Home > New vs. Old Paradigm > Why Paul Krugman is no real Keynesian

Why Paul Krugman is no real Keynesian

from Lars Syll

Keynes’s insights have enormous practical importance, according to Lance Taylor and Duncan Foley (who jointly received the Leontief Prize for Advancing the Frontiers of Economic Thought at Tufts University’s Global Development and Environment Institute on Monday.)

But isn’t Keynes now mainstream? No, say Foley and Taylor. The mainstream still sees economies as inherently moving to an optimal equilibrium … It still says demand causes short-run fluctuations, but only supply factors, such as the capital stock and technology, can affect long-run growth.

EVEN PAUL KRUGMAN, a self-described Keynesian, Nobel laureate, and New York Times columnist, writes in the 2012 edition of his textbook: “In the long run the economy is self-correcting: shocks to aggregate demand affect aggregate output in the short run but not in the long run” …

KeynesUpsidedownKrugman does point to one exception: If interest rates are nearly zero, as during the financial crisis, markets lose restorative force. But, Taylor asks, what’s the logic?

Keynes saw capitalism’s general state as allowing almost arbitrary unemployment: hence his “General Theory.” Full employment was a lucky exception.

To Taylor, calling full employment the general state and allowing one unlucky exception turns Keynes upside down. And look where this confusion has brought us, he adds. Take the current eurozone disaster. For two decades, the European Union bureaucracy in Brussels, the German Council of Economic Experts, and a chorus of others, branded Germany, the “sick man of Europe,” as suffering from a sclerotic supply side: rigid labor unions, impediments to layoffs, a burdensome welfare state. But German labor costs to produce output sank steadily, and Germany generated huge trade surpluses — hardly signs of a sclerotic supply side. Yet growth has barely averaged 1 percent a year since 2000.

Jonathan Schlefer

I can’t but agree with Taylor and Foley here. To a large degree one does get the impression that Krugman thinks he is a Keynesian because he is a stout believer in John Hicks IS-LM interpretation of Keynes.  In a post on his blog, self-proclaimed “proud neoclassicist” Paul Krugman has argued that “Keynesian” macroeconomics more than anything else “made economics the model-oriented field it has become.” In Krugman’s eyes, Keynes was a “pretty klutzy modeler,” and it was only thanks to Samuelson’s famous 45-degree diagram and Hicks’s IS-LM that things got into place. Although admitting that economists have a tendency to use ”excessive math” and “equate hard math with quality” he still vehemently defends — and always have — the mathematization of economics:

I’ve seen quite a lot of what economics without math and models looks like — and it’s not good.

However, being a student of Hyman Minsky, yours truly very much doubt that IS-LM is an adequate reflection of the width and depth of Keynes’s insights on the workings of modern market economies.

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 Economics article — 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.”

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. 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 modeled by “modern” social sciences. And often we “simply do not know.”

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. Most of the insights on dynamic coordination problems that made Keynes write General Theory are lost in the translation into the IS-LM framework.

Sure, “New Keynesian” economists like Krugman — and their forerunners, “Keynesian” economists like Paul Samuelson and (young) John Hicks — certainly have contributed to making economics more mathematical and “model-oriented.”

wrong-tool-by-jerome-awBut if these math-is-the-message-modelers aren’t able to show that the mechanisms or causes that they isolate and handle in their mathematically formalized macromodels are stable in the sense that they do not change when we “export” them to our “target systems,” these mathematical models do only hold under ceteris paribus conditions and are consequently of limited value to our understandings, explanations or predictions of real economic systems.

The kinds of laws and relations that “modern” economics has established, are laws and relations about mathematically formalized entities in models that presuppose causal mechanisms being atomistic and additive. When causal mechanisms operate in real world social target systems they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it (as a rule) only because we engineered them for that purpose. Outside man-made mathematical-statistical “nomological machines” they are rare, or even non-existant. Unfortunately that also makes most of contemporary mainstream neoclassical endeavours of mathematical economic modeling rather useless. And that also goes for Krugman.

