Wednesday, June 27, 2012

Has Econ 101 done just fine?

Krugman tells us that:
"huge government deficits could fail to raise interest rates in a depressed economy ... is what Econ 101 said – and it has been completely right. Basic IS-LM macro also said that under these conditions printing lots of money would not be inflationary, and that cutting government spending sharply would cause the economy to shrink. All of this has come true. So Econ 101 has done just fine ..."
Note, however, that Krugman basically believes that this is the case because the economy is in a liquidity trap, and the natural rate of interest for him is negative. That is, the rate of interest that would stimulate enough investment to bring about full employment savings is below zero. As I have argued here there are several empirical and logical reasons why one should doubt that kind of imperfectionist argument.

So, yes the Old Keynesians policy prescriptions do work, and have done quite well, even if their theories do fail miserably, as much as any other neoclassical approach that presumes that markets work by the magic of supply and demand producing optimal outcomes.

And that is also why what we need is not more monetary stimulus, or any hocus pocus to convince investors that inflation is going to be higher. We need more demand. And as Paul Davidson said in his reply to Tyler Cowen, only the government can do this now:
"if the government were to let contracts for, say, $1 trillion to private enterprise to rebuild our failing highways, bridges, and municipal water and sewage systems, and provide resources for our shrinking public and higher education systems, this would quickly restore companies’ confidence in the profit opportunities that are available if they hire workers and buy materials from other United States companies. When these newly hired workers go out and spend their wages, the confidence of United States retailers would immediately surge as these additional customers break down the doors to get at the merchandise on the shelves.  Nothing will build the confidence and trust of business and workers quicker than the continuous ringing of cash registers."
So Paul, that has complained about Econ 101 for a long time, is quite correct. We need spending and not the inflation expectations fairy.

PS: On my views on the ISLM go here.


  1. While I agree with your take here, NK, I think there is more to it.

    I mean, Coyle, Portes and Krugman (Krugman to a lesser degree, to be fair) agree on the notion that microeconomics is essentially fine.

    But it ain't. It totally sucks.

    Why does it matter? It matters because the models mainstreamers use require microfoundations: macro behaviour is only seen as explained if it's based on micro models.

    Have a look at Arnsperger, Christian; Varoufakis, Y. (2006). "What Is Neoclassical Economics?". post-autistic economics review. Issue no. 38.

    But this is not the end of the story, either.

    Let's forget the maths for a moment. We are entering the realm of Austrian economics (which is not considered mainstream).

    But for Austrians, there is only one economics: that of utility maximising individuals plus gold standard monetarism. They even say it explicitly: there is no such thing as Macroeconomics.

    Both sides have in common the notion that macro phenomena are at best secondary. What Austrians do is to take this to the extreme.

  2. Hi Magpie, thanks for the comments. A few brief replies. I know Yannis paper, but as much as I agree on his views on neoclassical economics and its limitations, it's important to emphasize that marginalism is based on the idea that equilibrium (used to be long term) prices are determined by supply and demand, and that relative prices respond to scarcity through the principle of substitution. As such neoclassical economics is a logical failure. Also, Austrian economics does share the neoclassical view of the determination of prices (which by the way implies full utilization of resources) and is very much part of the mainstream, even if for sociological reasons they are marginalized (no pun intended) within the mainstream.


Summers on secular stagnation, the ISLM, and the liquidity trap

Two short clips from Lawrence Summers talk at the ASSA meeting in San Diego. So he first says that secular stagnation is more plausible now...