Saturday, September 12, 2009

Beyond Krugman's Morality Tale

Paul Krugman has become the voice of economists for many businessmen, politicians, and lay people. Thus, when he writes an article entitled “How did Economists Get It So Wrong?” (The New York Times Magazine, September 6), it’s big news. Over the past week I’ve been continually asked by acquaintances what my view is of what he had to say. It’s difficult to respond; he’s a wonderful writer, and there’s some parts of the story he tells that are nicely expressed. But there are other parts that, from my viewpoint as an historian of economic thought and an economist watcher, he got quite wrong—sufficiently wrong to warrant a response.

The biggest general problem with the story Krugman tells is that it’s so black and white. There’s the good guys—the Keynesian gang, and bad guys—the Classical/Chicago gang. That, in my view, is seriously wrong. The real story is one of shades of grey, and full of nuances; it is a story in which it is hard to tell who are the good guys and who are the bad guys. The real story is one of systemic failure of the large part of the academic economics profession which led them to pretend, and some of them to actually believe, that they understood a complex system that they did not, and still do not, understand. It’s a story of the economics profession’s failure to express their ideas and arguments with the humility with which they deserve to be told. It’s a story of a profession that has lost the enormous insights of past economists—both Keynesian and Classical.

There are three places where I'd say Krugman gets it wrong. The first is that he does a hatchet job on Classical economics. He misses the depth of Classical understanding. The second is that he doesn't make clear what Keynesian economics he is talking about when he says that Keynesian economics is the future of macro. If he is saying that the Keynesian economics of the discredited IS/LM variety is the future of macro--I think he is quite wrong. The third place where he gets it wrong is where he seems to claim that mathematics is to blame for the crisis. It isn't the mathematics; it's the use of the mathematics. See the Dahlem's group's response to Tony Lawson which can be found at:

--David Colander


Gu Si Fang said...

"He misses the depth of Classical understanding."

One very telling example, it seems to me, is the way he uses the parable of the babysitting coop. Every economist knows that price controls entail shortages, i.e. disequilibrium. The coop model is based on the assumption that prices are rigid: 1 hour of babysitting gets paid 1 ticket, which in turn buys 1 hour. Another assumption of the model is that people have preferences - darn them! - and wish to hoard tickets in order to be able to go out in the Winter. With these two assumptions, it is pretty obvious that things will go South...

Greg Hill said...

The outcome of the debate between the Keynesians and the Classical/Chicago "gang" may not be "all black and white," but it's pretty close. The Keynesian view, with its casino-like capital markets, cascading waves of confidence and doubt, centrality of finance, etc., fits the facts more closely than the Classical/Chicago view, with its perfectly rational agents optimizing within efficient markets over an infinite time horizon.

I'm not sure what Colander means by the "depth of the Classical understanding," but try this: In the absence of complete (Arrow/Debreu) markets in contingent commodities - a general equilibrium of interlocking commitments - expectations will be disappointed, financial commitments will not be met, and businesses may sweep their chips from the table, unleashing a downward spiral of layoffs, defaults, and bankruptcies.

Which Keynesians got it right? Robert Shiller, co-author of the pretty Keynesian book with quintessential Keynesian title, Animal Spirits, certainly did. Some of the Post-Keynesians at the Jerome Levy Institute also got it right. Wynne Godley, in particular, warned of unsustainable macro imbalances. And others pointed out that debt-financed expenditures were reaching a dangerous level, in part because so much of aggregate income growth was accruing to the top 1% of the income distribution, which captured 2/3 of the total income gain between 2002 and 2007.

Finally, it's incorrect to say that Krugman blamed "the crisis" on "mathematics." Krugman said that the New Classical economists (some of whom "giggled" when Keynesians made seminar presentations) had become so mesmerized by the beauty of their mathematical models they neglected to ask whether the models bore any relation to the real-world economy.

Dave Prychitko said...

Here is some evidence that Krugman still believes IS-LM is applicable:

Dave Colander said...

Greg Hill states that he is not sure what I mean by Classical understanding. Here's what I mean. By Classical, I mean the economics in the tradition of John Stuart Mill. I mean economists who saw models as presenting at best half truths. I mean the economics of Bagehot's Lombard Street, which if policy makers had read it, they would have had a much better sense of the liklihood of crisis than they would have had if they studied modern economics. I see
Keynes as part of that Classical tradition and it was only his followers (neoKeynesians) who moved away from that broader classical vision, and narrowed the focus of enquiry, pretending that one could directly draw policy conclusions directly from models. Thus, I find myself in substantial agreement with what Greg Hill states. But what he describes as the Keynesian view, I would also call the Classical view. (In my view Keynes did a hatchet job on Classical economists to help market his ideas.) So I think Keynes was largely right--but the things that were new in Keynes were not quite as new as Keynes made them out to be.

Whatever the case, what most people today think of as Keynesian economics is not the economics of Keynes. As Paul Davidson makes clear, economists moved away from Keynes's original ideas. I fully agree that Wynne Godley and other Post Keynesians had it right, but Post Keynesian thought doesn't seem to be what Krugman had in mind when he wrote his essay. If it had been he would have (and should have) mentioned that they had it right, but were classified as heterodox for having it right.


Anonymous said...

I like the shades of grey analogy, and it probably explains why some economists can serve in different administrations.

I worked at a high level of an enforcement agency for both democrats and republicans, and once asked a guy who had been there longer than I how he survived.

He looked at me and said, Well, you remember Darwin's observations on the survival of the grey moths during the industrial revolution in England: the black and the white moths stood out to predators, and the grey ones survived.

White, black or grey, I vote for the better idea that survives any challenge, no matter what the label or the school.

Greg Hill said...

Re: the survival of grey moths and, by implication, "moderate economists," Anonymous doesn't have the story quite right. Before the Industrial Revolution and its pollution, the peppered moths of England were white. After the trees were blackened by soot, they became a darker color.

Moderation is, in general, a welcome character trait, and looking for worthwhile elements in rival theories is also commendable. But these elements can't necessarily be combined within a coherent synthesis, and there's no reason to conclude that Keynesians and New Classical economists were, in some sense, “equally” wrong (or right) unless you're ready to produce a lot of supporting arguments.


SlaveOfTheState said...

I just have to lmao when Krugman's kook babysitting co-op example comes up yet again (Gu Si Fang). It is so funny that Krugman's incompetance shines through in such glaring terms. But,...

... Of course, Krugman's major incompetance in the example is not usually considered. I mean, Krugman failed to recognize that *any* economic system designed by a bunch of loser Capitol Hill lawyers is guaranteed to be utterly stupid and fail. It's a good thing any real and important economic system is not touchable by Capitol Hill lawyers! ohhhh... wait.... Doh!!!!!!!!!!