In recent blogposts Paul Krugman has come back to his idea that it would be great if the Fed stimulated inflationary expectations so that investments would increase. I don’t have any problem with this idea per se, but I don’t think it’s of the stature that Krugman seems to think. But although I have written extensively on Knut Wicksell and consider him the greatest Swedish economist ever, I definitely – since Krugman portrays himself as “sorta-kinda Keynesian” – have to question his invocation of Knut Wicksell for his ideas on the “natural” rate of interest. Krugman writes (emphasis added):

Start with the very simplest view of how Fed policy affects the economy: the Fed sets short-term interest rates, and other things equal a lower rate leads to higher output; the “natural rate” of interest … is the rate at which output equals potential, that is, at which there are neither inflationary nor deflationary pressures …

What does this tell us? First of all, that there is nothing “artificial” or “unnatural” about low interest rates; they’re low because demand is low, and the Fed is responding appropriately. If anything, the “unnatural” situation is that rates are too high, because they’re constrained by the zero lower bound (rates can’t go below zero, except for some minor technical bobbles, because people can always just hold cash).

wicksell3Second, the Fed’s inability to get rates as low as they should be justifies a search for policies that can fill this policy gap. Fiscal stimulus is one such policy; unconventional monetary policies of various kinds are another. Actually, the natural policy — natural in a Wicksellian sense, and also the one that in terms of standard economics should produce the least distortion — would be a credible commitment to higher inflation.

Now consider what Keynes himself wrote in General Theory:

In my Treatise on Money I defined what purported to be a unique rate of interest, which I called the natural rate of interest¾namely, the rate of interest which, in the terminology of my Treatise, preserved equality between the rate of saving (as there defined) and the rate of investment. I believed this to be a development and clarification of Wicksell’s ‘natural rate of interest’, which was, according to him, the rate which would preserve the stability of some, not quite clearly specified, price-level.

I had, however, overlooked the fact that in any given society there is, on this definition, a different natural rate of interest for each hypothetical level of employment. And, similarly, for every rate of interest there is a level of employment for which that rate is the ‘natural’ rate, in the sense that the system will be in equilibrium with that rate of interest and that level of employment. Thus it was a mistake to speak of the natural rate of interest or to suggest that the above definition would yield a unique value for the rate of interest irrespective of the level of employment. I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.

I am now no longer of the opinion that the [Wicksellian] concept of a ‘natural’ rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such.

Paul Krugman has on his blog tried to explain why we should still use the neoclassical hobby horse Aggregate Supply-Aggregate Demand model:

So why do AS-AD? … We do want, somewhere along the way, to get across the notion of the self-correcting economy, the notion that in the long run, we may all be dead, but that we also have a tendency to return to full employment via price flexibility. Or to put it differently, you do want somehow to make clear the notion (which even fairly Keynesian guys like me share) that money is neutral in the long run.

Actually, this is the same unsubstantiated stuff you find in all of the “fairly Keynesian” Greg Mankiw’s textbooks.

Well, THIS “fairly Keynesian” guy is not impressed. And I doubt that Keynes himself would have been impressed by having his theory being characterized with catchwords like “tendency to return to full employment” and “money is neutral in the long run.”

As Taylor and Foley convincingly argue — Krugman is no real Keynesian.

  1. Robert Parenteau
    March 26, 2015 at 12:46 pm

    Here is another take at this question I put out a couple of weeks ago. False advertising, indeed, Paul. You should know better, having written the preface to the last edition of The General Theory! Do not miss the comment section, either, where I use Paul’s own words to demonstrate he (and his so called New Keynesian brethren) is at best and Old Fisherian, at worst, at New Friedmaniac.


  2. originalsandwichman
    March 26, 2015 at 2:50 pm

    “We do want, somewhere along the way, to get across the notion of the self-correcting economy,,,”

    And why, in Keynes name, would we ever want to do that? “Is the Economic System Self-Adjusting?” asked John Maynard K. in a 1934 BBC broadcast.


    “No,” was his answer.

  3. March 26, 2015 at 3:29 pm

    Indeed Krugman is no real Keynesian

  4. Norman L. Roth
    March 26, 2015 at 5:26 pm

    March 26, 2015
    All this material about Paul Krugman’s attachment to the “usefulness” of the GENERAL equilibrium, has come up before. Therefore, Please Reference:
    {1} ‘The Arrow Debreu Obsession’ from Lars Syll: Scroll down to Norman L. Roth,Sept.01, 2014

    {2} ‘Economics Odd Couple highlights a Nobel Folly’ from Steve Keen, Scroll down to Norman L. Roth, Oct.28, 2013:
    And most importantly:

    {3} “The Scientific Attitude of Modern economists” from Lars Syll, Dec.05, 2013: Scroll down to Norman L. Roth,Dec.06, 2013, Beginning with, “Lars Syll hit the bull’s eye…”

    In {3} you will encounter the reference to the pages of TELOS & TECHNOS, that could be described as, the “Wicksell and Keynes nobody knows”. Plus the ultimate debunking of the General Equilibrium construct by Gunnar Myrdal in clear common sense language. Although
    I don’t think that the Arrow & Debreu approach to describing the unrealistically narrow
    limits of the General Equilibrium construct, should be dismissed as arcane. Keep in mind that we are talking only about GENERAL equilibrium. Not about the great Alfred Marshall’s partial or sectoral “short-term” equilibrium.

