What’s wrong with Krugman’s economics?
from Lars Syll
Krugman writes: “So how do you do useful economics? In general, what we really do is combine maximization-and-equilibrium as a first cut with a variety of ad hoc modifications reflecting what seem to be empirical regularities about how both individual behavior and markets depart from this idealized case.”
But if you ask the New Classical economists, they’ll say, this is exactly what we do—combine maximizing-and-equilibrium with empirical regularities. And they’d go on to say it’s because Krugman’s Keynesian models don’t do this or don’t do enough of it, they are not “useful” for prediction or explanation …
The trouble is that the macroeconomic evidence can’t tell us when and where maximization-and-equilibrium goes wrong, and there seems no immediate prospect for improving the assumptions of perfect rationality and perfect markets from behavioral economics, neuroeconomics, experimental economics, evolutionary economics, game theory, etc.
But these concessions are all the New Classical economists need to defend themselves against Krugman. After all, he seems to admit there is no alternative to maximization and equilibrium …
One thing that’s missing from Krugman’s treatment of economics is the explicit recognition of what Keynes and before him Frank Knight, emphasized: the persistent presence of enormous uncertainty in the economy …
As Rosenberg notes, Krugman works with a very simple modelling dichotomy — either models are complex or they are simple. For years now, self-proclaimed “proud neoclassicist” Paul Krugman has in endless harpings on the same old IS-LM string told us about the splendour of the Hicksian invention — so, of course, to Krugman simpler models are always preferred.
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.
But if the 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,’ those mathematical models do only hold under ceteris paribus conditions and are consequently of limited value to our understandings, explanations and predictions of real economic systems.
For years now, Krugman has criticized mainstream economics for using too much (bad) mathematics and axiomatics in their model-building endeavours. But when it comes to defending his own position on various issues he usually himself ultimately falls back on the same kind of models. In his End This Depression Now — just to take one example — Paul Krugman maintains that although he doesn’t buy “the assumptions about rationality and markets that are embodied in many modern theoretical models, my own included,” he still find them useful “as a way of thinking through some issues carefully.”
When it comes to methodology and assumptions, Krugman obviously has a lot in common with the kind of model-building he otherwise criticizes.
If macroeconomic models — no matter of what ilk — make assumptions, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypotheses of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable.
So let me — respectfully — summarize: A gadget is just a gadget — and brilliantly silly simple models — IS-LM included — do not help us working with the fundamental issues of modern economies any more than brilliantly silly complicated models — calibrated DSGE and RBC models included. And as Rosenberg rightly notices:
When he accepts maximizing and equilibrium as the (only?) way useful economics is done Krugman makes a concession so great it threatens to undercut the rest of his arguments against New Classical economics.
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Real-World Economics Review Blog 
This is a refrain of Syll’s post of January 18, 2019, which It tells more detailed background of Rosenberg’s post of five years ago:
Alexander Rosenberg writes as his concluding words:
“For he [Krugman] recognizes that economics is at best, and at its best, a historical science, one which offers lessons, but not predictions.”
All right. Let us abandon predictions. I want to ask Lars Syll: How can we build an economics that can give good lessons? No idea? If so, your methodology (or philosophy of economics) is a tool as bad as mathematical models (with maximizing and equilibrium) are. This is the reason why Krugman could boast:
“I’ve seen quite a lot of what economics without math and models looks like — and it’s not good.”
Emphasizing uncertainty and reflexivity lead us nowhere unless we try sincerely to construct a new economics. Syll is missing this last point. Keynes and Knight are not enough. We have been reading their works more than 80 years and yet Syll talks as if we have no progress after them (except Soros?).
Syll cites a paragraph from Rosenberg:
“When he accepts maximizing and equilibrium as the (only?) way useful economics is done Krugman makes a concession so great it threatens to undercut the rest of his arguments against New Classical economics.”
Lars Syll, if you agree with Rosenberg, please show us a hint for an economics without maximizing and equilibrium. This is crucial to a constructive methodology.
Krugman does raise an interesting point in that simple models of the neoclassical variety that he is used to probably actually are better than complex models, because the complex models bring in extra complicating factors with very high error bars that just make the situation worse.
By that logic, maybe the perfect neoclassical model is … no model at all!
Historically, the actual operations of paradigm changes are always simple and yet profound. Complexity is fine for normal and necessary research, but when a body of knowledge has accumulated long standing problems and is bedeviled by conflict that is a key signature of the need for paradigm change. BZZZZZT! Okay, everyone chatter on.
May I add to the refrain of Yoshinori Shoizawa. Why does Lars Syll continue to beat a dead horse? The quantity calculus proves that there is NO valid neoclassical analysis. Lars would far better be dealing with analysis which might be valid theoretically. There is only a handful of analyses which could be valid. Really useful results are likely to be obtained. As Yoshinori Shoizawa has frequently reminded us, it takes a better theory to defeat an incorrect one.
But Frank, why do YOU continue to beat a dead horse? Economics isn’t about quantitative relations capable of being analysed, it is a process whereof one needs to know the intended outcome, the way there, and ways of correcting unpredictable errors as they arise (which one can’t do by prior analysis).
Actually one can.
