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Paul Krugman vs. Mervyn King on Keynes

from Lars Syll

Most self-described Keynesians are Part 1ers. They don’t necessarily believe that workers and consumers are perfectly rational, or deny that sudden shifts in behavior can happen, but irrationality and volatility are at the fringes of their worldview.

King argues, however, that this is all wrong; he is, basically, a Chapter 12er, asserting that economic decisions always take place under conditions of “radical uncertainty”—ignorance about the future that can’t be quantified by probabilities, so that there is no such thing as optimizing behavior. People cope with this uncertainty by settling on “narratives” that are conventionally accepted at any given moment, but can suddenly change. And he urges economists to turn away from supply-and-demand-type analysis, which he calls the economics of “stuff”—as in markets for prosaic physical goods—in favor of the economics of “stuff happens.”

That’s not an unheard-of position, but it’s a remarkable one for an ex–central banker to take, let alone one who, in a former life, was a card-carrying mainstream economist. Why does he go there?  

It’s not entirely clear, even though King spends a whole chapter explaining why radical uncertainty, not quantifiable risk, is the essence of economic life. Yes, economic forecasts are often grossly wrong; yes, even smart people often have far too much confidence in their ability to assess risks. Every serious economist knows this, yet most don’t consider it sufficient reason to abandon conventional tools of analysis. At most, it’s a reason to use them in the subjunctive—to analyze economic issues as if people were making reasonable choices, while being aware that they might not. What makes King decide that this isn’t enough?

Part of the answer seems to be the sheer scale of the misjudgments leading up to the financial crisis, with nobody in the financial sector even imagining that housing prices could fall so far. What’s odd, though, is that some economists using quite conventional tools—notably Yale’s Robert Shiller, arguably the world’s leading expert on bubbles—warned well in advance that housing prices were unrealistic and would fall to historically normal levels, which was what did in fact happen.

Paul Krugman

On this issue the self-proclaimed Keynesian economist Paul Krugman is simply wrong, and former governor of the Bank of England, Mervyn King, is right.


Well, as we all know, Paul Krugman and some other more or less unorthodox mainstream economists keep on arguing that, although they have one or two critiques to come with, their mainstream economic models are still valid for analyzing modern economies.

Yours truly disagrees.

Those models — DSGE, IS-LM, AS-AD, or what have you — don’t adequately reflect the width and depth of Keynes’s insights on the workings of modern market economies.

As is well-known, IS-LM models are Krugman’s favourite ‘simple gadgets.’ But they are typically set in a current values numéraire framework that definitely downgrades the importance of expectations and uncertainty — and hence give too large a role for interests as ruling the roost when it comes to investments and liquidity preferences. In this regard they are actually as bad as all the modern microfounded Neo-Walrasian-New-Keynesian models where Keynesian genuine uncertainty and expectations aren’t really modelled. Especially the two-dimensionality of Keynesian uncertainty — both a question of probability and ‘confidence’ — has been impossible to incorporate into this framework, which basically presupposes people following the dictates of expected utility theory (high probability may mean nothing if the agent has low ‘confidence’ in it). Reducing uncertainty to risk 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, whether we like it or not, often we ‘simply do not know.’ As Keynes writes in A Treatise on Probability:

The kind of fundamental assumption about the character of material laws, on which scientists appear commonly to act, seems to me to be [that] the system of the material universe must consist of bodies … such that each of them exercises its own separate, independent, and invariable effect, a change of the total state being compounded of a number of separate changes each of which is solely due to a separate portion of the preceding state … Yet there might well be quite different laws for wholes of different degrees of complexity, and laws of connection between complexes which could not be stated in terms of laws connecting individual parts … If different wholes were subject to different laws qua wholes and not simply on account of and in proportion to the differences of their parts, knowledge of a part could not lead, it would seem, even to presumptive or probable knowledge as to its association with other parts … In my judgment, the practical usefulness of those modes of inference … on which the boasted knowledge of modern science depends, can only exist … if the universe of phenomena does in fact present those peculiar characteristics of atomism and limited variety which appears more and more clearly as the ultimate result to which material science is tending.

We cannot — from a relevant and realistic point of view — just presuppose that what has worked before, will continue to do so in the future. How strange then that mainstream macroeconomists — both of the fresh water and salt water ilk — as a rule do not even touch upon these aspects of scientific methodology that seem to be so fundamental and important for anyone trying to understand how we learn and orient ourselves in an uncertain world. An educated guess on why this is a fact would be that Keynes’s concepts are not possible to squeeze into a single calculable numerical ‘probability.’ In the quest for calculable risk and quantities, one puts a blind eye to uncertainty and qualities and looks the other way.

Why is this important? Because the kind of involuntary unemployment and low investment activity that intermittently characterizes modern market economies is basically impossible to understand without weighing in the kind of uncertainties and expectations that was at the forefront of Keynes’s analysis.

King understands that. Krugman doesn’t.

  1. July 11, 2016 at 4:52 am

    “Mervyn King may well have written the most important book to come out of the financial crisis. Agree or disagree, King’s visionary ideas deserve the attention of everyone from economics students to heads of state.” —Lawrence H. Summers

    In simple terms, Summers’ comments are hog wash. Any practicing sociologist or anthropologist knows that simple dichotomies like King and Krugman put forward are not the only possibilities. The world we know of shows lots of other possibilities. It’s my view this is the fundamental issue with economics and economists. They are tied to a certain cycle and parameter of debate. They could break free of this repetitious game, but they choose not to. Why? If being an economist was painful or paid poorly or was not afforded a place at important public policy events, economists would soon tire of the game and seek other employment or if they remained economists’ theories would change rapidly. In 1930 Einstein’s dismissal of the ether was under brutal attack from “mainstream” physicists not only because it offended their orderly sense of the history of science beginning with Aristotle, but also because Einstein was a Jew. You might have heard Germany in 1930 was not a safe place for Jews. I think something similar is happening with the blind and almost pathological adherence to and defense of dominant economic theories, models, and methods, even as mountains of evidence pile up that these are just as useless and misconceived notions of the world around us as the ether. And frankly I also think there is some level of ethnic and economic discrimination involved in these choices. One “old boys” club that is definitely alive and well is economists.

  2. July 11, 2016 at 3:10 pm

    What is dead certain in an uncertain world: economists’ abysmal incompetence
    Comment on Lars Syll on ‘Paul Krugman vs. Mervyn King on Keynes’

    Paul Krugman summarizes: “It’s not entirely clear … why radical uncertainty, not quantifiable risk, is the essence of economic life. Yes, economic forecasts are often grossly wrong; yes, even smart people often have far too much confidence in their ability to assess risks. Every serious economist knows this, yet most don’t consider it sufficient reason to abandon conventional tools of analysis.”

    This evasive waffling shows one thing: the representative economist has no idea of what economics is and of what science is. First of all, science does NOT ‘predict the future’ simply because, as a genuine scientist said, “The future is unpredictable.” (Feynman, 1992)

    What is called prediction in science is categorically different from the commonsensical meaning of ‘predicting the future’. The sole criterion of science is true/false and not predicting the next crash or any other extraordinary event. This is the occupation of prophets, fear mongers, astrologers, gold bugs and other freaks/swindlers. In marked contrast, science is about invariants or ‘eternal’ laws.

    So, scientists do NOT predict when the next apple will fall from the tree. What they indeed predict is position and velocity at any point in time once the apple has started to fall. The commonsenser’s view of reality is entirely DIFFERENT from the scientist’s view. The commonsenser’s view is practical, trivial, and false but utterly convincing for other commonsensers. This is why false world views/theories that have no immediate grave negative practical consequences for commonsensers can survive for an indefinite time.

    Each falling apple is an unique historical event. There are arbitrary many causes for an apple to fall: a hailstorm, playing children, an exploding meteorite, material fatigue, an earthquake, and so on. In almost all cases the singular event is uncertain and unpredictable. That is so OBVIOUS that no physicist ever lost much words about the historicity and uncertainty of falling apples.

    Accordingly, when the apple fell on Newton’s head he did NOT discover uncertainty but the common principle that underlies the motion of the apple and the moon, i.e. the Law of Gravity.

    Science is NOT AT ALL interested in singular historical events as such but in the underlying invariants or ‘eternal’ laws. Uncertainty refers to historical events, certainty refers to laws. The uncertainty of when and why an apple falls is perfectly reconcilable with the certainty of the Law of Falling Bodies.

    Because of this, Keynes’s famous dictum ‘We simply do not know’ is NOT a great revelation for any scientist but a proof that Keynes had NO idea of what science is all about. This, of course, holds for all After-Keynesians including Mervyn King and Lars Syll.

    The real problem with economics is not commonsensical prediction but that it is NOT a science yet pretends to be one. It is of utmost importance to clearly distinguish between political and theoretical economics. The main differences are: (i) The goal of political economics is to successfully push an agenda, the goal of theoretical economics is to successfully explain how the actual economy works. (ii) In political economics anything goes; in theoretical economics scientific standards are observed.

    Theoretical economics has to be judged according to the criteria true/false and NOTHING else. The history of political economics from Adam Smith to Keynes and beyond can be summarized as utter scientific failure. This includes Krugman but also the whole bunch of heterodox political economists.

    Krugman’s manifest scientific incompetence is condensed in his methodological tenet: “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point.” This means in more detail that he subscribes to this set of foundational propositions, a.k.a. axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub 1985)

    Methodologically, these premises are forever unacceptable but economists swallowed them hook, line and sinker from Jevons/Walras/Menger onward. The failure of methodological individualism and all other psycho/socio approaches can be stated as an impossibility theorem: NO way leads from the explanation of human nature/behavior/action to the explanation of how the economic system works.

    There is NO such thing as a behavioral axiom because there is no such thing as a certain, true, and primary (Aristotle) behavioral proposition. The simple fact of the matter is that behavior is not only influenced by uncertainty but is itself the source of uncertainty: “we might say that the human factor is the ultimately uncertain and wayward element in social life and in all social institutions.” (Popper, 1960)

    Because of this, it is methodological idiocy to take behavioral assumptions into the set of axioms. HC1 to HC5 is inadmissible. All models based on this set are worthless.

    But things become even worse. Krugman is also a sorta-kinda Keynesian. Unfortunately, Keynesianism too is based on false axioms. Keynes defined the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income – consumption. Therefore saving = investment.”

    This two-liner is defective because Keynes never came to grips with profit: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson et al., 2010)

    Let this sink in, Keynes had NO idea of the fundamental concepts of economics, viz. profit and income. Because profit is ill-defined the whole theoretical superstructure of macroeconomics is false, in particular ALL I=S/IS-LM models including, of course, Krugman’s.*

    Krugman has not realized during a long career that (i) the neoclassical axioms are false, and (ii), that Keynes’s axioms are false, and (iii), that the two axiom sets are formally incompatible ― no ― he senselessly cobbles all this garbage together and derives his policy advice from it. Needless to say that all this gross logical inconsistencies sail smoothly through all peer-reviews into quality journals and textbooks.

    Krugman is provably false, Keynes is provably false, Orthodoxy is provably false, Heterodoxy is provably false, and last but not least the profit theory is false since Adam Smith. After more than 200 years of poor performance there is no hope at all that economists will ever say anything worthwhile about uncertainty. Methodologically retarded economists let the world know ‘We simply do not know’ and this, indeed, is an unintended true summary of current economics. One thing, at least, is certain: economics is a failed science.

    Egmont Kakarot-Handtke

    * See the working paper ‘Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It’

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