Krugman’s models — squeezing out central ideas from Keynes

1 September, 2016 at 16:58 | Posted in Economics | Leave a comment

The gist is that despite Krugman’s claims to the contrary, the analysis is not really Keynesian, at least in comparison to The General Theory, or GT. It does hark back to the world of the turn of the 20th century Swedish economist Knut Wicksell and contemporaries and followers such as Irving Fisher, James Tobin, and Robert Mundell …

Krugman argues that the central bank should somehow intervene to increase expected inflation, reduce the real interest rate, and drive up capital formation. Here he is following contemporary ideas about “inflation targeting,” whereby the central bank is supposed to set an inflation target and then manipulate the interest rate to try to hit it. At a zero interest rate floor, this sort of maneuver is impossible, so the bank is supposed to talk up expectations about rising prices. The observed inflation will then presumably speed up. Whether such incantations will prove effective is by no means clear. Absent a miraculous shift in model closure … supply-side interventions such as raising nominal wages, devaluation, or even FDR’s 1933 pig slaughter program would be more effective.

taylor_press_lowresA round of price increases might well do the US economy some good, especially if it is driven by money wage increases at the bottom of the income distribution. Still, there is no reason to believe that the inflationist confidence fairy’s powers to cure recession will be stronger than those of her austerian colleague. Expansionary fiscal policy and progressive income redistribution would do a lot more good.

Krugman’s model is ingenious, but is neither beast nor fish nor fowl. Natural rate theory and current ideas about inflation targeting and formation of rational expectations of price increases squeeze out central ideas from Keynes about how the macroeconomy functions under fundamental uncertainty. A pity.

Lance Taylor


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