Was Wynne Godley ‘Old Fashioned’? – Krugman’s Straw Man Excuse for Not Reading Him
Krugman has written a piece on the NYT article on the increasing influence of Godley’s work. Perhaps he felt under pressure to do so to avoid looking old fashioned and in a classic example of transference accuses Godley of being ‘old fashioned’. Clearly a blogosphere troll to which Ramanan has already done two spot on response (here and here) and we can expect many more. I hope this leads to as good an examination of Krugman’s assumnptions here as that of assumptions on loanable funds, but in that case he could wrongly state it doesn’t really matter, my neo-classical models would be the same. Here it really does matter as the assumptions of ‘maximising’ which he relies go to the heart of the neoclassical project. Krugman accuses Godley of reviving ‘Hydralic Keynsianism’ (ironic because the IS-LM models Krugman uses was one of the earliest results from this school) and states that there were
some notable predictive failures of hydraulic macro, failures that it seemed could have been avoided by thinking more in maximizing terms.
The aim of the hydralic models of Phillips was to use system dynamics to develop a stock-flow consistent model of aggregate demand and the whole economy. But this early work did not include a mathematical framework for ensuring stock-flow consistency between different sectors of the economy. Godleys great advance was to develop an accounting framework to ensure this consistency. Krugman gives as examples Freidman’s permanent income consumption function and NARIU. Again ironic because there were few greater challengers to Freidman’s ideas than Wyne Godley. The assumption here I think is that Godley’s ideas were not sufficiently ‘microfounded’ – wheras Freidman’s ideas, then embodied in the Real Business Cycle models – could predict 70s stagflation, and this of course evolved into the ‘New Keynsian’ macro models which Krugman champions. Lets take these claims in turn. Firstly that Godley had a ‘naive consumption function’ that doesn’t take into account booms or wealth effects. Lets look at one of Godley models from 1996
We assume, fairly conventionally, that real consumption is some proportion (less than one) of expected real income plus another proportion of the opening real wealth stock …or, solving out lagged wealth recursively, consumption can be written as a function of current and lagged income with the coefficients constrained in a particular way, to sum to unity
This clearly is someone who had read the literature on consumption functions and shows fairly clearly that Krugman has not read any Godley. Indeed the whole ‘portfolio balance’ approach to consumption which Tobin pioneered was considerably advanced by Godley. As Randall Wray points put In Tobin in and out flows of funds were considered exogenous leaving agents solely to consider portfolio balancing, in Godley’s models however all flows are considered endogenous. On the NARIU issue, Godley never agreed with it and offered alternative explanations of 70s stagflation. In Godley, W. and Lavoie, M. 2007. Monetary Economics: An Integrated Approach to Credit, Money, Income, Production, and Wealth, they deny the accelerationist approach and develop in chapter 10 an alternative stock-flow consistent approach to modelling stagflation.
So on both counts Krugman is building a straw man. New Keynsian macro relies on a rational expectations model whereby agents maximise and this achieves gneral equilibrium. Godley on the other hand models on the basis of
procedural rationality, with agents reacting to past disequilibria relative to norms (Monetary Economics P. 493)
Stock flow consistent modelling is able to fully explain price changes outside of equilibrium without heroic assumptions of rational agents being able to understand the models assumptions. This makes them useful for simulation in a way that New Keynsian models are not. You can of course assume that individual pursue behavior in a broad optimizing manner, indeed Fishers PHD thesis was to construct a ‘hydralic’ model that simulated a walras type general equilibrium, but SFC models in addition can explain violent disequilibrium processes including economic crises. ( I will be exploring n more detail the SFC approach to price determination in a future post)