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Not so Keen on Krugman

I have been critical of the theoretical positions held by Krugman for a while now, even if he and DeLong, and even Summers, have been useful for policy reasons. Now a lengthy debate between Krugman and Steve Keen, a very pragmatic and reasonable post-Keynesian (and I guess part of MMT tradition) that understands endogenous money has developed [a good summary with all the links here].

First, and foremost endogenous money implies that the rate of interest is exogenous and determined by monetary authorities. That per se is not necessarily in contradiction with a neoclassical/marginalist view according to which the rate of interest equilibrates investment to full employments savings, as Krugman clearly believes. Wicksell [see here] certainly did not think so either.

For Wicksell in a giro system, in which all transactions were recorded as debit/credit relations, credit could expand indefinitely, but in the real world, bank reserves would vanish and lending would eventually collapse if the bank rate remained below the natural rate for a long period. That is fundamentally the reason why Krugman does not understand the notion that banks can create reserves, and that loans cause deposits. In other words, what regulates the bank rate is, ultimately the natural rate of interest.

Further, the natural rate of interest is NOT a banking phenomenon in marginalist analysis, and, as a result, cannot be exogenous to the system. It results from the marginal productivity of capital and the intertemporal decisions of consumers. Krugman is in fact very clear that he supports the loanable funds theory of interest.

Hence, Peter Cooper is correct to point out that ultimately the debate with Keen must revolve around a notion of a long term normal rate of interest that is institutionally determined by the central bank independent of the marginalist notion of the natural rate. That can only be obtained with the proper critique of the neoclassical notion of capital.


  1. What do you make of Keen's efforts to formalize the PK position?

    Also, in a pure credit money system without a central bank, how would the interest rate be determined? Purely by convention. (That is not a rhetorical question -- pure convention might be right.)

  2. Not sure I follow all his arguments to tell you the truth. Too many posts to follow, and some fall outside the issue of endogenous money. My concern is that many post-Keynesians do not understand the importance of the capital debates for a proper debunking of mainstream economics (not saying that is the case with Keen, by the way). The whole discussion on DSGE models is a bit of a distraction. DSGE models are just one version, an intertemporal one, of the marginalist model. Problems are common to all types of marginalist analysis when it comes to the notion of capital.

    Interest rates before the appearance of central banks, first one being the Sveriges Riksbank in 1668, were fundamentally determined exogenously by lenders. Homer and Sylla's History of Interest Rates has a lot of interesting data. In other words, institutional factors were always relevant, and the idea that interest rates are regulated by the productivity of capital and the preferences of consumers is hard too prove. By the way, it is a neoclassical proposition so THEY have the burden of proof.

    1. My instincts would be to say that interest rates, like any other price, reflect power relations and bargaining positions - not just consumer desires and the actual productivity of capital.

  3. Bravo! At last someone puts things into perspective

    1. Dirk Bezemer at INET is another Keen-type:

  4. And, as always there is the specification of whether the institutional structure includes a fixed or floating exchange rate policy.

  5. Thanks for the link Barry. Dirk your instincts would be correct. Warren in either scenario (fix or flex) Krugman would still think that the interest rate is regulated by the productivity of capital and the intertemporal decisions of consumers. What would change is the adjustment of the balance of payments.


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