Home > The Economics Profession > The state of economics: Krugman is wrong

The state of economics: Krugman is wrong

from Peter Radford

Paul Krugman this morning hammers away at hedge fund managers who, by and large, are complaining about Fed monetary policy, and especially its so-called quantitative easing. The managers are all predicting doom and hyperinflation because of the ongoing ease of Fed policy. It might also have to do with those low interest rates making it harder to earn a living as a hedge manager, but let’s give them the benefit of the doubt. The point is that there are many folks out there who still predict doom based upon the continuance of monetary ease.

Krugman, and others, have long argued that such a view is misguided because an economy mired in the depths – like ours is – does not respond to loose monetary policy the way it would under more ‘normal’ conditions. In particular, no amount of cash whizzing around will cause an inflationary spiral while we are stuck in a liquidity trap. Thus the analysis of the hedge fund managers, which seems to ignore the existence of a liquidity trap, is just wrong and their dire predictions will never be correct.

Case in point: this week’s report that inflation is nonexistent and that consumer prices have edged up only a little over 1% during the last year. Clearly hyperinflation remains a way off. So Krugman’s analysis seems correct, and the hedge fund managers are wrong.

Where I disagree with Krugman in his blog today is his references to the economics profession.

In his discussion this morning he is critical of a defense of the hedge fund managers made by Jesse Eisinger. That defense rests on the notion that economists have no clue about the economy as demonstrated by their inability to predict the bubble and subsequent collapse. There were, of course, many economists who did predict the bubble, but they were not influential enough to have an impact. They remain mostly without influence due to their being outside the profession’s orthodox traditions. Krugman, however, defends the profession against Eisinger’s criticism, and this is where he goes wrong.

It does not matter that some economists were correct. The central orthodoxy of the profession, the source of most advice to policy makers and business people, and the basis of most commonly taught textbooks, totally missed both the possibility and then the existence of  the bubble. Economics was horribly wrong. It hasn’t recovered since. Instead it is stuck in an unproductive self-examination that has yet to have much impact. Those who were wrong still pronounce and influence policy. They continue unabashedly to teach and perpetuate their errors. The profession, such as it is, is splintered into ideological warring camps making no progress towards a newer or more complete understanding of actual economies where things like asset price bubbles can, and evidently do, exist.

In short economics is a mess and is completely deserving of the skepticism Eisinger attributes to the hedge fund managers. After all many of them made fortunes by ignoring economic theory, recognizing the bubble, and shorting sub-prime assets. People who have made fortunes by thinking about the real economy and then risking their assets based upon that thinking, have a right to look down on a bunch of academics who opine about theories whose proof  only ever resides in carefully constructed and highly constrained alternative worlds known as models. To win the respect of hedge fund managers, and anyone else out there in the real world for that matter, academic economists need to demonstrate a commitment to learning from their errors and toss aside erroneous theories. They need to stop regurgitating the same old stuff – some of which dates back to bygone eras and thus predates the development of tour modern economy.

This is not to say, naturally, that old ideas are necessarily wrong. But a social science like economics has to recognize that societies change and that the ‘social’ part of a social science provides the relevant context for the ‘science’ part. Ideas may, therefore, not be timeless. If economists want us to believe they are, then they need to prove that point, and not simply assume it. Economists still are stuck within an anachronistic vision of what they do. They may have stellar reputations as responsible professionals within academia, but, by and large, their relationship with society at large seems amateurish and somewhat naive. Indeed they oftentimes deny its existence, preferring instead to remain engaged in scholarly debate within their respective academic bastions. The point being that economic theory matters, or it ought to matter. People rely on it to inform their decisions. So if theory flounders, so does the profession.

Krugman wants us to believe that economics is still deserving of respect. But what about the current mess within the profession is so deserving? More to the point, and I have argued this before, given the great fractures and ideological splinters within economics, and given the often totally contradictory nature of different economist’s views, on what basis, exactly, does an outsider rest his or her trust? Who do they turn to for reliable advice? And how do they identify an economist’s credentials at all? Where is the professionalism in the profession?

Put it this way: in light of the evident failure of economic orthodoxy in recent years, were you in need of advice regarding the real economy would you turn to an academic economist? Or would you trust your own experience?

Clearly many hedge fund managers and business people choose their own experience. And that says a lot about the state of economics, doesn’t it?

  1. Garrett Connelly
    May 18, 2013 at 8:32 pm

    Krugman’s latest book hinges on the idea that the borrowings will become so valueless from inflation they will be of no concern to the future. He has forgotten econ 101, where money is defined in part as a store of value.

  2. May 18, 2013 at 9:56 pm

    Ok, Krugman is wrong, so What? Who is Right? I think that Krugman is less wrong that others.

    • Garrett Connelly
      May 19, 2013 at 11:30 am

      Those who have a correct basis for economic theories understand the human economy as a subset of the planetary environment, which is based upon a solar budget that must be shared with a biodiversity that creates earth’s atmosphere as it exists. What makes Krugman so totally wrong, and bullheaded, is his complete disregard for mathematics; his reputation hinges on convincing rational people that it is possible to grow to infinity in a bounded system upon a finite planet.

  3. May 18, 2013 at 9:58 pm

    And there is no possible experiencie without a Theory.

  4. paul davidson
    May 18, 2013 at 10:04 pm

    There can be no bubbles if financial markets are efficient.

    so the problem is that we need a theory of financial markets that explains why markets can not (never) be efficient.

