Skip to main content

Krugman is right: "Macroeconomics is all wrong"

Krugman seems to be surprised to find out that there is no direct relation between fiscal deficits and higher interest rates, and that for the most part the relation seems to be upside down. He gets everything right, including the bold claim that mainstream macro [the only one he acknowledges, even though he knows better] is all wrong. And seriously why is he surprised that crowding out does not hold water?!

It's not new that the evidence for crowding out is weak, at best. For the most part the evidence on the positive effects of fiscal policy on the level of activity has been well established (see here Eisner, and here a review by Arestis and Sawyer). Note that essentially the surprise comes from the fact that Krugman does accept the natural rate (for more on this go here).

In that case, conventional wisdom says that it must be true that if the level of output is above its natural level (or the actual unemployment rate is below the natural, or, finally, the rate of interest is below the natural) then prices would increase and eventually credit would contract (as bank reserves decrease, or as the real balances fall) leading to a higher rate of interest. The monetary rate of interest would approach the natural. So, if the evidence for that is not there, shouldn't Krugman, like Keynes [when shown that real wages were pro-cyclical he abandoned the notion of a marginal decreasing schedule demand for labor] revise his views?

Further, if one accepts the notion of endogenous money (or MMT) then it cannot be assumed that successful fiscal adjustment (lower deficits) will lead to lower interest rates, since those rates are managed by monetary authorities. Yes the Fed normally manages the short-term rates, but the long-term ones usually follow (only before recessions, and for a short while, yield curves becomes downward sloping). And if necessary the Fed can directly intervene on long rates, as it did during the Great Depression and WW-II, and now with QE.

At any rate, some more evidence that supports the notion that fiscal expansion does not affect interest rates according to what the mainstream would suggest. Below the relation of interest rates and, instead of using fiscal deficits, public debt (source here).
As you can see there does not seem to be a relation between higher public debt and higher rates of interest. In fact, most of the time the relation goes in the wrong direction. Yes, Krugman is right, macro is all wrong, and he should abandon his model, which would be the only coherent thing to do.


  1. It's Krugman-Magoo everybody!


Post a Comment

Popular posts from this blog

A few brief comments on Brexit and the postmortem of the European Union

Another end of the world is possible
There will be a lot of postmortems for the European Union (EU) after Brexit. Many will suggest that this was a victory against the neoliberal policies of the European Union. See, for example, the first three paragraphs of Paul Mason's column here. And it is true, large contingents of working class people, that have suffered with 'free-market' economics, voted for leaving the union. The union, rightly or wrongly, has been seen as undemocratic and responsible for the economics woes of Europe.

The problem is that while it is true that the EU leaders have been part of the problem and have pursued the neoliberal policies within the framework of the union, sometimes with treaties like the Fiscal Compact, it is far from clear that Brexit and the possible demise of the union, if the fever spreads to France, Germany and other countries with their populations demanding their own referenda, will lead to the abandonment of neoliberal policies. Aust…

A brief note on Venezuela and the turn to the right in Latin America

So besides the coup in Brazil (which was all but confirmed by the last revelations, if you had any doubts), and the electoral victory of Macri in Argentina, the crisis in Venezuela is reaching a critical level, and it would not be surprising if the Maduro administration is recalled, even though right now the referendum is not scheduled yet.

The economy in Venezuela has collapsed (GDP has fallen by about 14% or so in the last two years), inflation has accelerated (to three digit levels; 450% or so according to the IMF), there are shortages of essential goods, recurrent energy blackouts, and all of these aggravated by persistent violence. Contrary to what the press suggests, these events are not new or specific to left of center governments. Similar events occurred in the late 1980s, in the infamous Caracazo, when the fall in oil prices caused an external crisis, inflation, and food shortages, which eventually, after the announcement of a neoliberal economic package that included the i…

What is the 'Classical Dichotomy'?