paul krugman

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Krugman and Sumner on the Zero-Interest Lower Bound: Some History of Thought

Published by Anonymous (not verified) on Fri, 09/07/2021 - 1:20pm in

UPDATE: Re-upping my post from July 8, 2011

I indicated in my first posting on Tuesday that I was going to comment on some recent comparisons between the current anemic recovery and earlier more robust recoveries since World War II. The comparison that I want to perform involves some simple econometrics, and it is taking longer than anticipated to iron out the little kinks that I keep finding. So I will have to put off that discussion a while longer. As a diversion, I will follow up on a point that Scott Sumner made in discussing Paul Krugman’s reasoning for having favored fiscal policy over monetary policy to lead us out of the recession.

Scott’s focus is on the factual question whether it is really true, as Krugman and Michael Woodford have claimed, that a monetary authority, like, say, the Bank of Japan, may simply be unable to create the inflation expectations necessary to achieve equilibrium, given the zero-interest-rate lower bound, when the equilibrium real interest rate is less than zero. Scott counters that a more plausible explanation for the inability of the Bank of Japan to escape from a liquidity trap is that its aversion to inflation is so well-known that it becomes rational for the public to expect that the Bank of Japan would not permit the inflation necessary for equilibrium.

It seems that a lot of people have trouble understanding the idea that there can be conditions in which inflation — or, to be more precise, expected inflation — is necessary for a recovery from a depression. We have become so used to thinking of inflation as a costly and disruptive aspect of economic life, that the notion that inflation may be an integral element of an economic equilibrium goes very deeply against the grain of our intuition.

The theoretical background of this point actually goes back to A. C. Pigou (another famous Cambridge economist, Alfred Marshall’s successor) who, in his 1936 review of Keynes’s General Theory, referred to what he called Mr. Keynes’s vision of the day of judgment, namely, a situation in which, because of depressed entrepreneurial profit expectations or a high propensity to save, macro-equilibrium (the equality of savings and investment) would correspond to a level of income and output below the level consistent with full employment.

The “classical” or “orthodox” remedy to such a situation was to reduce the rate of interest, or, as the British say “Bank Rate” (as in “Magna Carta” with no definite article) at which the Bank of England lends to its customers (mainly banks).  But if entrepreneurs are so pessimistic, or households so determined to save rather than consume, an equilibrium corresponding to a level of income and output consistent with full employment could, in Keynes’s ghastly vision, only come about with a negative interest rate. Now a zero interest rate in economics is a little bit like the speed of light in physics; all kinds of crazy things start to happen if you posit a negative interest rate and it seems inconsistent with the assumptions of rational behavior to assume that people would lend for a negative interest when they could simply hold the money already in their pockets. That’s why Pigou’s metaphor was so powerful. There are layers upon layers of interesting personal and historical dynamics lying beneath the surface of Pigou’s review of Keynes, but I won’t pursue that tangent here, tempting though it would be to go in that direction.

The conclusion that Keynes drew from his model is the one that we all were taught in our first course in macro and that Paul Krugman holds close to his heart, the government can come to the rescue by increasing its spending on whatever, thereby increasing aggregate demand, raising income and output up to the level consistent with full employment. But Pigou, whose own policy recommendations were not much different from those of Keynes, felt that Keynes had left out an important element of the model in his discussion. As a matter of logic, which to Pigou was as, or more important than, policy, an economy confronting Keynes’s day of judgment would not forever be stuck in “underemployment equilibrium” just because the rate of interest could not fall to the (negative) level required for full employment.

Rather, Pigou insisted, at least in theory, though not necessarily in practice, deflation, resulting from unemployed workers bidding down wages to gain employment, would raise the real value of the money supply (fixed in nominal terms in Keynes’s model) thereby generating a windfall to holders of money, inducing them to increase consumption, raising aggregate demand and eventually restoring full employment.  Discussion of the theoretical validity and policy relevance of what came to be known as the Pigou effect (or, occasionally, as the Pigou-Haberler Effect, or even the Pigou-Haberler-Scitovsky effect) became a really big deal in macroeconomics in the 1940s and 1950s and was still being taught in the 1960s and 1970s.

What seems remarkable to me now about that whole episode is that the analysis simply left out the possibility that the zero-interest-rate lower bound becomes irrelevant if the expected rate of inflation exceeds the putative negative equilibrium real interest rate that would hypothetically generate a macro-equilibrium at a level of income and output consistent with full employment.

If only Pigou had corrected the logic of Keynes’s model by positing an expected rate of inflation greater than the negative real interest rate rather than positing a process of deflation to increase the real value of the money stock, how different would the course of history and the development of macroeconomics and monetary theory have been.

One economist who did think about the expected rate of inflation as an equilibrating variable in a macroeconomic model was one of my teachers, the late, great Earl Thompson, who introduced the idea of an equilibrium rate of inflation in his remarkable unpublished paper, “A Reformulation of Macreconomic Theory.” If inflation is an equilibrating variable, then it cannot make sense for monetary authorities to commit themselves to a single unvarying target for the rate of inflation. Under certain circumstances, macroeconomic equilibrium may be incompatible with a rate of inflation below some minimum level. Has it occurred to the inflation hawks on the FOMC and their supporters that the minimum rate of inflation consistent with equilibrium is above the 2 percent rate that Fed has now set as its policy goal?