    In a recent seminar that I gave to the University of Chicago Economics students (which you can see on you tube — if you look for Paul Davidson at the University of Chicago) I explained why the correct Keynesian theory , namely Post Keynesianism builds on Keynes’s General Theory of liquidity and uncertainty to explain why it is impossible for financial markets to be efficient. Efficiency requires the ergodic axiom as a foundation.

    Bubbles occur when financial markets that are thought to be liquid suddenly become illiquid– Why? I guess you will have to read my book — or see my Chicago seminar –to find out.

    Paul Davidson

    • Garrett Connelly
      May 19, 2013 at 12:46 am

      C’mon, Paul. Give us a tad more to chew on. Really. Are you going to buy my book on the $5/sq ft house that pays the occupants to live in itself?

      • paul davidson
        May 19, 2013 at 3:38 am

        I have made my seminar at the University of Chicago available on this blog — so you do not have to buy my book!!

        Just start teaching your students some good Post Keynesian economics and that will be reward enough for me!

        Paul Davidson

  5. Doug
    May 19, 2013 at 12:57 pm

    Just making stuff up and stating it as fact doesn’t make it true.

    “There were, of course, many economists who did predict the bubble, but they were not influential enough to have an impact. They remain mostly without influence due to their being outside the profession’s orthodox traditions.”

    Huh? Nobel prizewinners like Krugman and Stiglitz had no influence and are unorthodox?

    “After all many of them (hedge fund managers) made fortunes by ignoring economic theory, recognizing the bubble, and shorting sub-prime assets.”

    Maybe the author should read The Big Short by Michael Lewis about the very few who actually got it right and shorted sub-primes. It’s non-fiction BTW.

    “given the great fractures and ideological splinters within economics, and given the often totally contradictory nature of different economist’s views, on what basis, exactly, does an outsider rest his or her trust? Who do they turn to for reliable advice? And how do they identify an economist’s credentials at all? “

    For starters you could ignore the ones who have been predicting incorrectly for the past 5 to 10 years that their debt bubble was shortly to produce runaway inflation and sky rocketing bond yields. Instead focus on the ones like Krugman and Stigliz to name two of many who have been right all along.

    Maybe the author has similar problems with deniers and believers in global warming and evolution.

  6. May 20, 2013 at 12:08 am

    Thanks Garrett. Nice reminders. I’ll look up your book. Sounds like it may be a good one for an under-employed ecotect living in an insane world. Hmmm… could that have anything to do with why “the ecocomy” and “economics” are so broken? ;-) Perhaps a study of “Alice’s Adventures in Wonderland” or “Through the Looking Glass” would be illuminating and/or sobering?

    • Garrett Connelly
      May 20, 2013 at 12:55 pm

      Hello Michael, and thanks. Here’s a link to the low cost shelter manual (the specific applied econ verbiage is kept to a tongue biting minimum). This is a fairly large site, over time you might also enjoy the hurricane harvesting water tanks that pay for themselves while the people practice democracy, and the fly catcher compost toilet that saves 85% of our food investment from being converted to pollution.


  7. Robert Locke
    May 20, 2013 at 6:11 am

    It is pointless after events to go back and note that some economic predictions were accurate. You have to be able to select, before events, which predictions will be true and state why, and live with the consequences. Economists avoid reality checks like the plague.

  8. May 20, 2013 at 7:33 am

    Krugman is better than most economists – admittedly a pretty low bar to clear. But he is missing some very basic things like:
    1. Who controls the creation of money and debt? If it’s a private central bank, as it is now, than seigniorage will be lost to the country and go to the banks. This is trillions of dollars.
    2. Who profits from the natural resources and locational values that are created by all of us as part of the commons? If it is private speculators, as now, they will drive prices to unsustainable heights, make a killing selling at the top, or not, and then accelerate a crash. Meanwhile, that resource value is lost to the People whose demand created it and given to rent-seekers (Rent is calculated to be 1/3 of GDP by Hudson and other economists who actually understand rentier behavior. Hudson is miles ahead of Krugman, as is Stiglitz)
    3. Who “owns” the corporations and profits from them? This may seem strange when it seems the corporations own us, but it is actually the large shareholders who own them, including the largest ones of all – the collective governments of the U.S. in nearly 200k Comprehensive Annual Financial Reports. This value is in the 10s of trillions, maybe even 100 trillion dollars (a full audit needs to be done).

    If economists don’t address these macro-issues, they are wasting their time with minor issues of pricing and unemployment from the so-called “business cycle” (really, a Land cycle).

  9. May 20, 2013 at 8:16 pm

    Thanks Garrett, Scott, et al. This is a pretty useful, promising thread, with lots of good clues & hints for youngsters. I agree with Planck. Paradigm change is not evolutionary. They shift when enough of the Old Guard has died off. Too bad, eh? Oh, well… par for the course (of Planet Stupid). Garrett, I think you like my little FAQ page () on my “Ultradobe” materials, which are much better & can be much lighter, stronger & far more durable than Portland cement compounds, also withstanding much hotter firestorms. Love wattle & daub & ferrocement building envelopes & hulls. Best etc…

  10. May 20, 2013 at 8:19 pm

    PS: the URL link didn’t make it in my previous post. The FAQ & basics on Ultradobe are at my WordPress blog > EcotectureNOW. Cheers

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