The preliminary paper posted by Krugman for the Cambridge conference on the 75th anniversary of the publication of the General Theory (GT) is an interesting piece. Not fundamentally for what it says, which is nothing new if you read his blog. Something along the lines liquidity traps imply that you need fiscal policy, and we are at one right now. But it is revealing piece about what mainstream Keynesians understand about the evolution of macroeconomics, and how much knowledge has been lost with the rise to dominance of the neoclassical/marginalist approach.
First, it is important to note that by the time of the New Deal and the Keynesian Revolution American academia was dominated by institutionalism. Mitchell was the head of the National Bureau of Economic Research, John Maurice Clark at Columbia was one of the leading figures of the profession and was the president of the American Economic Association in 1935, and so on. Yes, neoclassical economics dominated in England, with Marshallian traditions in Cambridge, and there were several neoclassical economists in the US, like Irving Fisher, but in America they were still not dominant.
Also, Keynesians or proto-Keynesians like Marriner Eccles and Lauchlin Currie, and institutionalists like Adolph Berle and Rexford Tugwell, were instrumental in bringing a whole generation of economists that where like Clark a mix of institutionalists with Keynesians into the New Deal administration. John Kenneth Galbraith would be the most prominent example. It is important to note that none of these economists thought that Keynes’ ideas were related to wage or interest rate rigidities, or that the problem with the Depression was that wages were too high.
These ideas only became dominant after Hicks and Modigliani, and were popularized in Samuelson’s neoclassical synthesis. In fact, it was the neoclassical synthesis, and not General Equilibrium, that made neoclassical economics the dominant approach in the US. The new economists were trained basically in Marshallian micro (partial equilibrium consumer and production theory) and Keynesian macro (Keynesian cross and ISLM). Old institutionalism started to vanish. [And by the way that is fundamentally, with the addition of natural rate ideas, and a Phillips curve in the macro part, what is essentially taught to undergrads; General Equilibrium is a graduate thing].
Krugman correctly criticizes Barro for the interpretation that the problem for Keynes was high wages, and that monetary policy was the solution. But he says: “if that’s all that it was about, the General Theory would have been no big deal.” Note that neither is a correct interpretation of the GT. Krugman having been trained as an old Keynesian, in the neoclassical synthesis (even if it is very likely that Rational Expectations were already important in his graduate training), is okay with the notion that Keynes believed in some sort of rigidity. For him, contrary to Barro, the main rigidity is not in the labor market, but in the capital market. Namely: a rate of interest that is too low and cannot be reduced further.
I should say here that it is a bit amazing that the discussion does not even include a footnote on Keynes and Pigou effects, and how wealth effects according to the neoclassical authors reestablished the notion of full employment equilibrium, and Keynes’ own views in chapter 19, and Kalecki’s famous reply to Pigou. Not even a footnote on Patinkin’s work on the topic. And that in a nutshell is the problem with Krugman’s paper. He gets stuck with two interpretations the uncertainty version of chapters 12 and 17, and the neoclassical synthesis of chapter 18, but he never bothers with chapter 19, the first in the whole book in which flexible wages and prices are allowed, and still no full employment is reached.
That’s why is weird that he thinks that Keynes didn’t say anything about debt. In chapter 19 Keynes says:
“the depressing influence on entrepreneurs of their greater burden of debt may partly offset any cheerful reactions from the reduction of wages. Indeed if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, — with severely adverse effects on investment.”Debt deflation is integral to Keynes' analysis. And that’s why Krugman has to reinvent what was already known (redundant originality one could call it), but put it into a New Keynesian model (his paper with Eggertsson cited in p. 18), which further complicates the issues, since New Keynesian models assume a natural rate and a tendency to it, that is not reached because of some sort of rigidity. Krugman never learnt the ancients (and I’m not even talking about the surplus approach, but just the old Keynesian tradition).
Don’t get me wrong, as I said about the DeLong in another post, Krugman has been essential to debunk a lot of crazy ideas, and support adequate policies. But it is a problem when the reasonable people in the mainstream still use a model that is basically self-adjusting to full employment.
I would not venture a full explanation of why this happened. But my hunch is that the defeat in the capital debates of the 1960s, admitted by Paul Samuelson, which among other things showed the impossibility of having a natural rate of interest (the existence of a rate of interest low enough that would provide full utilization of capital, something that Keynes knew it was important, saying so in the GT, but was unable to obtain because of his insistence on the concept of a marginal efficiency of capital), the dominant approach turned to eclecticism. This meant that Arrow-Debreu General Equilibrium (a short run equilibrium solution) provided the totem for the idea that markets work and are efficient (freeing the radical market fundamentalists to unleash the Rational Expectations revolution, for which markets always clear), while more reasonable authors (still within the mainstream, like Krugman) developed several research agendas on the basis of finding imperfections.
While one might agree with several policy propositions by the more reasonable mainstream authors (we need fiscal stimulus and the debt ceiling is not a real problem being two of those), it is important not to forget that their theoretical stance is deeply flawed. For more on this see my paper on a forthcoming edited book on the 75th anniversary of the GT.