Home > Uncategorized > Oh dear, oh dear, Krugman gets it so wrong, so wrong

Oh dear, oh dear, Krugman gets it so wrong, so wrong

from Lars Syll

Economic-Model-1024x576Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the typical natural science, the material to which it is applied is, in too many respects, not homogeneous through time. The object of a model is to segregate the semi-permanent or relatively constant factors from those which are transitory or fluctuating so as to develop a logical way of thinking about the latter, and of understanding the time sequences to which they give rise in particular cases … Good economists are scarce because the gift for using “vigilant observation” to choose good models, although it does not require a highly specialised intellectual technique, appears to be a very rare one.

J. M. Keynes in letter to Roy Harrod (1938)

I came to think of this passage when I read “sort of  New Keynesian” economist Paul Krugman’s blog in the ongoing discussion on the state of macro. Krugman argues that even though he and other “sort of New Keynesian” macroeconomists use the same “equipment” as RBC-New-Classical-freshwater macroeconomists, he resents the allegation that they are sharing the same endeavour. Krugman writes

The real test came when the financial crisis struck, and pretty much to a man freshwater economists not only argued against fiscal stimulus — which is a defensible position — but insisted that there was no possible way to justify stimulus, that such ideas had been refuted and that “nobody” believed in them anymore  … I’m not saying that the [“New Keynesian”] NK approach is necessarily right; but it’s a serious intellectual effort, undertaken by people who thought they were part of an open professional dialogue. Oh, and there’s a lot of evidence for the price stickiness that is central to NK models; again, maybe it doesn’t mean what the theorists think, but surely that evidence ought to be part of any discussion.

Here we get a view that all macroeconomists more or less share the same basic mainstream theory and “techniques”, so when we discuss and argue it is only about which special assumptions we choose to make (sticky wages or not). But people like Hyman Minsky, Michal Kalecki, Sidney Weintraub, Johan Åkerman, Gunnar Myrdal, Paul Davidson, Axel Leijonhufvud — and yours truly — do not share any theory or models with Real Business Cycle theorists and  “sort of New Keynesians” like Greg Mankiw or Paul Krugman.

It’s nice to see that Krugman explicitly acknowledges what I have argued for many years now — “New Keynesian” macroeconomic models are at heart based on the modelling strategy of RBC and DSGE, using representative agents, rational expectations, equilibrium and all that. And yes, they do have some minor idiosyncracies like “menu costs,” “price rigidities” and “sticky wages.” But the differences are not really that fundamental. The basic model assumptions are the same.

The macroeconomic modelling strategy of people like Greg Mankiw and Paul Krugman has a lot to do with Robert Lucas and Thomas Sargent – and very little, or next to nothing, to do with John Maynard Keynes. “New Keynesian” macroeconomic models build on Real Business Cycle foundations,  regularly assuming representative actors, rational expectations, market clearing and equilibrium. But if we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. Macroeconomic theorists – regardless of being New Monetarist, New Classical or ”New Keynesian” – ought to do some ontological reflection. For those of us who have not forgotten the history of our discipline, and not bought the freshwater nursery tale of Lucas et consortesthat Keynes was not “serious thinking,” we can easily see that there exists a macroeconomic tradition inspired by Keynes — a tradition that has absolutely nothing to do with any New Synthesis or “New Keynesianism” to do. Its ultimate building-block is the perception of genuine uncertainty and that people often “simply do not know.” Real actors can’t know everything and their acts and decisions are not simply possible to sum or aggregate without the economist risking to succumb to “the fallacy of composition.”

Instead of basing macroeconomics on unreal and unwarranted generalizations of microeconomic behaviour and relations, it is far better to accept the ontological fact that the future to a large extent is uncertain, and rather conduct macroeconomics on this fact of reality.

Building models based on an “equipment” that assumes the equivalent of portraying people as being green and coming from Mars is not recommendable. There have to be better ways to optimize our time and scientific endeavours than spending hours and hours working through or constructing unreal and irrelevant “New Keynesian” RBC and DSGE macroeconomic models.

  1. May 17, 2018 at 12:25 am

    Thanks, Democrats for holding together! The Internet is a public enterprise like education and must not become merely a profit center! When the state trusts citizens, citizens trust the state, said Justin Trudeau, Canadian Prime Minister The security state is a distortion of the constitutional state and is marked by the generalization of fear, the depolitization of citizens, and demogogic claims of supreme leaders. Trump created his own reality when he spoke of Iran as a threat to the world and described the 100 missiles as “beautiful missiles.” The Horror clown could bring the world to the edge of the abyss and doesn’t care about the Syrian people, international law, the Children’s Health Insurance or the rights and dignity of the poor. There should be robust discussions of pluralist economics and reduced working hours, post-growth, post-fossil,, and post-patriarchal economies. Progressive taxation, closing tax havens and sharing the benefits of productivity, dignitalization and information technology could create new revenues and new possibilities. Community centers (like the 26 in Vancouver B.C.) have multiplier and cushioning effects!

  2. tyillc
    May 17, 2018 at 12:48 am

    I agree with your observation “that people often ‘simply do not know.'” In the financial markets, this is frequently intentional. Wall Street knows it makes a lot more money per transaction selling high margin opaque securities than low margin transparent securities.

    Your observation in fact is the key to understanding financial crises and how to respond to them. Please see http://instituteforfinancialtransparency.com/2018/05/14/yale-professor-basically-you-dont-understand-the-crisis/.

  3. May 17, 2018 at 5:56 pm

    The explanation of the causes of the Great Financial Crisis is best explained by Carl Levin and Tom Coburn in their 650-page report ( https://www.nytimes.com/2011/04/14/business/14crisis.html ). Of special interest is their description of Goldman Sachs’ fraud and corruption.

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