owe to ourselves; yes, the United States has debt to China and other countries, but ... our net debt to foreigners is relatively small and not the heart of the problem. (p. 146)

Why does Krugman favor increased government spending? After the collapse of the housing market and the bank and investment house failures that accompanied this collapse, consumers' spending fell. Faced with the prospect of diminished spending by consumers, investors were reluctant to invest. Unless the government acted, the economy threatened to spiral downward. Government aid programs and actions by the Fed prevented total collapse, but spending has not been sufficient. The government needs to do more. "Why is unemployment so high, and economic output so low? Because we – where by 'we' I mean consumers, businesses, and governments combined – aren't spending enough" (p. 24).

One might at first object to Krugman's argument in this way. If the government spends more but does not increase the supply of money, must it not be the case that someone else has spent less money? In this view, there cannot be an overall failure of demand. More of particular goods can be produced than people want at the price they are offered for sale, but there cannot be general overproduction.

Krugman rejects this counterposition. "This is the fallacy Keynes called 'Say's Law'" (p. 25).

What is wrong with Say's law, in brief, is that money need not be either spent or invested. People can hoard money; and, if they do so, a failure in total demand can indeed result. Surprisingly, he does not offer a detailed account of how hoarding produces this failure in total demand. "You can write down a little mathematical model to illustrate the issues, but this works only with economists, not with normal human beings (and it doesn't even work with some economists)" (p. 26). Instead, he supports his criticism of Say's law with a story that he has already used in his The Return of Depression Economics. The story is about a babysitting cooperative, the members of which find themselves at cross-purposes.

I do not propose to rehearse here the details of Krugman's babysitting example and its relevance to the case of economic depression.[1] Let us instead look at the Keynesian analysis directly. Does it rest on plausible assumptions? What evidence supports it?

It will come as no surprise to readers that the Keynesian account strikes me as unpersuasive. For one thing, as Krugman himself acknowledges, the depression starts with the collapse of particular markets such as housing. If this is so, why are investors supposed to fear a general fall in future consumer demand? Is not the problem rather that there has been malinvestment in specific areas? The solution would then be to shift resources away from these areas into others. So long as this is done, why would businessmen refuse to invest?

Krugman is aware of this response, but he believes it is just what we need to avoid. He cites Joseph Schumpeter, who warned against policies of government stimulus to end depressions. Instead, bad investments should be left to fail:

For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another crisis ahead. (p. 204, quoting Schumpeter)

Krugman does not tell us what is wrong with Schumpeter's reasoning. Instead, he takes for granted that investors in a depression expect a general collapse in consumers' demand.

But suppose, contrary to fact, that investors did expect a general fall in consumer demand. Would it follow that investment would stop, miring the economy in continuing depression? By no means. As Friedrich Hayek noted long ago, investment in a business can be profitable even if demand for the product of the industry has fallen. What concerns the businessman is not the quantity of his product that buyers demand at a given price, considered in isolation, but rather that amount compared with his costs. If his costs have also fallen, why cannot investment continue?

As Hayek says,

As it is not the absolute level of the prices of the product, but only their relative level in comparison with factor prices which determines the remunerativeness of production, it is, therefore, never the absolute size of the demand for consumption goods, but the relative size of the demands for the means of production to be used for the various methods of producing consumption goods that determines this relative profitableness.[2]

Krugman might respond to our objections in this way: "You may cavil at various details of Keynes, but the evidence demonstrates that he is right. Government spending does indeed revive prosperity and create jobs."

Does not this response ignore the obvious? The government under Bush and Obama has spent a great deal of money; but, on Krugman's own showing, the economy has failed fully to recover. Does this not give us some reason to think that the Keynesian prescription is inadequate? Krugman does not think so. He says the problem with current American policy is that the government has not spent enough. Further, he says, he does not here speak with the wisdom of hindsight. He warned long ago that the amount of money the government proposed to spend would not suffice to bring about recovery.

I personally was more or less tearing my hair out in public as the shape of the [Obama] administration's plan began to come clear.... I feared that an inadequate stimulus would both fail to produce adequate recovery and undermine the political case for further action. (p. 119)

In cases where a correlation exists between government spending and increases in employment, he awards full marks to Keynes:

As military spending [in 1940] created jobs and family incomes rose, consumer spending also picked up (it would eventually be restrained by rationing, but that came later). As businesses saw their sales growing, they also responded by ramping up spending. And just like that, the Depression was over. (p. 39)[3]

Krugman does not so much as mention the pioneering work of Robert Higgs, Depression, War, and Cold War, which decisively challenges the contention that World War II ended the Great Depression. Higgs convincingly shows that prosperity returned only after the war ended. But let us, very much contrary to fact, suppose that Krugman is correct about the effects of government spending in the years after 1940. His defense of Keynes would still be grossly deficient.

What he is in effect saying is this: "Instances that appear to confirm the claim that government spending ends depressions count in favor of Keynes. But cases that go against Keynes do not count, because we cannot rule out the possibility that greater spending would have worked."

What Keynes's friend Piero Sraffa, who cannot be suspected of bias in favor of the Austrian School, wrote in his copy of Keynes's General Theory applies to Krugman as well: "as usual, heads I win, tails you lose."[4]

One passage in the book is unintentionally revealing. Given Krugman's stress on the importance of propping up investment through government stimulus, one might have expected him to favor measures to boost business confidence. Instead, he cites with approval the Polish Marxist Michal Kalecki, who warned that appeals to business confidence were an instrument by which the capitalist class endeavored to control policy. Government should not placate business but instead control the economy directly:

Every widening of state activity is looked upon by business with suspicion, but the creation of employment by government spending has a special aspect which makes the opposition particularly intense. Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence.... This gives the capitalists a powerful indirect control over government policy; everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. (pp. 94–5, quoting Kalecki)

Krugman remarks, "This sounded a bit extreme to me the first time I read it, but it now seems all too plausible" (p. 95).

Krugman yearns for the glory that was Roosevelt and the grandeur that was Truman, but he evidently thinks that their revolution against capitalism needs to proceed further.

Krugman has nothing to say about the Austrian theory of the business cycle. Hayek is mentioned once (p. 205) in connection with the passage from Schumpeter previously quoted, but his name does not appear in the book's index. Mises and Rothbard are not mentioned at all. Given his manifest lack of understanding of the Austrian theory in earlier work, this is just as well.[5]

Notes
[1] I have elsewhere discussed the babysitting cooperative and Krugman's use of it. See my "Krugman's Nanny State" in The American Conservative for January 12, 2009.

[2] Hayek, "The 'Paradox' of Saving" in Prices and Production and Other Works (Mises Institute 2008), p. 177.

[3] See also the discussion of military spending, pp. 234 ff.

[4] Heinz D. Kurz, "Keynes, Sraffa, and the Latter's 'Secret Skepticism" in Bradley W. Bateman, et al., eds. The Return to Keynes (Harvard 2010), p. 199.

[5] See Krugman's "The Hangover Theory" in Slate, December 3, 1998, and my discussion in The Mises Review, Spring 1999.

David Gordon covers new books in economics, politics, philosophy, and law for The Mises Review, the quarterly review of literature in the social sciences, published since 1995 by the Mises Institute. He is author of The Essential Rothbard, available in the Mises Store. Send him mail. See his article archives. Comment on the blog.

[Where Keynes Went Wrong And Why Governments Keep Creating Inflation, Bubbles, and Busts • By Hunter Lewis • Axios Press, 2009 • Vi + 384 pages]

© 2012 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules