Krugman on Economics

This weekend’s New York Times Magazine has the 7,000-word article about the state of macroeconomics that Paul Krugman has been hinting at for some time now. It’s a well-written, non-technical overview of the landscape and the position Krugman has been presenting on his blog, which for now I’ll just summarize for those who may not have the time to set aside just now.

Like many, Krugman faults the discipline for its infatuation with mathematical elegance:

“[T]he central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

“Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.”

His history of post-Depression macroeconomics goes through roughly three phases: Keynesianism; Milton Friedman and monetarism, which, he argues, was relatively moderate compared to the positions of some of his self-styled followers; and the period from the 1980s until 2007, which he describes as the conflict between the Saltwater (coastal, pragmatic, New Keynesian) economists and the Freshwater (inland, efficient markets, neo-classicist) economists. According to Krugman, these two schools had differences on a theoretical level, but those differences were papered over by practical agreement on government policy: namely, monetary policy was superior to fiscal policy at managing the economy.

This false peace was exploded during the financial crisis by the zero bound, something Krugman has invoked often. The agreed-upon way to stimulate the economy in a recession is to lower interest rates. When interest rates hit zero, they can’t be lowered anymore (rather than lend you money and expect to get less back in the future, I should put it under my mattress), and then the policy question is what if anything else should be done. This provoked the fallout between people who favored the stimulus as a way of propping up demand and those who thought that for theoretical reasons a stimulus could not possibly have any positive impact.

In addition, Krugman argues, the two sides shared the same desire to represent the world using elegant mathematical models: “But the New Keynesian models that have come to dominate teaching and research assume that people are perfectly rational and financial markets are perfectly efficient.” Instead, we need to look to behavioral finance and behavioral economics, which has just gone from a hot fad in economics to the bandwagon to end all bandwagons. Krugman mentions Larry Summers’s “There Are IDIOTS” paper, which must now be the world’s most-cited-although-unpublished article, Robert Shiller, Andrei Schleifer, and Robert Vishny in particular.

This is from Krugman’s conclusion:

“So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.”

In other words, the world is messy and people are irrational, and as a result the world breaks down occasionally.

The field of economics has been going on a massive land-grab over the past few decades. It’s ironic that the area it seems to understand the least well is how an overall economy functions.

By James Kwak

101 thoughts on “Krugman on Economics

  1. I read Krugman’s piece last night. I have always admired his frank and honest view, which is typical of views often expressed in these blogs. But last night I get a feeling of impending bankruptcy hovering over the economics profession. As a person who has quietly studied double-entry bookkeeping history as it evolved over the past 650 years, including its abandonment by software developers about 30 years ago, it seems clear that the economist is going bankrupt because of a loss of meaningful numbers that are his stock in trade.

    Garbage in garbage out never sounded a clearer call. Our culture needs to get back to basics.

    When one studies the culture one lives in for a few decades, as an extension of its commercial trading of good and services, the need for double-entry bookkeeping emerges as natural phenomena. Culture’s need to do bookkeeping is studied in How Writing Came About, by Denise Schmandt-Besserat. Language that drove primitive accounting, 8,000 years ago, she demonstrates, would 5,000 years later, drive the art of writing itself. Social Science as culture’s need to “keep the books” suggests that language itself is integral to the function of a civil society. The study of bookkeeping, as Schmandt-Besserat’s argument implies, may be the ideal language for studying the optimization of our economic life.

  2. …gave economists a chance to show off their mathematical prowess.

    …which people who understand mathematics would call mathematical chicanery.

  3. In other words, the world is messy and people are irrational, and as a result the world breaks down occasionally.

    That’s not his point.

  4. Will make time to read the 7000 words sometime soon.

    However, in all honesty, as one who lives life far removed from math, I cannot understand how such financially literate people could create such a mess.

    I bought and sold a house during the bubble. It was clearly a bubble. What people were paying for real estate was simply unbelievable – and clearly unsustainable. To develop math models based on a steep and rising trajectory of housing prices is one of the stupidest things I’ve ever heard smart people talk about doing.

    Then let’s talk about the corruption of lending practices. I don’t know any math equation that can add up a ton of bad mortgages and come out without a large amount of bad debt. To make such terrible loans on the widely held belief that housing prices would continue to rise irrationally (thus the home would suffice as collateral in no-collateral loans) – well, clearly a terrible business error, in this brave new world of falling home prices.

    I’m really unclear how the Ivy-educated masses in the investment banks didn’t know that so many of the mortgages were bad, but I suppose we can assume they viewed their investment strategies from a point of woeful ignorance. Otherwise, why would they bundle up all those bad loans into those MBSs and sell them off to all those pension funds for teachers and the like? Those folks over on Wall Street get paid LOTS of money for their expertise – and one would assume they’d do the due diligence needed to fully understand what they were asking clients to invest in. But oh well, whoopsie!

    And let’s talk about the failure of the rating agencies. HOW can so many terribly insolvent tranches be given Triple A ratings? Seriously! There is some criminally negligent behavior going on – and I’ve yet to hear “boo” about any kind of prosecution for negligence or whatever it is such activities would be called.

    With businesses and debt now commodities to be traded and exchanged, much like milk, eggs, cars and the like, I don’t think anyone understands how an overall economy functions anymore.

  5. Krugman writes: Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations.

    Do economists live in special enclaves where they are prohibited from witnessing economic activity first hand?

  6. I have recently come across mention of an economics paper called “The General Theory of Second Best”. It seems relevant to this discussion.

  7. I agree James: economists have invaded other patches of intellectual activity with an elan and hubris quite out of keeping with their insights into actual economies.

    I spent much of my career making speeches etc about economics to my employer bank’s customers. Whatever I read in a textbook was irrelevant at best and rubbish at worst. What the average macro or micro textbook teaches is not about economies, it is about the dream world of economics.

    But: the big universities churn our PhD’s who rush to Wall Street and inflict efficient markets, and rational expectations upon the rest of us … and when their models implode they act as if they are innocent. These folks treat economic theory as a technology: they take it literally to be true. All I can say is that the naivety is extraordinary. And what a fatally flawed technology it has proven to be.