Or in general, epistemologically, “… imaginations do not vanish at the presence of the truth, in virtue of its being true, but because other imaginations, stronger than the first, supervene and exclude the present existence of that which we imagined.” Spinoza. Ethics 3, Proposition 1 Note.
Correct description of actual analysis, good science and cognition itself. And is the mental process of all paradigm changes, of which all are so obviously progressive and hence increased survival phenomena….that the choice is easy if not inevitable.
Krugman’s wrong turn is more fundamental: He ignores banks and banking by arguing them away as mere intermediaries. You’d think that after witnessing the near collapse of the world economy due to a banking crisis, that neoclassical economists might revisit that, banks don’t matter, assumption. Nope.
What we get is a tweak: Ok, maybe there are impatient and patient agents who are intermediated by banks.
No Paul. Banks don’t just intermediate. Banks also create new credit money by lending. Banks significantly determine the money supply in this way. Increases in money supply affect important macro variables including unemployment. Any economist who still doesn’t understand this should be embarrassed.
Correct. And cutting edge heterodox economists and reformers ignore or are unconscious of the monopoly paradigm of Debt Only held by the banks which is the even deeper problem.
Free every individual and every enterprise from that tyranny with the new paradigm of Abundantly Direct and Reciprocal Monetary Gifting at the point of retail sale with a 50% Discount/Rebate monetary policy. It’s too simple for the intellectual vanities of the erudite to countenance, too beneficial and freeing for all economic agents not to garner their support and too exposing of the naked domination of the banks to deny.
Evolutionary economics offers an alternative to the maximization approach, using realistic premises about uncertainty and the nature of people’s reactions, implying some sort of bounded rationality. To gain insights it is still necessary to build simple models whose application to any real situation will be uncertain and which may work only with ad hoc fixes. No real world engineer relies simply on Newton’s equations of motion. Proceeding directly to complex models results in “black boxes” whose workings are no more understood than those of reality itself. The problem with orthodox economics is not the use of maths but the insistence that models be simple enough to have an analytic solution. This leads to a massive amount of misplaced ingenuity in the search for elegant theorems. Starting from more realistic premises, and accepting that model properties will have to be explored by simulation would lead to fewer fatuities.
Correct. “It’s the monetary and financial paradigm, stupid.”
Gerald, do you have some sources you think are worth a read in evolutionary economics? Have your read Microfoundations of Evolutionary Economics (Shiozawa et. al. 2019)? I have. I am also now reading at this time Modern Evolutionary Economics: An Overview (Nelson et. al. 2018) and the citations and literature from both sources.
Simple models must exclude some facts while emphasizing others. The question then becomes are their excluded facts that are relevant and do the included facts truly represent the reality under investigation. Evolutionary Economics is no more immune from the instruction of error due to oversimplifying assumptions than is mainstream economics. Is it better and does it rest upon more realistic assumptions? Well, the devil is in the details and there is certainly not a single version and/or interpretation of Evolutionary Economics. I can document right now a case where someone purporting to engage in Evolutionary Economics is insisting upon a model being so simple so as to make the so-called “theory” mathematically tractable that leads to a “massive amount of misplaced ingenuity in the search for elegant theorems,” and grossly misrepresents and distorts the current state of evolutionary theory being utterly autistic to recent discoveries that have greatly modified our view of evolutionary theory. I won’t get into the details on RWER because, frankly, I consider it a waste of time, but will on another forum document in full my findings. That is not to say that I don’t see something good and useful in Evolutionary Economics, just that it is not immune form the same errors you castigate mainstream economics being guilty of, and rightly so I might add.
their –> there, instruction –> introduction, please correct as needed.
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A friend summed the issue up best:
What’s wrong with Krugman’s economics? Just about everything. This failure emerges from Krugman’s starting point – accepting that maximization and equilibrium are the correct foundations of economics. In my view this understanding is obviously fallacious. Clearly, though economists can offer definitions of maximization and equilibrium, I defy any to show actions and events that are maximized (optimal) or in a state of equilibrium. Any economist can, of course look at an event or action announce it is optimal or in a state of equilibrium. But where’s the proof that the announcement is correct?
Lars states, “One thing that’s missing from Krugman’s treatment of economics is the explicit recognition of what Keynes and before him Frank Knight, emphasized: the persistent presence of enormous uncertainty in the economy.” Yes, the economy is uncertain, but only indirectly. The source of the economy’s uncertainty is people. People build what they consider to be the best economic arrangements in the face of ongoing and comprehensive uncertainty. This problem cannot be remedied. People focus on first understanding the uncertainty facing them and then inventing ways to reduce or mitigate the effects of the uncertainty they believe they recognize and understand.
Lars addresses at least part of my concerns here, “If macroeconomic models — no matter of what ilk — make assumptions, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypotheses of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable.” I believe Lars takes too much for granted in this statement. The only assumptions that matter are those of the people who create and operate an economy. And this is not economists. Economists may translate these assumptions into their models or research hypotheses, but in that translation, economists must remain in the background – merely and always supporting players in all economic arrangements. Economists should have no – or minimal – role in creating, judging, or explaining an economy. Their only role is to reveal and describe what others have invented and perform. However, I press on you that generally economists do not accept my conclusion. Which is one of the main factors in the current failure of economics as a social science.