Blog Brawl Bests Nobel Prize Winning Economist – and ‘gulp’ i’m dragged into Brawl

Lauren Lyster’s Capital Account covers probably what has been the biggest economists bust up since Hayek v Keynes and has caused something of an internet sensation.

The argument is between Professor Paul Krugman, Noble Prize Winner and undoubtedly the worlds most famous economist through his outspoken NYT column and blog, and Professor Steve Keen – who until recently was a marginalised and little known figure based in Australia.  Keen had one major claim to fame though, he was only one of a tiny handful of economists who predicted the great financial crisis of 2007 to today (and Krugman didnt) and the only one to do so with a mathematical model.

Now both figures are progressives and critics of the neo-conservative austerity ‘consensus’ that somehow we will get out of this great depression by austerity which is and will make matters worse.  So why have daggers been drawn? Well the reason is that Krugman and some of his more conservative colleagues such as Greg Mankiw and Robert Lucas all share the same underlying theory of economics – the neoclassical synthesis.  This approach of course failed to predict the crisis and is used to justify austerity economics.  However over a number of years the dissatisfaction with this approach has been growing.  Because progressive Neo-Classicals – the so called New Keynesians, have been unable to lend a clear blow on austerity economics, either to show why we had the great depression, to prove that it does not work and present a clear policy alternative, many have concluded that they are an active impediment to a change in thinking about economics.  But the austerians can point to progressives supporting the foundations of their own economic theory it must be right mustn’t it.  The New Keynsians have become the ideological prop to the status quo.  A potemkin village to be pointed at by neo-cons to critics of economics.  YankeeFrank on Naked capitalism sums it up

Actually, I would argue that Krugman and his Rubinite sponsors are our worst enemies. They provide many of the theoretical underpinnings for our current lemon socialist/crony capitalist system. Krugman, as far as I recall, has still refused to utter the words “fraud” or “crime” in relation to the misdeeds of our bankster overlords.

To say that debt can be “modeled out”, or banks can be ignored, in our understanding of the financial system is exactly how the devil gets in….

Krugman’s answer to our problems is the typical limousine liberal response, and it amounts to pretty much the same thing as the republican response: charity for the “losers” in our economy. The main difference is who should provide it, the government or private donors.

Sure Krugman wants “money drops”, but insists the current system is sustainable if we just do that. He in no way calls for real reform of finance, banking or industrial policy. But that is because he’s spent his career pushing the policies we now live under. …So yes, Krugman is the enemy. The idea that he is an ally just shows us how far from any real solutions this nation is; which is why we’re going to have another, much more massive and destructive, collapse before the ideas discussed on … truly progressive sites get the airing and support they deserve.

The alternative school has emerged from the ‘post Keynesian’ school.  This school grew out of Keynes closest associates and was based on the idea that the key issue in economics is that of disequilibrium.  That is when different markets are out of sync with excess/under supply, such as of course lack of demand for labour – unemployment, or excess demand for money, inflation. This group held that what was important about Keynes was that it was a disequilibrium theory.  Whereas in America the synthesis in the neoclassical synthesis squeezed Keynes into a more conventional ‘equilibrium’ box where economies are stable and markets stabilising and things tend to settle down except where there are external ‘shocks’, or where prices are ‘sticky’ – like – heaven forfend – when people don’t automatically drop their wages if their is a bad week.  The Post Keynsians attacked the foundations of this view, but for many years were a small group.  They achieved a few notable victories, notably from economist Piero Sraffa who for a time seemed to shake the whole foundations of economics with results neo-classicism couldn’t explain and which even the giants of the time such as Paul Samuelson admitted defeat on.  But it didn’t go anywhere.  It was a Pyrrhic victory.  The results were dismissed as being abstract and of no practical importance.

Have the heirs of Wyne Godley and Hyman Minsky begun to defeat neoclassical economics?

Everything carried on as before and heterodox figures were confined to a small club.  There was a reason for this – money – or rather lack of a theory and model of money and banking.  In the last 20-30 years however to fill that that huge gap, a theory of money, credit and banking, developed.  It was known as the French circuitist school.  Its ideas were actually very similar to ideas which were dominant before the second world war, that an expansion of money is based on credit, which is founded on profits in the future funding loans and creating monetary expansion today, through profits funding interest on loans, as opposed to investments created through savings, which is not monetary expansion as it is simply spending deferred until the future –  the monetary stock does not change.     A second breakthrough came with the work of Wyne Godley,  who incidentally is the model for the St Michael defeating the Devil on the side of Coventry Cathedral.  He took this approach toward money and modelled how it flowed between bank accounts and the economy.  This approach became known as stock-flow consistent economics.  The other key figure was Hyman Minsky – again a fairly marginal figure in his lifetime but a cult figure now –  since who set out a model of financial instability – how a boom in credit could create a financial crash and recession.  Steve Keen was the figure who brought these ideas together and more importantly created a dynamic computer economic model – which he used to predict the 2007 crash, and further more the risk of a further ‘double dip’ which we have actually now begun to see.