    Not only is there a crisis of basic understanding in economics, there is a crisis of ethics: why are we teaching this stuff?
    We have avoided the truth long enough: economics as a discipline has lurched off into a world of nonsense. Until it re-engages with the real world we should all ignore it.

    One final thought: the whole notion of tenured professors preaching perfectly elastic labor markets as a cure for recession is such rotten hypocrisy that it should make any right thinking person sick.

  8. Everyone I’ve ever talked to KNEW. They were making fantastic sums of money and therefore were naturally reluctant to blow the whole thing wide open.

  9. Who more appropriately to consider economics narcissistically than the narcissist, Paul Krugman? Just watch out for flying party-based political bias, forever a contaminant with an eel like Krugman. Who was it that said, remarking on Krugman’s prognostigative skills, that he called all seven of the recessions that have occurred in the last five or six years?

  10. Yes they do. They sit safely in tenured bubbles and discuss models with each other.

    When the entire economy is a ‘failure’ with respect to the theory, I suggest we need a new theory.


  11. Nonsense. The reason Krugman has a shred of respectability is that he has tried to change his views in light of the facts. Try getting the likes of Lucas to do that.

    This has nothing to do with politics anyway.

  12. The problem is that the ‘woeful ignorance’ is exactly what they learn as high theory. These are incredibly well educated fools. They have PhD’s to demonstrate their grasp of the subject. It’s just that the subject itself is rotten all the way through.

  13. The man won a noble prize. He may be disliked by many of his economic and policy contemporaries, but they still all admit he is a brilliant man and one the best economists to come around in a generation. And if you read his textbooks or his longer works, not just his NYT columns, you can see how his insights have been sorely missed over the last few years. If anyone should be a narrcissist, its Paul Krugman. He is one of the few people with the courage to challenge both the right and the left consistently, and while a bit abrasive, believe, the USA needs more abrasive people right now.

  14. One must remember that all those MBA types on Wall Street
    were beneficiaries of perverse income and their immorality allowed them to accept a state of fraudulent activity. Read M. Lewis “Liars Poker” to understand this by one person who got out of the criminal racket of Wall Street in the early 90’s.

  15. One must remember that all those MBA types on Wall Street
    were beneficiaries of perverse income and their immorality allowed them to accept a state of fraudulent activity. Read M. Lewis “Liars Poker” to understand this by one person who got out of the criminal racket of Wall Street in the early 90’s.

  16. If everyone involved knew, then the fault lies not in “economics” but in the perverse nature of the human character.

  17. Oh, I dunno.

    Within a reasonable range economists agree on the economy’s likely growth rate, and it’s hard to imagine many economists believing that a $14 trillion economy could support $56 trillion of debt — much of which was/is short-term.

    They were just shy.

  18. If economics is the study of what people do with their money, you’d think the “people” part would figure more prominently!
    I think the point is that “economics” did fail, because it did not account for the existence of a system where risk and reward were completely divorced from each other.

  19. I recently came across this gloss of Veblen’s, “The preconceptions of economic science,II” published in 1899. Martin Sklar (1988:9,n.7)”Veblen observed that the prevalent economic theory, like the prevalent everyday business mind, in taking capitalism as identical with economics as such, or as natural, could be regarded not as objective economic theory but as the prevailing interpretation of human nature drawn in terms of unverified a priori premises attributing pecuniary calculation, investment for gain, private ownership of income-yielding assets, as inherent to human nature. His observation found substantiation in the propensity of leading marginal utility theorists of his [Veblen’s] day to declare, not unlike Adam Smith, that their theory was based upon, and gave adequate expression to, human nature.”
    Krugman is in no small way echoing a critique of the discipline made a century ago! Certainly, all the social sciences suffer from the kind of hubris Veblen (and Krugman) have identified, but only economics has risen to the level of modern metaphysics and theology combined in its knowledge claims. I always rather liked Albert Hirschman’s quip that economics suffered from “physics envey.”

  20. One of the most interesting parts of Krugman’s article occurs on p.7 where he explains how Chicago economists reject even Milton Friedman as too liberal. Listen to some of their brilliant analysis:

    Chicago’s Casey Mulligan suggests that unemployment is so high because many workers are choosing not to take jobs…[and] that high unemployment is actually good: “We should have a recession. People who spend their lives pounding nails in Nevada need something else to do.”

    …it’s as if talk-radio show hosts were appointed to be professors at the University of Chicago.

  21. No.

    At least not to the Chicago School, and their neocon fellow travelers. To them, a failure of reality with respect to theory means we need a new reality.

  22. Points well taken.

    In the natural sciences we have the ideal gas law, for example. Simple and elegant P * V = N * R * T. We also realize that it is an IDEAL, a hypothetical construct, and that no actual gas in the real word follows it.

    Of course, things are much simpler when dealing with statistical numbers of thinking, feeling, screaming, sweaty human beings than with essentially indistinguishable helium molecules.

  23. Thanks D Christopher Leonard. You have articulated something I have mused over.

    As a non-expert, I would put it this way. Marx declared religion the opiate of the masses. The fresh water economists and their acolytes created a New Opiate for the Masses. A “free market” that promises a utopia of happiness, liberty, freedom and unlimited wealth. Thereby unleashing crass materialism and avarice writ large.

  24. Another interesting Krugman tidbit:

    To get anything like the current slump into their models, New Keynesians are forced to introduce some kind of fudge factor that for reasons unspecified temporarily depresses private spending. (I’ve done exactly that in some of my own work.)

    This was explained very clearly in Keynes’s “General Theory of Fudge Factors and other Fudge Products”

  25. “The reason Krugman has a shred of respectability is that he has tried to change his views in light of the facts.”

    Seven times? Now there’s “respectability” for you. :-)

  26. Thanks D Christopher Leonard. You have articulated something I have mused over.

    As a non-expert, I would put it this way. Marx declared religion the opiate of the masses. The fresh water economists and their acolytes created a New Opiate for the Masses. A “free market” that promises a utopia of happiness, liberty, freedom and unlimited wealth. Thereby unleashing crass materialism and avarice writ large.

  27. There are economists who are idiot and forget they are working with models. Models are tools to provide language to certain types of problems. Things like rational expectations and perfect markets allow us to say things about individual decisions. No one thinks people are rational or markets are perfect and people write papers characterizing different types of market failures. People often go to other market models: monopolistic competition of various forms.

    At the end of the day, it is very difficult to get a big macro model with all of the components which went into this crisis: asset bubbles, banking liquidity lending, financial institution balance sheets, default rates… Doing all of this in a macro setting is technically difficult. One of Krugman’s research recommendations is “simplify, simplify, simplify”. This is great advice for answering a specific research question, but unhelpful employing models outside the immediate purpose.

    The problem isn’t the tools, it is the researcher. The economist needs to be aware of the intent of his model and potential weaknesses. Those wanting to employ those models for finance or policy, need to be made aware of what they are using. If you want the perfect model, you’ll never get it. But since decisions must be made, it is best to have economists providing doing some modelling on imperfect assumptions.

    One final thought: It is fair to say that unemployment is the cost associated with the benefits of rigidities (i.e. job continuity) in the labor market.

  28. “If anyone should be a narrcissist, its Paul Krugman.”

    That’s cogent, tyson. You do stand up?

  29. The only consistent and serious Macroeconomist wrote a book many years ago. His name was Karl Marx and his book “The Capital”.

  30. Yes, but Marx has been throughly refuted by the example of people who claimed to be following him, but actually didn’t.

  31. The real name is “Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”

    According to wikipedia Taleb also criticizes it

    Nassim Taleb has also criticised the Prize for promoting economic theories based on a misunderstanding of risk. He points to the 1990 Prize in Economics, awarded to William Sharpe and Harry Markowitz for theories that, Taleb says, had already been undermined by the stock market crash of 1987; the 1997 Prize, awarded to Robert C. Merton and Myron Scholes for their option pricing formula; and the 2003 Prize, awarded to Robert F. Engle for his “ARCH” method of prediction of volatility, which Taleb says underperforms relative to volatility forecasts made by ordinary traders.[36]

    I recommend that it be renamed to “The Alfred E. Newman Prize in Economic Quackery”

  32. “The field of economics has been going on a massive land-grab over the past few decades. It’s ironic that the area it seems to understand the least well is how an overall economy functions.”

    If you take the perspective that many or most or all of the most influential economists were collaboraters — taking NBER and NSF and Sloan money and producing “research” that served an interest other than the publics — then this is something other than ironic.

  33. Veblen was the last economist who studied reality. He died in 1929. Everything coming afterwards (and much that came before, starting with Marshall) has been religion, not science. Keynes was a pragmatist, not a Keynesian, and war ended the Great Depression, not his General Theory. War is the ultimate stimulus. Milton Friedman was a simple charlatan, and those guys in Chicago are a lunatic fringe. Still, when you write what corporations like to read the financial results can be quite encouraging. You can’t separate economics from politics and have anything left but nonsense. Still, people will keep trying for as long as someone pays them.

  34. Re: “They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts;” – They turned a blind eye to – or simply eliminated, any discussion of 19th century “rational man” who is still underneath the whole edifice economics… This might just be a good starting point for a little philosophical discussion and debate on that sticky dilemma of the “limitations of human rationality”. I am well aware that people have already done this…but it does not mean that all the ground in this field was covered.

    Re: “They turned a blind eye…to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes;” – I’m old enough to argue that these are not at all unpredictable. We all know that there is going to be another crash!

    Re: “They turned a blind eye … to the dangers created when regulators don’t believe in regulation” – Regulators don’t believe in regulation because they still believe in “rational man” and they are trained by and “loyal” too or depend upon – economists.

    Plus…I can’t help but want to ask why or how is the infatuation with mathematics “elegant”? Elegance defined is; “Characterized by or exhibiting refined, tasteful beauty of manner, form, or style.” ( In particular, how has the infatuation with mathematics (of the past few decades) been related to “form” when in the end, as James so aptly points out; “…the area it seems to understand the least well is how an overall economy functions”. I think this may be due to the points of debate made above. I also believe that maybe, with a little debate the matter of elegant mathematics could be revitalized.

    By the way, I don’t mean to give the wrong impression…I love reading Prof Krugman’s articles! The article in question, I thought was an excellent read.

  35. As a mathematician myself, originally, I would like to say a word in defence of mathematics.

    Maths is just a language. You can lie or tell the truth in it. Just like accounting, actually. Well-educated mathematicians (and accountants for that matter) know this.

    The problem is the winning by intimidation factor – all those gobbledegook symbols! Bit like the reverence accorded to anything on computer printout in the early days. The people most enamoured of saying things in numbers, I find, are the soft scientists. Whereas serious mathematicians (like Bertrand Russell) try very hard to say things in plain English.

  36. Tempest in a Tea Pot …

    Krugman’s analysis is a failure on three levels …

    ~ The role of debt in the bubble … the aggregate debt bubble began with the Reagan Tax Cuts.

    ~ The role of the privately owned and operated Federal Reserve and its fealty to Wall Street Banks …

    ~ The role of cornucopian economics, that is, the failure of contemporary economics to measure externalities and acknowledge the finite limits of natural resources.

  37. Economics is one of the social sciences. It is a soft science. It is not a hard science.

    I spent 26 years working with economists (soft science) and biologists (hard science) in the fishery management industry. I myself majored in mathematics. Economists were always wanting to be viewed as equals of the hard scientists. Mathematics (i.e. the mathematical model) seemed to create this level playing field with the hard scientist.

    Economists seemed to resent being labeled soft scientists.

    One federal fisheries office appointed a biologist to supervise the economics department consisting solely of economists. I thought this was strange at the time, but I slowly recognized the wisdom.

