The “crude Keynesian” debate

This is my Perspective column from this week’s Fund Strategy magazine.

Readers of this column may wonder why I often use Paul Krugman as a foil for my arguments. The reason is straightforward. His views are a lucid and high profile expression of the economic mainstream.

In that sense quoting the New York Times columnist, Nobel laureate and Princeton professor should be seen as a compliment. I choose to critique his arguments precisely because they are a sophisticated exposition of the dominant view.

If he has a personal failing it is intolerance. He too often assumes that anyone who strays far from his own views must either by stupid or malevolent.

None of this is meant to suggest that Krugman agrees entirely with, say, the Obama administration. On the contrary, he has criticised it for not going far enough in promoting fiscal stimulus. But Krugman’s views can be seen as broadly akin to what Obama would do if he did not feel obliged to make messy political compromises.

There are also other high profile economists who share similar views including Bradford DeLong of the University of California, Berkeley, Larry Summers of Harvard and Martin Wolf of the Financial Times. But none quite have Krugman’s public presence.

Given his importance it is worth noting when he gets into a huge public spat with another well-known public figure: Jeffrey Sachs of Columbia University in New York. With Sachs, as with Krugman, it is a great understatement to call him an “economist”. He is an important political figure (with a small “p”) who, among many other things, has advised the United Nations on its development goals.

The public bust-up started when Sachs co-wrote a piece for the Washington Post in which he slated Krugman for arguing that fiscal deficits do not matter (“Deficits do matter” Washington Post 7 March 2013). It accused Krugman of holding a “crude interpretation of Keynesian economics” and argued that cutting the deficit should be an immediate priority.

Krugman responded with a post on his New York Times blog which was simply headed “crude” (10 March 2013). The main thrust of his rebuttal was his argument was “pretty sophisticated” and that he only favoured ignoring the deficit in the special conditions of today.

Sachs responded with a full scale riposte in the following day’s Huffington Post (“Professor Krugman and crude Keynesianism”). Sachs alleged that Krugman was wrong in four main areas including his view that the crisis is overwhelmingly cyclical and the focus should be on raising aggregate demand.

At the time of writing Krugman had fired the last salvo (“Dwindling deficit disorder”, New York Times, 11 March 2013). He used it to point out that the deficit is dwindling and saying that “fiscal scaremongering” is a pretext for slashing welfare spending.

No doubt part of the reason for the heat generated in the debate is the clash of giant egos. But, behind some of the technicalities, there are some important issues at stake.

It is not necessary to accept all of Sachs’ points or his agenda, including his support for a green infrastructure, to see a kernel of truth in his criticisms.

First, Krugman and others clearly seem wrong to me in arguing that the current crisis is largely cyclical. For example, the long-term trend in US productivity growth is downwards (see the recent study by the Conference Board, an independent business research organisation: (2013 Productivity Brief – Key Findings 24 January 2013). Despite all the hype about robots and information technology there is relatively little innovation going on in the American economy and indeed elsewhere in the West.

The financial crisis of 2007-08 and the subsequent fall-out can be seen as a symptom of measures taken to postpone tackling this underlying problem. For many years in the run-up to the crisis the authorities kept public spending high and interest rates low as a way of offsetting this underlying weakness. Yet postponing the challenge just made matters worse.

Krugman makes clear that he favours more prevarication or what is sometimes called “kicking the can down the road” (“Kick that can”, New York Times, 8 February 2013). This ignores the reality that the authorities have already prevaricated for many years.

This point relates to Krugman’s second important error. He sees the crisis as existing primarily on the demand side of the economy. The weakness of the productive sphere is played down or ignored.

Krugman acknowledges that he developed his theory of the current crisis through studying Japan’s malaise in the late 1990s. Yet his argument at the time was essentially circular.

He claimed that Japan was suffering from a liquidity trap in which consumers were anxious about spending. They were fearful that if they bought something today it might be cheaper tomorrow.

Although this might describe how consumers perceived the problem it is not an adequate explanation. It failed to explain how Japan got stuck in a rut of low growth in the first place.

The same is true in Krugman’s writing on contemporary America. He is much more comfortable discussing problems related to consumption than in grappling with the economy’s weak underlying dynamic.