Although Steve Keen launched frequent attacks on the neo-classical citadel Krugman seemed to ignore Keen.  Until last week, and then it all kicked off.  Exactly what the issues were and how they were argued will have to wait till another day as it deserves a more through treatment in terms people can understand without jargon and maths.  In short though Krugman attacked a paper of Keen’seven though he professed not to really understand the ideas behind it.  The reaction on the internet was instant, the comments on Krugman’s blog made it clear that Krugman should learn this stuff and moreover most felt Keen was right.  The reaction of Krugman was to lash out accusing Keen and his critics of mysticism.  This simply unleashed a torrent of criticisms on the web, which to my eyes were about 20:1 in favour of Keen.  The problem was that Krugman seem to express some very naive and out of date ideas on how money works.  If you want to follow the arguments here is  Krugmans follow up and a third post. To which Keen replied here, and then  here.

Keen responded by calling Krugman’s economics ‘ptolomiac’ as outdated as assuming the sun revolved around the earth.  I chipped in a short piece explaining how Krugman’s economics weren’t even ptolomiac – as it was timeless so the earth didnt even spin.  The piece went through Krugman’s ideas on how investment is funded and how money is created and tried to show some flaws in his approach.  To my surprise Keen to whom I am just an acquaintance of and occasional correspondent with posted my piece in support and retweeted some of my more abtuse theoretical points.  From his blog.

I’m rather lucky with the calibre of my blog members, and that’s been in evidence in the discussion over Krugman here in the last few days. One comment by Andrew Lainton simply has to be shared more widely…

Gulp.  Krugman responding to the Ptolomiac criticism lashed out – but made a critical error, he quoted Keen selectively in order to make him look like some kind of unknowledgeable idiot.  The blogoshere spotted this instantly and came down on Krugman like a tonne of bricks, the argument became for a time intemperate.  Scott Fullweiller made a slam dunk intervention.  Until suddenly, Krugman, seeing that many had considered he had made an idiot of himself withdrew from the field saying im right, the rest of you are wrong and im not taking part in the debate any more – he took his ball home.  Though he did come back with the rather limp defence that the New Keynesian theories  were somehow different and not the kind of ‘DGSE’ models that Keen has attacked and.

I’m all for listening to heretics when they offer insights I can use, but I’m not finding that at all in this conversation, just word games and continual insistence that the members of the sect have insights denied to us lesser mortals. Time to move on.

Which the blogosophere immediately picked up on as hypocracy as New Kenynsian models are built on the mathematical foundation on DGSE and it was Krugman who was playing word games and refusing to engage with the criticisms of why they were wrong.

Ana -Berlin summed it up

What this latest Krugman post shows is a bad faith, not superior knowledge. I’ve read Keen’s blog and Krugman’s original posts along with all the readers comments and seems to me that 1) Krugman tried to debunk an opposing theory with a couple of coffee table talk remarks which is in itself a massive display of petulance. 2) Krugman constantly appealed to “authority” to disguise is inability to engage the opposing theory on scientific grounds (e.g. cannot go to Berlin due to more important engagements). 3) When hounded by readers who, correctly, point out that his arguments are fallacious and that he fundamentally misunderstands the role of banking, Krugman resorts to some third party opinion who, conveniently, misrepresents Keen’s points completely. 4) it all ends in a nasty tone, with Krugman insulting Keen, and here, one should note, that this is not a symmetric battle, you are talking about a Nobel prize winner, world wide known economist trying to diss and belittle a much lesser known professor out of spite.  On a final note i would advise everybody to get acquainted with Keen, Krugman is not going to write economical history

In terms of the argument the overwhelming view of the internet was the Krugman had lost the debate and this was one for the history books – perhaps even a turning point in the dominance of neolassical economics – or neo-con economics as I call it.  As I said a few days ago ‘this week will be remembered as the end of the beginning of the end of neo-classical economics’.

Interestingly many of the key theoreticians in this new approach come from a non economics background, such a historians, traders, and engineers, so why should not even a town planner join in.  Neo-classical economics had become so degraded that it needed to be torn down from the outside.

Neo-classical economics now has its wagons circled because there have been a number of attacks recently even from outside and inside the corral, from figures such as Eggertson and Kocherlakota which imply that disequilibrium is the norm and that you get this even when prices are fully flexible – so the defence that New Keynsianism is somehow immune to criticisms for its inclusion of ‘stickiness’ falls apart.  These results if followed through imply that the foundational principles of neo-classical economics are incoherent and must be replaced by a dynamic disequilibrium alternatives on broadly the lines that Keen and others have suggested.

As Keen Said on Capital Account last night – video at top

Hey, your models didn’t predict the financial crisis, we can ignore your models….

[Y]ou can’t model the economy without including the role of banks, debt, and money. And Krugman’s part of the economic establishment, which for thirty or forty years has got away with arguing that you can model a capitalist economy as if it had no banks in it, no money, and no debt… You just don’t have a model of capitalism if you don’t include those components.

19 thoughts on “Blog Brawl Bests Nobel Prize Winning Economist – and ‘gulp’ i’m dragged into Brawl

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  2. The only reason why people on his blog are taking Krugman to task with his fallacious arguements, misrepresentations and lack of basic economic knowledge, is because Steve Keen is also a progressive.

    Welcome to the world of Paul Krugman. Because his usual targets are republicans, libertarians and anyone to the right politically, never a critical eye is passed upon his general ignorance.

    Let me give you an example, he claims the great depression of the 1930’s was caused by Hoover, who implemented austerity and refused to spend. Even the briefest facts show Hoover increased spending and actually implemented most of the ‘New Deal’ programs before the next administration.

    Krugman many times quotes Hoover diary ‘liquidate the banks, liquidate the farmers, liquidate everything’ as proof that Hoover was an austerity devil. But the actual quotes are taken out of context, Hoover mentioned them as an example of advice he did NOT take. He did the opposite!!

    So why would Krugman selectively misquote like this? Because Hoover was a republican and the next administration were democrats. He will dishonestly misquote even his reading of history to score political points. You will not get an unbiased and scientific analysis from Krugman, he is incredibly dishonest.

    • Hoover was qouting his own treasury secretary Andrew Mellon – actually hoover gets a poor rap as he actually reigned in that Secretary. Poor scholarship from Krugman. The federal budget rose from 1929-1931-32 and was only cut in 32-33, the fiscal year beginning in July 1st. By 1931 the deficit had risen to -4.1% of GDP. Hoover was strongly influenced by the proto-Keynesian ideas of Foster and Catchings, who also influenced FDR who increased the deficit.

      Hoovers problem was he didnt follow through and contracted the budget in 32-33, just as bank failures were reaching crisis point. Monteary policy was looened in 1932 -33 but popular opinion was that Hoover had done too little too late and FDR swept the board in 1933, 34-36 were boom years. You will know from Keen that it is the change in debt that matters this tracks across these years and across administrations.

      See William J. Barber. Herbert Hoover, the Economists, and American Economic Policy, 1921-1933 (1985)

      • I should add that Hoover may have accidently done the country a favour by trashing the Bonus Army camp in 1932, as it so pissed off Gneral Smedly Butler, a republican, that he supported FDR, and when Du Pont and JP Morgan (allegedly) approached him to lead a coup against FDR he reported it to congress.

        Of course the other thing Hoover did to seal his own fate was to stick to the Gold Standard too long.

  3. Robert Higgs says the series of government decisions of the time created so much uncertainty that business were not willing or confident to invest, thus prolonging the great depression.

    Your comment about Smedly Butler and the coup attempt ties into this. Imagine if you were a capitalist or industrial leader, and you hear on the grapevine about a failed fascist coup attempt. You look across the water and see what is happening in italy and germany. Would you put up your capital to build factories and expand business? You could be on the wrong side of the next coup, and thus be a big loser in the coming highly regulated fascist economy.

    • If the Higgs thesis was correct how come GDP growth grew to 14% under the new deal, a record? Certainly some may have held out early on but people with jobs spending again turns around business confidence – neo-con FUD i’m afraid.

      After the failed coup crony capitalists knew the new deal was around for the duration and so no investment strike. Also they knew the supreme court decisions were as good as they would get – no fear of drift to ‘socialism’ but fiscal policy would cause expansion. Expectations adjusted.

  4. Are you serious? You equate government spending GDP growth with real business led GDP growth? And then you label Higgs theory as Neo-Con FUD? Since when has this ever been a neo-con or even neo-liberal arguement?

    It seems you have a limited knowledge of this area, but because it sounds ‘kind of right-wing’ then it must be those neo-cons eh Andrew? Very Krugman like.

    • Sorry Higgs theory is not backed by the evidence – GDp growth is GDP growth – what matters is whether the deficit is sustainable. Most jobs in mid 30s were private sector jobs growth not public.

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