One final point, which I am still trying to work out more coherently, is that it really may not be appropriate to think of the real rate of interest and the expected rate of inflation as being determined independently of each other. They clearly interact. As I point out in my paper “The Fisher Effect Under Deflationary Expectations,” increasing the expected rate of inflation when the real rate of interest is very low or negative tends to increase not just the nominal rate, but the real rate as well, by generating the positive feedback effects on income and employment that result when a depressed economy starts to expand.

Paul Krugman On “Economic Nationalism”

Published by Anonymous (not verified) on Sun, 13/06/2021 - 6:35pm in

Paul Krugman has a new article titled Wonking Out: Economic Nationalism, Biden-Style, in which he defends Biden’s economic policy which is a deviation from laissez-faire, in particular free trade.

The article has reference to a 250-page report by the White House titled Building Resilient Supply Chains, Revitalizing American Manufacturing, And Fostering Broad-Based Growth,

The United States’ balance of payment and international investment position is unsustainable and it needs to do something to reverse it. Weakness in international trade and offshoring have led to a lot of economic destruction which was exploited by Donald J. Trump. But the Democratic Party—led by Paul Krugman on economics—attacked Trump for deviating from free trade. But now that they are in power, they have learned a bit from their mistakes and economic realism has also taken over. Even during the Democratic Party primary election, the candidates all agreed that something has to be done on international trade and proposed policies to address it.

Elizabeth Warren, for example had a post on Medium titled A Plan For Economic Patriotism.

It’s a shame that the Democratic Party which has voters consisting of more educated people had to copy or at least follow Donald Trump.

Why is manufacturing important? Because (a) manufacturing is important to exports (b) rise in production leads to faster rise in productivity compared to other things. (c) a process of success leads to higher competitiveness of firms—not just price competitiveness but also non-price competitiveness.

The Biden administration has also not rolled back the tariffs imposed on China by Trump.

Instead, Paul Krugman has this spin:

In any case, however, we seem to be entering a new era of worries about the role of the United States in the world economy, this time driven by fears of China. And we’re hearing new calls for industrial policy. I have to admit that I’m not entirely persuaded by these calls. But the rationales for government action are a lot smarter this time around than they were in the 1980s — and, of course, immensely smarter than the economic nationalism of the Trump era, which they superficially resemble.


As you might guess, then, a lot of the Biden-Harris report focuses on national security concerns. National security has always been recognized as a legitimate reason to deviate from free trade. It’s even enshrined in international agreements. Donald Trump gave the national security argument a bad name by abusing it. (Seriously, is America threatened by Canadian aluminum?) But you don’t have to be a Trumpist to worry about our dependence on Chinese rare earths.

Donald Trump is a shady person and so it’s ironic that the Democratic Party was behind. Paul Krugman in fact even spent the last 5 years or so denying that US trade is a problem. Now he is making it look like Biden and Co. are doing something original.

Many people present the recent changes as some kind of break from neoliberalism. In a sense it is but that way of presenting is misleading: finally the US policy makers are furthering US interests, which could be at the expense of the rest of the world. The United States needs policies to promote net exports—to make its international investment position sustainable—but there are various ways of doing it, such as moving to a system away from free trade or even expanding domestic demand to the point of full employment which won’t restrict total imports, and hence isn’t beggar-thy-neighbour and which is good for the whole world.

But it’s a bit like recent changes in fiscal policy: once the US is out of the woods, leaders and the academia will again go back to same old policies. So Krugman’s piece has a lot of praise for free trade which allows him to argue in the future that free trade is good. Another reason is while US deviates from free trade, politicians and pundits can continue to impose free trade on other countries. Finally the aim is to promote policies which are beneficial to oligarchies and oligarchs. Whatever works! Just like “liquidity trap” is used to argue that fiscal expansion can be done now but that neoclassical economics works otherwise, “national security” concern is used now in case of trade.

In summary, the United States needs policies to make net exports rise faster over imports, which Post-Keynesians have argued earlier than anyone, but the Democratic Party has only learned it by losing. They will try to spin this, impose more free trade on the world, while taking protectionist measures and running industrial policy themselves and create a narrative which makes it easier for them to go back to their old ideology.

The Gatekeeper: Adam Tooze On Paul Krugman’s Evolution

Published by Anonymous (not verified) on Mon, 19/04/2021 - 4:46am in

The Gatekeeper: Adam Tooze On Paul Krugman’s Evolution

Snip from a Paul Krugman article from the 90s.

Adam Tooze has a nice essay on evolution on Paul Krugman’s views. It’s decent although I would critique much more if I were to write it.

There was one part which was quite amusing to me:

The hour and a half Krugman spent laying out his new trade theory at the National Bureau of Economic Research in July 1979 was, he later wrote, ‘the best ninety minutes of my life. There’s a corny scene in the movie Coal Miner’s Daughter in which the young Loretta Lynn performs for the first time in a noisy bar, and little by little everyone gets quiet and starts to listen to her singing. Well, that’s what it felt like: I had, all at once, made it.’

Imagine being so wrong but feeling this way.

Paul Krugman has shifted his views but it’s not as if he has changed for the better to benefit mankind. He is still doing whatever as an establishment hack, trying to preserve power for top corporations.