    The economy is too import to be left to the economists, much like health care which is too important to be left to doctors.

    The CIA chief is not a spy guy. Obama did a good job here. He decided putting a spy guy in charge of the CIA was going to lead to more of the same. Likewise, Obama should employ someone other than an economist to supervise his stable of wild economists including Larry Summers, Robert Rubin, etc. Maybe a sociologist? How about a physicist? Is this pointing to the idea that economists have the inability to manage themselves, to control their impulses to unknowingly spout nonsense?

    So, are we now saying the economic emperor has no clothes, and hasn’t for a long time?

  38. Yakkis, thank you for reviving a long forgotten point.

    For all that the Soviet Union played lip service to being Marxist, their actual government, society, economy and structure bore little relationship to anything that Karl Marx ever wrote about or advocated. Interestingly, I visited the USSR during the 1970’s: while portraits and statues of Lenin were omnipresent, it was very hard to find any imagery of or memorials to Marx in Moscow (though a major street was named after him). When I asked my Intourist guide about it, her face turned red and she got all flustered–in the end, she said she didn’t know of any. I finally ventured off on my own and found a small statue of him in a remote little square. I’m probably lucky I didn’t get arrested for doing that.

  39. FTA: monetary policy was superior to fiscal policy at managing the economy.

    even if this is true and it still might be, it appears to me that we would never know it in our little econ expirements because we went the way of monetary policy and ignored any fiscal policy at all except for lowering taxes. (it’s nice to see fiscal policies starting to get a lil attention again). I think the important thing to do is to pay attention to all things affecting the economy and that includes behavior (which might indeed be even triggered by things that don’t appear to be money oriented (though i wonder what isn’t economic it seems econ covers everything))

  40. That is not possible. You are ignorant or you are not…. and if you act as an ignorant while in full possession of facts and wisdom, there’s something else going on….

  41. Economics, like all social sciences, are fundamentally different from the natural sciences in that they rely on human affairs. This has been uniformly understood.

    The tragedy was attempting to push a Newtonian like approach in fields that were intrinsically human. Yet I suspect the events in world economies and financial markets of yesteryear will, nevertheless, serve the purpose of advancing human knowledge. A paradigm shift in economic thought has clearly been observed. The ascendancy of economists like Paul Krugman and Robert Shiller (Animal Spirits) are just some evidence.

  42. Paul: “One final thought: It is fair to say that unemployment is the cost associated with the benefits of rigidities (i.e. job continuity) in the labor market.”

    My impression is that Japan, at least until recently, was a counter-example: a free society with both job continuity and low unemployment.

  43. Geoffrey Morton-Haworth: “The people most enamoured of saying things in numbers, I find, are the soft scientists. Whereas serious mathematicians (like Bertrand Russell) try very hard to say things in plain English.”

    Hear, hear! :)

  44. Well, it helps if your field of study is so rarefied that you’ve moved beyond mere worldly, base things like numbers. (Russell studied set theory.)

  45. There is a man who has a theory for how economics and markets and humans interact in the messy real world as opposed to some theoretical perfect world, in fact this man’s theory is based on the Imperfectability of human knowledge. His name is George Soros and his theory, called reflexivity, seems to work very well for him.

    The academics will never grant Soros’ economic ideas any respectability because, first, they originated in the crass, materialistic world rather than the rarified atmosphere of the ivory tower, and second, he doesn’t dress them up in sufficiently obtuse language. Not only that, the basis for his theory, that human knowledge is always incomplete and is therefore prone to feedback loops (contrast this with the perfect knowledge assumption of the efficient market theorists) is a natural fit for any culture that practices a messy form of government like democracy or believes in individual rights such as freedom of speech.

    This is not to say that Soros has everything worked out. His several books on the subject leave you wanting a more detailed examination of how his theory would be applied to policy. But he has certainly pointed in a new direction and in light of the disaster created or at least not foreseen by the existing economic theories, one would think his ideas would get a little more attention.

  46. or you (the person acting in willful ignorance, not you you) are in denial and or you are rationalizing.

  47. Krugman writes “most economists … turned a blind eye… to the dangers created when regulators don’t believe in regulation.”

    What is he talking about? We are years into the crisis. Has he no idea that never ever before did the regulators believe so much in the power of regulations like when they elaborated the minimum capital requirements for banks based on risk, and which allowed for example a bank to leverage its equity 62.5 to 1 whenever an AAA rating was present. So much did the regulators believed so in these capital requirements and in the capacity of those they appointed as risk sentries, the credit rating agencies…that they simply went to sleep.

    Again, economist should not write about financial matters without having read the Epistles from the Basel Committee. Otherwise and if they are Nobel prizes winners someone could even think of suggesting they return the award.

    Day by day I am losing more and more the respect for the PhDs and sincerely I am even beginning to think that at least when it comes to financial regulations they are in many ways part of the problem.

    Could you really think one can jump in and introduce so much bias in favor of risk adverseness without doing any major damage to the financial system? If so you must be one of those deskbound regulators who have never walked the beat.

  48. Karl Marx asserted that the fundamental law with capitalism is that the contradiction between the irrationality of the aggregate economy and the rationality of the producer corporation individually in pursuit of its own interests. The individual corporation is rational to the extent that production is increased based on its own plans of the expected growth. The economy as a whole, however, in connection to what the competitors are doing, are either not visible to the individual corporation or is totally ignored for the immediate interests of the corporation in pursuit of ever rising profits or market share; while there may be risks, at least it is in the hope that it is the competitors who will be going out of business.

    Now, we need to introduce a second fundamental law on the contradiction, within a capitalist economy, of the rational pursuit of the interests of the individual vs. the irrationality as a whole of such pursuit, conducted by the members of the corporation, putting the corporation at risk. A trader would have the incentive to continue to push the envelope for the expected income (or bonus) despite the knowledge that such activity may be harmful, or even fatal, in the distant eventuality to the corporation as a whole, but he/she anticipates either that the corporation can withstand the shock of these risks, or that even when the corporation fails, he is unharmed or at least well protected with the immediate gains at hand.

    These contradictions have significant implications to the economic policies of our society, and may well be worth someone’s PhD thesis. While Adam Smith was correct in his theory on the invisible hand in the age of the economy composed of small and relatively unsophisticated traders, it is indeed doubtful that it still holds true that the punishment of the market shall be the only force of moderation relied in the complexity of the economy of our age. (I already have mine in a real-knowledge field, but would be interest seeing this being developed to fruition.)

  49. Economics, smeconomics…. I do not understand. I can’t even invest my IRA well. I have not the aptitude, training, or interest. However, I have seen This Depression (ah, er,..”slump”) coming, like a freight train, for many many years.

    I believe that This Depression (think of it, full blown, in another couple of years…), has little to do with dueling economic theory, at least now, post-“quantitative easing.” It does have a lot to do with lack of commonsense bank/investment house regulation and a *whale* of a lot to do with corruption on Wall Street.

    Wall Street gamed the economy and it will game any newly implemented economic theory, as well.

    I see no reason why we cannot have exactly the same system, but run by people making modest salaries – not commissions and bonuses – who think of themselves as fiduciary priests and the management of the markets on behalf of investors as a trust. (Most of the present Wall Street players will leave, sure. Good riddance. There are many smart people who eschew the greed game.)

    We don’t pay bank tellers by the end–of-day amounts in their deposit drawers. Why do so on Wall Street?

    (While I’m on a roll, I would like to read a Krugman-like 7K word piece on The Fed: how America operated before The Fed, why The Fed was created, who owns it, what happens to its profits, etc., and why it can’t be investigated/controlled by anyone.)

  50. Larry checks himself in the mirror every morning. He considers that paper to be a “work in progress”.

  51. Lots of interesting tidbits. My problem with Krugman is his overly optimistic belief that by merely stimulating the economy we will achieve recovery and sanity. But merely getting back to where we were doesn’t feel adequate to me. The social damage done by the recession will not quickly be undone; we need to confront the inadequacies in our understanding of and valuation of work and the use of free market ideas that allow a race to the bottom on compensation and conditions.

    The prospect of a lagging recovery of employment suggests that after each cycle we are left an ever larger pool of the unemployed and underemployed because job creation lags. Economics, as I understand it, should give us insight into how individual in a free society make choices, and politics is the systems by which we make collective choices about allocating resources. Capitalism creates optimal wealth, but the political system we have fails to suppoort values that make life livable for the majority of the people.

    I question whether inadequate market models are a good enough explanation of our problems. That’s why I am unwilling to discard Marx completely. I may not like his solution, but some of his diagnosis seems sound. Human greed is obviously part of the problem, but capitalism is built on greed. Are there countervaling values that inhibit the behavior we see on Wall Street and in the major banks?

  52. mmckinl,

    You and I probably don’t agree on much, but we are as one on the debt issue and Krugman’s total miss of it.

    We’ve obviously been through one of the biggest debt bubbles in recorded history. The neo-classicists and the keynesians are pointing at one another claiming the other doesn’t know which way to turn the steering wheel now that we’ve gone off the cliff. It’s an amusing argument, but it misses the point.

    The problem with the 1930s wasn’t the 1930s. It was the 1920s.

    The problem with Japan in the 1990s and 2000s wasn’t the 1990s and 2000s. It was the 1980s.

    The problem with the late 2000s (and into the late 2010s, I expect) isn’t the late 2000s. It was the late 1980s, 1990s and early 2000s.

    The one group that got it right is the one group excluded from the discussion in academic, political and popular circles: the Austrians. I’ve got mixed feelings about a lot of their writings, but they’ve been far more reliable in their prediction of and analysis of this crisis than either of the dominant “water” schools.

    Carson Gross

  53. What makes you think that the slippery bankers won’t be able to game any regulations regarding their compensation? They do it for a living.

  54. Adam Smith (author of The Money Game, aka George Goodman) tells a nice joke about economists:

    A chemist, a physicist, and an economist were stranded together on a desert island. All they had to eat was a giant tin of tuna, but first they had to devise a method of opening it.

    Says the chemist: “Why don’t we build a really hot fire and melt the tin?”
    Says the physicist: “Why don’t we build a catapult, hurl a huge rock at the tin, and smash it open?”
    Says the economist: “First of all, let’s assume a can opener…”

  55. Per, is this fellow credible in your world?

    There have been plenty of books and articles that confirm in general the activity that he describes taking part in — huge corporate domination and rape of the rest of the world. Perhaps this is what’s happened to us? Certainly “feels” that way. We now owe an enormous debt, which is just what we did to many countries all over the world, no? Can’t remember where I got the concept (Sun Tzu?) but one recommended strategem in war is to turn the enemy’s own princes against them. It is not difficult to see our situation in those terms. We’ve been sold out by our very own. I realize this is a very american-centric view, as the rest of the world is going down with us, but certainly ground zero was the USA is this was an economic nuclear blast.

  56. The Austrians are only correct by coincidence …

    That is because of fractional reserve banking … You will find that all currency bubbles have occurred since the implementation of fractional reserve banking …

    Leverage on the way up … leverage on the way down …

    Fractional Reserve Banking is the greatest Ponzi Scheme ever perpetrated on humanity … And why it fails so regularly and so spectacularly …

    What we need is sovereign money, created by and spent into circulation by the government … Look into Ben Franklin’s Colonial Script … no inflation, no depressions for decades in colonial Pennsylvannia.

    In fact the biggest reason for the American revolution was not taxation without representation but the prohibition of colonial script and the requirement that taxes be paid in the Pounds issued by the privately owned and operated Bank of England …

  57. I guess Marx is worth a thought. After all he seems to have originated Communism which must surely rank as an opiate of the masses? But then we see Marx as unable to accept competition for his ideas? Hmmmm, hardly a sound base for rational diagnoses?

    Alas, his opiate/religion failed because of man’s fear/greed drivers. Surprise surprise could Wall St be a replay of these same drivers? In which case recent comments re psychology highlight a missing or undervalued element in any study of market behavior is worth increased consideration in economics studies?

    Regulation may well be the process to manage this fear/greed function but what principles/ethics platform will be used? Like all absolutes, an external reference is required for perspective and what is it? Do we see the law of entropy looming?

  58. Good comment re fractional reserve mmckinl

    Of course if this system is so good, maybe Mr. Geithner should deposit $1 in a bank and allowing infinite leveraging solve all our problems?

    OK, make it a $2 deposit

  59. Having now read the Krugman piece, I am struck by his willingness to believe the profession’s intellectual bankruptcy is all an honest mistake. The rewards reaped by collaborators in the Friedmanite Chicago fantasy of the past thirty odd years are immense. Meanwhile, Krugman does not even mention the institutional economists descending from Veblen to Galbraith and moving on to people whose names are not even recognizable. Neither the so called Keynesians, who believe in government binges to supplement periodic swoons in corporate growth, nor the monetarists, who cannot even understand that it is credit rather than some idiotic measure of money which drives the entire business, have anything to suggest concerning the structural problems that turn human beings into so many mice on a treadmill even during the so called good times, such as the much balleyhooed Clinton prosperity of the Nineties, which was fine for those who cashed in on it, but not so good for a bewildered majority faced with McJobs and lacking either means or a zest for speculation.

    So now we can look forward to four years of Stimulus according to Reid and Pelosi. One does not have to be a genius to see that this will be a corporate gold rush to cash in on poorly conceived government boondoggles, for which succeeding generations of taxpayers will pay and pay, assuming it works which is by no means certain. I am still waiting for one economist to mention the words monopoly and usury by way of explanation for our basic economic problem.

  60. Absolutely not! And here is what I wrote about it in my “Voice and Noise”, 2006… and by the way you have not been sold by your very own.

    Confessions of an Economic Hit Man by John Perkins, 2004

    This book made it to The New York Times Bestseller List and after that anyone who has ever worked for the World Bank and other similar development institutions is now exposed to hear: “Daddy/Mommy, were you ever an Economic Hit Man? And, when you answer NO!, hear them ask: “Daddy/Mommy where’ve you been?

    I found the lack of general protest to the book absolutely astonishing, and so I feel compelled to include the following note I have posted on some Web sites. The last thing I heard about the book was that it has been nominated for a book-of-the-year award … in the category of Business! Holy mackerel!

    Perkins’ Confessions … The mother of all mid-life crises

    I just read the Confessions of an Economic Hit Man by John Perkins. It is a repulsive autobiography, I guess about the mother of all mid-life crises, as the author describes his remorse with the active role he played in a conspiracy aimed at inducing developing countries to incur excessive debts so as to subjugate them and control their natural resources. That individuals could on purpose miscalculate in order to gain benefits is a fact of life, but that this would be happening with malice on a worldwide scale and as part of an American conspiracy is just too much to fathom—and then just sit back.

    I haven’t the faintest clue whether the book is true or not and in fact I don’t care because, in either case, Mr. Perkins needs to be prosecuted. Either by American or international courts for committing fraud and crimes against humanity, or, by the same courts, for seeding that kind of distrust that makes it so much harder for good people to trust good people—a basic requisite if the world is to stand a chance.

    Something should be done, soon, before it gains more credibility. The book is already a New York Times Bestseller and even though it states that the “World Bank doesn’t help them [the poor countries] to defend themselves. In fact, it forces them into this position,” on the back cover we read a former lead economist of The World Bank saying that it “succeeds as a wake up call because the reader cannot help but assess his or her role on a personal level, thus providing impetus for change.” Pearson ends his book with, “Like all confessions, it is the first step toward redemption.” Good for you! But, pal, a rough book tour is not punishment enough!

    I have been vociferously arguing against the Debt Sustainability Analysis of poor developing countries which is currently so much in vogue, basically because I feel that debt should always be contracted because it is productive, not because it might be sustainable. Nonetheless, against Perkins’ Confessions my arguments do sound hollow and naïve though, come to think of it, I much prefer to live out my life with this kind of naïveté than to live with the cynicism otherwise obligatory. Perkins says he wrote so that his daughter could have a future. So do I—for my daughters and for his.

  61. Today if a bank lends to a normal unrated citizen then it can only leverage 12 to 1 but if it lends to someone who a human fallible credit rating agencies has rated AAA then he can go to 62 to 1 and if he lends to his AAA government then there is no capital requirements at all and the sky is the limit. Crazy!

  62. War as such is not the ultimate stimulus, but no one has ever managed to come up with a mobilization of the same magnitude for any other purpose. It would be interesting to see an economic policy not predicated on the primacy of the military.

  63. jake chase writes “Krugman piece, I am struck by his willingness to believe the profession’s intellectual bankruptcy is all an honest mistake”

    Do you suggest “the profession’s intellectual bankruptcy” was on purpose?

    jake chase writes poorly conceived government boondoggles, for which succeeding generations of taxpayers will pay and pay

    That is of course a major assumption that the taxpayers will pay…now when the bill is running up all talk about the taxpayer but truthfully the US taxpayer seems conspicuously absent and all we hear is about tax-cuts.

    jake chase “I am still waiting for one economist to mention the words monopoly and usury by way of explanation for our basic economic problem”

    “usury” maybe not but I have complaining a lot about how non-transparent tools like credit-scores allows to capture much higher financial margins because these give the impression that the rates are “objectively” set on a debtor by debtor basis and this reduces the willingness of the debtors to fight for better rates

  64. I read the full article, I have three comments.

    1. Policy decisions should not be left to economists.

    2. Krugman acknowledges the role of human behavior such as the behavior of bankers ,traders, Federal Reserve, and other market players as an important factor in the current financial crisis.

    3. Near the end of the article Krugman says :

    “…a focus on depleted capital of financial institutions helped guide policy actions after the
    fall of Lehman, and it looks like (cross your fingers) as if these actions successfully headed off an even bigger financial collapse.”

