Why doesn’t Krugman listen to Krugman?

31 July, 2014 at 22:50 | Posted in Economics | 8 Comments

Paul Krugman wonders why no one listens to academic economists … 

Listening_TitleOne answer is that economists don’t listen to themselves. More precisely, liberal economists like Krugman who want the state to take a more active role in managing the economy, continue to teach an economic theory that has no place for activist policy.

Let me give a concrete example.

One of Krugman’s bugaboos is the persistence of claims that expansionary monetary policy must lead to higher inflation. Even after 5-plus years of ultra-loose policy with no rising inflation in sight, we keep hearing that since so “much money has been created…, there should already be considerable inflation” … As an empirical matter, of course, Krugman is right. But where could someone have gotten this idea that an increase in the money supply must always lead to higher inflation? Perhaps from an undergraduate economics class? Very possibly — if that class used Krugman’s textbook.

Here’s what Krugman’s International Economics says about money and inflation:

“A permanent increase in the money supply causes a proportional increase in the price level’s long-run value. … we should expect the data to show a clear-cut positive association between money supplies and price levels. If real-world data did not provide strong evidence that money supplies and price levels move together in the long run, the usefulness of the theory of money demand we have developed would be in severe doubt …

A permanent increase in the level of a country’s money supply ultimately results in a proportional rise in its price level but has no effect on the long-run values of the interest rate or real output.”

This last sentence is simply the claim that money is neutral in the long run, which Krugman continues to affirm on his blog …

You might think these claims about money and inflation are unfortunate oversights, or asides from the main argument. They are not. The assumption that prices must eventually change in proportion to the central bank-determined money supply is central to the book’s four chapters on macroeconomic policy in an open economy …

So  these are not throwaway lines. The more thoroughly a student understands the discussion in Krugman’s textbook, the stronger should be their belief that sustained expansionary monetary policy must be inflationary. Because if it is not, Krugman gives you no tools whatsoever to think about policy …

Liberal Keynesian economists made a deal with the devil decades ago, when they conceded the theoretical high ground. Paul Krugman the textbook author says authoritatively that money is neutral in the long run and that a permanent increase in the money supply can only lead to inflation. Why shouldn’t people listen to him, and ignore Paul Krugman the blogger?

J. W. Mason/The Slack Wire

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8 Comments »

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  1. Let me preface this question by acknowledging that I have very little grasp on these concepts, BUT, is it possible his views have simply changed as a result of that book being first published in 1988?

  2. I think it’s far far more likely that Krugman does not see QE as a *permanent* monetary expansion.

  3. As usual, a claim is presented: increase in the money supply causes inflation, but without any reasoning. Does anyone else wonder why?

  4. I’m not sure I get the contradiction between Krugman’s two positions, one is short run, one is long run…. ??

    • Exactly right, donald. But in the PR war of smearing someone with opposing views, intentionally misunderstanding is a powerful strategy.

  5. Year after year I was teaching Krugman/Obstfeld I doubted the inter-temporal current account equilibrium theory that they put in their book (see last slide here: http://eml.berkeley.edu/~obstfeld/182_sp06/c16.pdf). I stopped teaching that in 2012 and replaced it with discussion of current account imbalances, which are more complicated, but also much closer to reality. Spain’s current account caused by Spanish people’s wish to consume more today than tomorrow? Inter-temporal equilibrium is not supported by any empirical evidence, and to assume that nations do inter-temporal optimization is way out there.

  6. 1. This is the 2011 edition of the textbook.

    2. Krugman explicitly states that this relationship can be seen even in annual data, at least in Latin America. (And he does not suggest that LA is exceptional in this respect.)

    3. Even if it is a “long run” relationship, that still means higher money growth will lead to proportionate inflation eventually, so inflation hawks are right to expect it. And if he really means a “long run’ relationship that is too slow to matter for policy, why is his entire discussion of macro policy built around this relationship.

    4. Ditto for “permanent” — if 7 years is not long enough, what time frame is this relationship supposed to be operating over. In any case, I very much doubt that Krugman is claiming that markets believe the Fed is going to undertake contractionary policy on the colossal scale required to get money growth back to trend anytime soon — certainly he’s never said so on his blog or elsewhere.

    If he did believe this, then he would be taking a consistent market monetarist position — the whole problem is that the Fed has not stated its intentions sufficiently clearly. As I say in the post, that would save him from the charge of inconsistency — but he is not a market monetarist, and good for him.

    Pontus and Donald, why not read my linked post, and then the chapters in Krugman’s text, and judge for yourselves?

  7. Dirk-

    It was teaching with his text that prompted this post. I’m glad others have had a similar reaction.

    I don’t think the alternative has to be more complicated. IS-LM-BP works fine for an intermediate macro class.


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