Paul Krugman has responded to Tom's article and here is his reply. Let me just add my two cents. Krugman says that:
New Keynesians assert — as Keynes did, although I don’t think it matters for this debate what he said — that both liquidity preference and loanable funds are true. There are conditions under which one or the other is the main one to focus on — at full employment, loanable funds are crucial, in a liquidity trap, liquidity preference.Oh Lord. Paul can you send us the quote were Keynes says that Loanable Funds is correct? And again this is NOT about irrelevant exegesis. If you do have that Investment and Savings are equilibrated by a natural rate of interest, then that means that you must, with interest rate flexibility, reach a point at which investment would equate the full employment level of savings. Krugman and other New Keynesians argue then for a version of what they call a Liquidity Trap (actually a zero lower bound problem), in which the monetary rate of interest (of the Liquidity Preference Theory) is not capable of equating the natural rate (of the Loanable Theory).
Note that here Keynes has a problem. Although Keynes clearly rejected the concept of a natural rate of interest (Keynes, 1936, pp. 242-4), and said very clearly that savings are equated to investment by changes in the level of activity (Effective Demand), his acceptance of the notion of the marginal efficiency of capital implies that there is a sufficiently low interest rate that would be associated with an investment that would produce the full employment level of savings, very much like Krugman. Excluding imperfectionist arguments related to the downward rigidity of the interest rate, or the possibility that a negative interest rate would be required to increase investment to its full employment savings level, it would seem that the acceptance of the marginal efficiency of capital is in contradiction with the notion of a “highly conventional” rate of interest (ibid., p. 203).*
So as noted here you do need to abandon the notion of a natural rate of interest and the marginalist theory of distribution (besides the evidence is that investment does not react to cost of capital, but it does to expected sales, that is expected demand). Here Krugman's comments are disingenous at best. He says:
I think, is a fairly desperate attempt to claim that the Great Recession and its aftermath somehow prove that Joan Robinson and Nicholas Kaldor were right in the Cambridge controversies of the 1960s.As I noted it is logically required to get rid of the idea of the natural rate, and there is no need to argue that in the 1960s capital debates Robinson and Kaldor (Sraffa really, dude) were right, since Samuelson (1966; subscription required) already did.
* The capital debates show that there is no correspondence between the intensity of the use of capital and its remuneration. No natural rate of interest that would lead to more intensive use (full utilization) of capital. And that's what Samuelson admited. To understand the capital debates go here, and to get its relation to Keynes' theory go here.
PS: Krugman also gets a bit testy suggesting that: "as for wage and price inflexibility as the cause of unemployment — grrr. I’ve written again and again on this subject, pointing out that in a liquidity trap price flexibility probably makes things worse, not better." Yes, grr. Dude, first it's not a liquidity trap that you're talking about, but a lower limit to nominal rates of interest. And debt-deflation and negative effects of income distribution discussed in chapter 19 of the GT occur even if you are not at the lower bound (or the real liquidity trap). And Keynes said that the liquidity trap was irrelevant to explain the Great Depression, it's worth noticing, since really it seems you never read the GT (even though you wrote a preface to one edition). So price flexibility in a world with extensive debt contracts and where income distribution affects spending is always kind of bad. That's Keynes' message. Tom is correct on that one too.