    Krugman should stopped while he was ahead. The evidence for believing that the actions – namely the fed bailout of financial institutions was the best course of action is about as strong as the evidence that economists are united in their views.

    On the other, a behavioral approach would suggest that we should have wiped out the equity holders and creditors of these problem financial institutions, as a first step.

    This would have placed losses where they belong; disciplined excessive risk=taking; severely limited the ability of some large institutions to grow in size and power;avoided public outrage over bailouts and bonuses thereby increasing public support for administration public policy initiatives.

  65. sippycupnation: “and if you act as an ignorant while in full possession of facts and wisdom, there’s something else going on”

    Indeed. Witness the preceding 8 years of the Shrub.

  66. Krugman writes “There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year”

    Absolutely not! Krugman has no idea of what he is talking about. The collapse was doomed to happen, courtesy of the financial regulations in place.

    In January 2003 the Financial Times published a letter I wrote and that ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

    Also, in February 2000 in the Daily Journal of Caracas in an article titled “Kafka and global banking” I wrote the following:

    A diminished diversification of risk. No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.

    The risk of regulation. In the past there were many countries and many forms of regulation. Today, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.

    Excessive similitude. By trying to insure that all banks adopt the same rules and norms as established in Basle, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs.

    Truth is only some PhD regulators who have never ever stepped outside their offices to walk the real streets of finance could have been as naïve and gullible to believe they could empower the credit rating agencies so much to determine the financial flows without setting them up to be captured.

    The sooner the world stops the financial regulations from falling excessively in the hands of the PhDs the better and this, of course, does not mean that I do not recognize the importance of the PhDs.

    And, by the way, I am an economist… only that I have walked the streets as a professional for over 30 years.

  67. If Prof. Krugman is right, it’s entertaining to note the problem economists – including “progressive” economists – have created for themselves in the US health care debate.

    I wonder how many “progressive” economists who support a public option for US health care now ask themselves whether teaching the wonders of free market economics to generations of kids was really such a good idea. It makes it a bit more difficult now to turn around and say, in effect: “Hey, we were just fooling. Actually you need a healthy dose of socialism to make the system work”.

    Second, Krugman’s piece seems to show that the “Dark Age” of forgotten ideas has lasted for a long time. Maybe since the 1950s when the Cold War was raging. Could there be any connection?

  68. On the other hand, Minsky not only understood “…that it is credit rather than some idiotic measure of money which drives the entire business…” and “…the structural problems that turn human beings into so many mice on a treadmill even during the so called good times…” He wrote articles and books (culinating in 1986) that not only explained how periods of economic stability (low inflation, low unemployment, steady GDP & productivity increase) lead to exactly everything that happened during the last thirty years culminating in the current state. He provided extremely clear, direct analyses of productive credit, unproductive credit, and ponzi finance using concrete descriptions and examples. No mathematematical models, just an accurate explanation of how credit cycles in the post-industrial world drive everything else, and how credit cycles themselves actually work. There is no way anyone could read him and not understand. There is also no way that that modern schools of economics, completely coverted to the Chicago way of thinking was going to allow these analyses room in the marketplace of economic thought. As for the financio-governmental
    axis of Greed, well, what did you expect?

  69. Friedman – of “Inflation is everywhere and always a monetary phenomenon [right, like Japan 1989-2009]” and “The only objective and measure of a corporation is the maximization of shareholder value” fame also won a Nobel and had become as a God in America by the time of his death (the eulogies were as dramatic as Kennedy’s). The bizarre Chicago fanaticism for math modeling “pure market” (non-credit) equilibriums brought them many Nobels, a monopoly of economic legitimacy (until 2008), and virtual mind-control over Wall Street and D.C. in driving them over the cliff.

  70. Actually, the vast majority of major deficit wartime programs have ended in huge financial problems (even for the winners, e.g. France and England after WWI even though they ripped off Germany for years – and the U.S. as well, since we ended up indirectly paying most of Germany’s reparations at the end; and then there’s the losers). The U.S. – as usual – thinks its own experience represents everyone, even though our experience in WWI & WWII were special primarily because we could get the benefits without experiencing the destruction. In the case of the Depression, we actually had a powerful recovery process from 1932 to 1936, then a second (relatively small) dip from 1936-1938. Then we continued the recovery – all before the effect of WWII spending which commenced late in 1939 as England and France began to spend enormous sums in the U.S for our war-related products. The gigantic American war time deficits were plopped onto a non-depressed economy and it required wage and price controls and rationing to keep our economy from blowing up. So, you’re right Katherine, war is not the ultimate stimulus, at least not in a good way.