    But, as argued in TELOS & TECHNOS, there is no way that the workings of a modern, complex, quasi-organic economy can be described, without taking into account the Technological time in which [historically non deterministic, non ergodic} path-dependent economic events occur. This is what makes TELOS & TECHNOS impossible to reconcile with the GENERAL equilibrium witch doctors. And it was the Achilles heel of Keynes as well. Who accepted [sotto voce] his father’s [John Nivelle Keynes] authority that Technological change does not lie within in the domain of “Political Economy”.

    Norman L. Roth, Toronto Canada.

  5. March 27, 2015 at 3:27 pm

    Forget Krugman, forget Keynes, forget economists
    Comment on ‘Why Paul Krugman is no real Keynesian’

    Keynes wrote in his General Theory:
    “Income = value of output = consumption + investment. Saving = income – consumption. Therefore saving = investment.” (1973, p. 63)

    It can be rigorously demonstrated that this two-liner contains an elementary mistake (2011). By consequence, all models that contain I=S are worthless. This holds for all variants of IS-LM and therefore also for Krugman’s model (2014).

    Because of defective logic both Krugman and Keynes are out of science. There is nothing to choose.

    Constructive Heterodoxy cannot build upon the accustomed concepts but has to dig deeper (2015). This leads to the testable employment function for the investment economy:

    This equation helps to answer Keynes’s pivotal question: Is the economy self-correcting? The answer is NO. This follows from the factor cost ratio rhoFC, which formally represents the price mechanism. This variable is defined as quotient of average wage rate W, price Pc and productivity Rc in the consumption good industry.

    The fact of the matter is that a fall of the average wage rate relative to the price reduces employment L under the condition of market clearing in the product market (all other variables fix for the moment). The fatal defect of the price mechanism is that the right (=full employment) factor cost ratio does not come about spontaneously. Just the contrary. If unemployment effects a flexible fall in the average wage rate then unemployment INCREASES. Thus, stickiness is NOT the problem. There is a POSITIVE feedback loop built right into the structural core of the economic system.

    The claim that the market system is basically an equilibrium system that regulates itself with a tendency to full employment is entirely unfounded (methodologically it is a quite ordinary petitio principii). Politicians who rely on the advice of representative economists to get out of recession or depression are bound to fail.

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN
    Working Paper Series, 1966438: 1–15. URL http://ssrn.com/abstract=1966438.
    Kakarot-Handtke, E. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of
    Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
    Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Employment.
    SSRN Working Paper Series, 2576867: 1–11. URL http://papers.ssrn.com/sol3/
    Keynes, J. M. (1973). The General Theory of Employment Interest and Money.
    The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke:
    Macmillan. (1936).

  6. March 30, 2015 at 8:29 am

    Not all Keynesians have exactly the same opinions on what Keynes said or meant. Economics is not science. Scientists do not label themselves according to others’ beliefs – they are only concerned with what they themselves think is true.

  7. Ezra Davar
    April 24, 2015 at 6:51 pm

    Krugman’s Unrealistic Theory

    Krugman, in his paper “John and Maynard’s Excellent Adventure” (14 March, 2015, The New York Times), demonstrates an absolute misunderstanding and misinterpretation of: (1) Keynes’s theory; (2) Hicks’ Theory; and finally, most importantly (3) Real economics; stating that: “And the framework in question – basically John Hicks’s interpretation of John Maynard Keynes – was very much the natural way to think about the issues facing advanced countries after 2008”.
    First of all, Keynes’s General Theory is irrelevant, incompatible and inapplicable to the real world, because of that:
    (1) Keynes’s macro model is an incomplete and imprecise; and the mathematical model for the individual economy is not formulated; and the adjustment (coordination) process between micro and macro economies is not discussed.
    (2) The amount of investment is generally determined by deducting the amount of consumption from the amount of income.
    (3) The aggregate functions of Keynes’s demand and supply, unfortunately, are incomplete; because they are depend only on one variable, namely on the physical quantities of the given labour; in this case, the following variables are missing: wages; the fixed capital and its price; the land capital and its rent; circulation of capital and money for circulation and their prices. (4) The determination of the effective demand is unclear.
    (5) Keynes’s original definition of the types of unemployment, voluntary and involuntary, is very vague and unfinished; and does not allow us to calculate their magnitudes when we come to consider their implementation for an employment policy.
    (6) The Keynesian investment multiplier is based on the substitution of the cause (the national income) for the effect (investment); yet, the rate of the multiplier depends on the marginal propensity to invest; therefore, its genuine meaning is that requirement, which indicates on the quantity of the national income that is needed for the realization of one unit of investment.
    (7) Keynes’s money theory is incomplete and even incorrect.
    Second, Hicks’s IS-LM model, which is described as the “core of modern macroeconomics”, played a leading role in monetary policy during the 30-40 years succeeding the Second World War, while now it is generally used for “pedagogical purposes”; Krugman is trying to return it for policy recommendation. However, by careful examination of the assumptions and definitions that Hicks assumed, it is impossible to draw the curves IS and LM. One of the main reasons for such conclusions is that Hicks assumed that the functional relationship between the income (both national income and national product which are always equal in the Hicks’ model as well as in Keynes’ approach) and the rate of interest is invertible; but it may been shown that even in the case when income is determined only by one variable (service-labour as Keynes’s approach), the invertible character of the function is questionable. Moreover, if we take into account the fact that the function of income must include at least one additional variable – factor of production: labour, fixed capital, land, such a relationship is doubtful.
    Hicks claimed that the IS-LM model is compatible with Keynes’s General Theory. But the first equation of the Hicks system, M =L (I,i), is incompatible with Keynes’s approach, because in that equilibrium the connection between money and the rate of interest has disappeared.
    And, the third equation, Ix =S (I), is also doubtful, because saving in Keynes’s approach firstly depends on the marginal propensity to consume (save) and then on the rate of interest. Finally, the third crucial incompatibility between Hicks’s model and Keynes’s approach is the fact that the unique contribution of Keynes is involuntary unemployment issues, while Hicks’ IS-LM model problem of unemployment does not discuss this at all.
    To sum up, is it not only impossible to draw curves for Hicks’ IS-LM models but it is also incompatible with Keynes’s General Theory. It is difficult to evaluate the damage caused by such a “theory” to economic theory and its application in practice. This continuing use of the IS-LM model for pedagogical purposes has been negatively influencing several generations of Economics students.
    In the following, Krugman connects IS-LM models with Hicks second work Value and Capital: “What many macroeconomists don’t realize, I believe, is that Hicks on Keynes actually grows directly from Hicks’s own work on microeconomics — not mainly macroeconomics — embodied in his book Value and Capital. V&C was a seminal work on the economics of general equilibrium – that is, getting past one-market-at-a-time supply and demand to the interactions among markets. Hicks didn’t invent general equilibrium, of course, but he sought to turn it into a useful tool of analysis”.
    However, there are two notes: first, Hicks himself never connected these works; moreover, in Value and Capital he did not even mention IS-LM models; second, the opposite is true, namely, Value and Capital played a crucial role in directing economic science, especially General Equilibrium Theory, towards an erroneous direction for two crucial and central reasons (among many): (1) According to Hicks’s approach equilibrium prices may be either positive, equal to zero, or even negative; (2) Hicks did not discuss at all the problems of unemployment (voluntary-involuntary) in the equilibrium state, i.e., full employment is assumed. The same is also true for the IS-LM model.
    The result is that Krugman describes today’s economics using the unrealistic model “Well, as Hicks realized, a minimal model of macro issues involves three markets: the markets for goods, bonds, and money”. So, it is possible to produce goods without factors of production (labour, capital – fixed and circulation, land). Alas! Krugman the magician! So, Krugman’s model has no connection with today’s economic life, and therefore his recommendation is meaningless and not useful; on the contrary, it is harmful.
    Finally, the responsibility for such a situation is not only due to Krugman, but also to The New York Times, the leading newspaper of the world, propagator of the erroneous theory of Krugman around the world and, of course, the irrelevant and incompatible theory of Keynes to reality.

    Dr. Ezra Davar, Independent Researcher,

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