Paul Krugman’s Return of Depression Economics

A few months ago I commented on Dr. Paul Krugman’s receipt of a Nobel Memorial Prize for Economics. Well he just recently released an update of a ten year old book he has called, The Return of Depression Economics and the Crisis of 2008. Personally, I don’t see how Dr. Krugman is qualified to talk about the return of the current financial crisis given that he didn’t see it coming. However,  if real insight or predictive power were required for macroeconomists to write books, the field wouldn’t exist. 

I haven’t read the book, so I’m not going to judge the proverbial book by its cover, but judging by the reviews off of Amazon Dr. Krugman doesn’t spend much time in this book addressing our current financial crisis. It would seem that the theme of the book is that more regulation is needed to correct various situations that he feels are excessive and most of the situations he presents (such as Long Term Capital Management) are ten years old. Towards the end of the book, Krugman presents his analysis of the current financial crisis. I am not the least bit surprised to read that he feels that our current crisis was the result of insufficient demand.

Krugman is a Keynesian through and through. In a previous column, Krugman attacks Austrian economics (the only econoists which DID see this crisis coming) as being as worth of serious study as “as the phlogiston theory of fire.” Why does Krugman attack Austrian economics so, well let him explain it for himself:

Here’s the problem: As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income (every sale is also a purchase, and vice versa). So if people decide to spend less on investment goods, doesn’t that mean that they must be deciding to spend more on consumption goods—implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?

Krugman is absolutely correct… almost. In fact, he’s so close to the point, you wonder if he is intentionally trying to misunderstand the other side in order to defeat a straw man argument. You see, if the money supply were fixed, then it would be, as he puts it, “a matter of simple arithmetic” regarding total spending. That means exactly what he goes on to say, “an investment slump should always be accompanied by a corresponding consumption boom.” Thus there should not be a rise in unemployment exactly as he says.

He understands Austrian theory perfectly. Surely he must also understand why Austrians demand a return to the gold standard in order to fix the money supply and eliminate the business cycle. But then Krugman goes off the deep end by accusing Austrian economists of having no way to answer why there are any slumps at all. The answer is easy, Dr. Krugman, the money supply is not fixed. Banks are free to expand the money supply at will through the expansion of credit which often finds its way into investments. This creates an unsustainable boom. But surely he must have know that? 

How could someone with a PhD in Economics, much less a Noble Memorial Prize, not understand something so basic? Furthermore, how could someone so completely miss the entire crux of Austrian theory: that expanding the money supply through the expansion of credit often leads to unsustainable booms followed by crashes? He understood it enough to paraphrase the theory, so clearly he must have some familiarity with it. For that matter, why does he go on to suggest that Austrian theorists have never provided an answer to this question given that Dr. Frederick Hayek won a Nobel Memorial Prize for addressing that very question. Did he somehow dupe the Nobel Committee?  If so, I suppose that offers an explanation for how Krugman got his own prize. Even if Krugman somehow didn’t know the answer to his critique of Austrian theory when he penned that article ten years ago, all he would have had to do is read the response to his attack at where they clearly spell it out for him. 

The only answer I can come up with is that Krugman didn’t have an easy answer for the elegant of Austrian theory, and so he chose instead to defeat a straw man argument. In so doing, he has done a disservice to his readership by saying that anyone who believes that recessions are unavoidable if an economy is properly managed is not worth listening to. And yet, here we are in what’s shaping up to be the biggest economic crisis since the Great Depression. Should we listen to the one area of economics that actually predicted this? Not according to Krugman. 

Krugman’s book mirrors his views. If only we could put in the right regulation and oversight (and presumably combined it with just a little inflation) then we could stay in a goldilocks economy forever. His theory does not even stand up to the most cursory of historical analyses, but that doesn’t seem to slow him down. Furthermore, how can Krugman explain Bernie Madoff? He was a multibillion dollar scam going on right under the regulators nose to the tune of billions of dollars. This was EXACTLY the kind of thing the SEC was supposed to stop, but it didn’t. Not even multiple tip-offs that Madoff was up to no good by Harry Markopolos got them to move. For that matter, Madoff had been investigated by the SEC multiple times, and they still came up with nothing. 

If the SEC, FDR’s watchdog industry that was supposed to prevent this kind of thing from happening, failed spectacularly in their duties, then what hope do we have that Krugman’s model of the proper regulation/regulators will keep our economy from ever entering crisis? I’d say not much? Of course, you’re never going to hear Krugman say that. He’s a Keynesian through and through, and a central plank of Keynesianism is that a wise and objective bureaucrat can help compensate for the excesses of the free market. Surely Dr. Krugman is qualified to be a wise and objective, yet he really didn’t see this crisis coming. His explanation for the crisis now that it has occurred is that it was caused through insufficient demand; he acts as though having over-leveraged American consumer  borrow more to spend more is a sustainable theory for economic growth. Dr. Krugman’s solution for this crisis is more of the same that got us here: more government intervention, more debt to fuel more consumer spending; and, whatever you do, don’t listen to the one branch of economics that says this is a bad idea. 

Kudos to you Dr. Krugman. When it comes to altering facts and theory to stubbornly make the failed ideas of John Maynard Keynes seem like the only logical solution, you win the noble prize.

One thought on “Paul Krugman’s Return of Depression Economics”

  1. As an aside: be as hard on Krugman for his ideas as you want, but he’s not the first (and certainly won’t be the last) person who won a Nobel Prize only to be later quoted saying ridiculous things.

    Remember Linus Pauling and his over-the-top craziness about Vitamin C? Very smart people sometimes fall for their own dumb ideas. I guess it’s because they think they can trust their brains not to be fooled. Well, Vitamin C as a cure for cancer is pretty much thorougly discredited, though it lives on in “alternative” medicine land where the twin cults of personality (Linus Pauling won a Nobel Prize, OMG!) and anecdote (my sister had breast cancer, she took Vitamin C and was cured!) will get you a lot farther than rigorous scientific method.

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