  71. Reading Krugman is like enduring a tooth ache anymore.
    The end intellectual analysis of keynes was generational gradulism to socialism, yes he stated that in his treatise also. I will not take the time to list who warned this effect to us but we know who they were. It is a sick mask to ignore contract and law so here we are. When pushed hard by economists, welfare propagandists and socialists admit that impairment of the average standard of living can only be avoided by the maintenance of capital already accumulated and that economic improvement depends on accumulation of additional capital. History does not provide any example of capital accumulation brought about by a government. The consumers are merciless. They never buy in order to benefit a less efficient producer and to protect him against the consequences of his failure to manage better. They want to be served as well as possible. And the working of the capitalist system forces the entrepreneur to obey the orders issued by the consumers. The corruption of the regulatory bodies does not shake his blind confidence in the infallibility and perfection of the state; it merely fills him with moral aversion to entrepreneurs and capitalists. No one should expect that any logical argument or any experience could ever shake the almost religious fervor of those who believe in salvation through spending and credit expansion. The final outcome of the credit expansion is general impoverishment. As for me are you not still under an Ancient Roman edict to consumers then and now of Caveat emptor: Let the buyer beware? And let stockholders beware of wayward leadership.
    To date to preserve capital and serve the customer which to date is being exterminated by observation to its ideological burden they wish. The preservation of our net cash flow to date consists only to serve the remaining customer base. We are in the mode to this hidebound reality since theories explain, but cannot slow the decline of a great civilization as they plan. I set out to be a reformer, but only became the historian of a decline. For decades jobs left as did countless patents. Today In a few segments over the next 16 weeks, in 4 of those weeks they are to be layoffed being department specific. Housing is not stabalized as conveyed. Incremental pain is witnessed as saving to uncertainty being you are working on and off. Global bull dozing to a new predicated business cycle and many have watched this for over 3 decades.
    Washington ignored reality -“Paul Volcker, Stanford, Feb 11, 2005
    A few selected excerpts:
    “Altogether, the circumstances seem as dangerous and intractable as I can remember.”
    “Boomers are spending like there is no tomorrow.”
    “Homeownership has become a vehicle for borrowing and leveraging as much as a source of financial security.”
    “I come now to the heart of the problem, as a Nation we are consuming and investing, that is spending, about 6% more than we are producing. What holds it all together? – High consumption – high leverage – government deficits – What holds it all together is a really massive and growing flow of capital from abroad. A flow of capital that today runs to more than $2 Billion per day.”
    “What I’m really talking about boils down to the oldest lesson of financial policy in Central Banking: A strong sense of monetary and fiscal discipline.”
    Bend the trend now fiscal sanity with more pain or lingering balance sheet depression as more linger without Jobs over the next 3 to 5 years. You do not need a Idiot Thesis Paper since the people voted them in. Business has to survive predation of the state unless there leashed to corruption and overall both are to date from top to bottum by percentages which is basic math. no spell check tools exist to read wise men called acedemia /rant off

  72. In many ways I agree with Paul. Macroeconomics is about far more than charts, graphs and math formulas to predict both trends and outcomes. The enchantment reminds me of the old saying about the two handed economist. The profession is interesting, and can be meaninful if combined with a broader understanding of the non-quantifiable impacts of social trends and public policy. On the other hand, as they say, microeconomics can be quite useful in predicting outcomes of discrete markets. I love to read and study it, because it can be fascinating. But economists are not, and never will be, scientists, and their profession should well be included in all art forms which in which quantification plays a serious role.

  73. I believe Economist need to open their eyes and view what is going on in their own section of the world. The view from their back porch is more informing than the view from their computer. The world is not perfect and neither are markets.Reagan said to “Trust- but verify”. Economist need to observe and predict, not predict and observe.

  74. Mathematics is absolutely necessary to ensure some sort of common understanding and agreement. The problem is that the original foundations of economics can no longer account for the relationship between people and a financial sector that’s taken on a “life and meaning” of its own. Instead of entertaining the notion that the epistemological foundation is too far removed from reality, the mathematicians focus on explaining data that is far removed from reality. Prof Krugman and other leaders in the profession study the area of observable effects irrational behavior and this has been very important and will continue to be fruitful to a degree… But as he points out so elegantly; “It will be a long time, if ever, before the new, more realistic approaches to finance and macroeconomics offer the same kind of clarity, completeness and sheer beauty that characterizes the full neoclassical approach.”

    Bubbles, recessions and depressions hurt people. The impact of poverty increases rates of sickness and mortality. (See for example, research by D. Raphael). Children who suffer poverty bear the brunt of risk and harm. The impact of financial crisis on very poor nations is yet another story.

    So somehow, in light of this human suffering, it does not seem acceptable to continue on without inquiring into a range of other possibilities for theoretical advancement. Note that if a sickness causes human suffering private pharmaceutical companies rush in to research causes and cures!

    New theoretical investigation must use mathematics…. It remains the source of hope for linking theory to knowledge and science. My feeling is that the area of mathematical thought that needs change lies at the foundations of economics rather than be limited to the field of observable effects. Unfortunately questioning this foundation is a ‘social-academic’ taboo – It’s an exercise that ruffles way too many feathers! As long as this is the case, the math will be ‘rarefied’.

  75. That piece read to me like a discussion of the history of any of the liberal arts in academia–the evolution of theories and schools of thought, all somewhat removed from the real world outside. For instance, the 30 year expansion of debt has no place in his argument.

    The difference is we somehow give these people control over things that they only understand through narrow, abstract models.

    Literary theory is just as other-worldly, but we don’t give these people control of the printing presses.

  76. aedens “The corruption of the regulatory bodies does not shake his blind confidence in the infallibility and perfection of the state; it merely fills him with moral aversion to entrepreneurs and capitalists.”

    Blindness indeed! When the regulators order that the capital of banks should be a function of the credit rating agencies and then afterwards something goes wrong… they cannot think of anything better to say than “the bankers should have done their own due diligence”.

    How long would Madoff have survived without the backing of a SEC supposedly doing its job?

  77. Paul Volcker is quoted with: “Boomers are spending like there is no tomorrow.” “Homeownership has become a vehicle for borrowing and leveraging as much as a source of financial security.” “I come now to the heart of the problem, as a Nation we are consuming and investing, that is spending, about 6% more than we are producing”

    Absolutely! The US baby-boomers have signed themselves up in a “reverse mortgage” arrangement with the rest of the world. “Après nous le deluge”

    It is rumored that the older baby-boomers, in old Swedish somewhat Viking times, threw themselves out of from cliffs, called “ättestupa”, whenever they felt they had become a burden on society. Somehow our modern baby boomers have become so powerful they think they can throw the younger generations down an “ättestupa”.

  78. Heh.

    Maybe. But when I see “Behavioral Economics” ascendent, and I read through an old copy of Mises’ “Human Action” I can’t help but laugh.

    I think I agree with you vehemently regarding reintroducing greenbacks. I think.


  79. The Shrub and his peeps operated on the theory that they made the reality.

    And we’ve paid a terribly costly price for their arrogance.

  80. For Yakkis & others…
    seems like economics (like some other fields) discovered that mathematically elegant models could be built (if you got the assumptions under control). As time went on, more and more work was simply perturbations of the models and the subsequent consequences, as opposed to trying to reflect reality.

    The field then devolved into endless mathematical perturbation, or math-turbations, which, while fun, is pointless

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