by Michael Roberts
Paul Krugman has laid into Ben Bernanke, the head of the US
Federal Reserve, for stopping his previous policy of easy money and
quantitative easing. By pausing, Krugman reckons that the Fed could
allow the US economy to slip back into recession: “He has not done
remotely enough. The Fed, under its eminent chairman, was supposed to be
an important part of the solution to mass unemployment. That isn’t
The thing is that Ben Bernanke is not a Keynesian. He is really a
follower of Milton Friedman, the deceased right-wing Chicago economist
and adviser to the Chilean dictatorship of General Pinochet in the
1980s. Friedman started off as a Keynesian, but eventually argued that
depressions are caused by the lack of sufficient money supply (the
quantity theory of money). Central banks need to get the right amount
of money supply in an economy to get it to grow at full employment: too
little and you have a recession or even depression as in the Great
Depression; too much and you get inflation. So recessions are the fault
of central banks.
Bernanke agrees with this theory. As he said at Friedman’s 90th birthday tribute: “regarding the Great Depression, you’re right. We did it. But thanks to you, we won’t do it again.” He
meant that the Great Depression was the fault of a Federal Reserve that
released too much money into the economy and then took it away too
quickly. Now Bernanke wants to avoid a debt deflation, where
debt rises in real terms because inflation turns into deflation in a
slump. But he also wants to avoid inflation. Right now, at least
according to his latest Fed statement last Wednesday, he is not sure
which way the economy is going. So he is sitting on his hands and
pausing on any further quantitative easing. Bernanke said in his press
conference that his current policy, given that there is inflation, is
completely consistent with his old views on the Great Depression.
Krugman wants more action, presumably more QE, as he reckons the
economy is in a Keynesian ‘liquidity trap’, where companies are not
investing and households are not spending and instead are ‘hoarding’
cash, even though interest rates are near zero (at least from the Fed)
and borrowing is cheap. For Keynesians like Krugman, government
spending is fine under certain conditions: when there is liquidity trap;
when there is high unemployment and when the lack of demand persists.
Then the multiplier effect on GDP growth from more spending can be high
(see Pontus Rendahl, A case for balanced budget stimulus, 26 April 2012, www.voxeu.org).
The Modern Monetary Theory (MMT) guys reckon that it does not take a
liquidity trap to prolong a depression. If there is no demand for
credit, then no amount of leading a horse to the trough will work. So
the MMT guys want fiscal action through more government spending. As
Bill Mitchell put it in his blog (http://bilbo.economicoutlook.net/blog/): “The
Modern Monetary Theory (MMT) does not rely on the existence of a
“liquidity trap” (however conceived) to make a case for the
effectiveness of fiscal policy. Paul Krugman and others, who currently
advocate the the use of fiscal policy, only do so because they claim
there is a liquidity trap which renders monetary policy ineffective.
However, in normal times they advocated the primacy of monetary policy.
MMT can demonstrate the ineffectiveness of monetary policy outside of a
liquidity trap. The reality is that policy makers have very little idea
of the speed and magnitude of monetary policy impacts (interest rate
changes) on aggregate demand. There are complex timing lags given how
indirect the policy instrument is in relation to its capacity to
influence final spending. Further there are unclear distributional
effects – creditors gain when rates rise, debtors lose. What will be the
net effect? Central bankers do not know the answer to that question.
Monetary policy is also a blunt policy instrument that has no capacity
to target specific segments of the spending population or regions. We
always knew that. … By continuing to see quantitative easing as the
solution, the more progressive mainstream economists have also caused
the current crisis to be extended.”
That brings me back to my previous post (Paul Krugman, Steve Keen and the mysticism of Keynesian economics,
21 April 2012) and taking it a little further. Some comments on my
last post on Keynesian economics suggested that I had been too harsh on
Keynes and his followers, not distinguishing clearly enough between
‘New’ or ‘Post-Keynesians’ who had watered down Keynes so his theory
could be synthesised with neo-classical economics. Keynes, himself, was
much more radical, says Krugman. Well maybe. Keynes himself
considered his ideas as “moderately conservative in its implications”.
But then Keynes changed his views and his opinions on a regular basis.
Once, when questioned about his inconsistency by his neoclassical
critics, he said “well, when the facts change, I change my ideas, don’t you?”. The trouble is it depends on whether the facts have changed or just your view of them.
One of the main issues for me is whether Keynesian claims about the
lack of ‘effective demand’ constitute a causal theory of crisis or just a
tautology. Is not the lack of effective demand really a description of
a slump rather than its cause? Paul Krugman, in a little piece called Reading Keynes,
tells us that where aggregate demand intersects with aggregate supply,
we can find ‘effective demand’ and this equilibrium point could be well
below that necessary for full employment in an economy. This is the key
argument of Keynes against the neoclassical school of economics, who
claim that supply will create sufficient demand to avoid unemployment.
This is Keynes refuting the fallacy of the so-called Say’s law that
claims supply creates its own demand. This is supposed to be startlingly
new, although several economists in the 19th century, including Marx,
had already shown this.
In his well-known (among economists) attack upon the failure of
neoclassical economics to explain economic recessions and particularly
the Great Recession (How did economists get it so wrong? 6 September 2009, NYT Magazine), Krugman presents his ‘co-op babysitting’ example. He says “a
recession is a problem of inadequate demand. There isn’t enough
babysitting demand to provide jobs for everyone who wants one.” But
this is not an explanation, but a description. Inadequate demand
arises in the baby coop because people hold onto the money rather than
buy babysitting services. This is really yet another refutation of
Say’s law. All it shows is the possibility of a breakdown between
buying and selling because of money. Marx had described that
possibility over 150 years ago. It’s not new. But in Krugman’s
example, there is no explanation of why or when the coop starts hoarding
money rather than spending it; it just starts happening. Krugman puts
it down to ‘irrational’ people and ‘imperfect’ markets (the latter, a
It’s the same problem with the explanation of depression as due to a
liquidity trap i.e we get to ‘zero bound’ interest rates and there is
still no new spending on investment or consumption. This liquidity trap
can be shown by the ‘velocity of money’ in an economy. Look at this
graphic. It tells the same story as the money multiplier graphic in my
In the Great Depression, the economy becomes ‘stuck’ in a trap of
unwillingness to spend – the velocity of money line is well below
average. This is the problem, says Keynes and Krugman. Yet in the
Great Recession, according to the graph, the liquidity trap is not so
obvious. And anyway, why has it happened? Because there is an
unwillingness to spend! In other words, there appears to be no rational
explanation for why the velocity of money drops suddenly in the Great
Depression or the Great Recession except that it does. But in a
capitalist monetary economy, such hoarding can be perfectly rational if
we connect with a fall in profitability for investment. Then there is
less confidence to invest further and hoarding starts. Look at the
current state of affairs, with US corporations building up huge cash
piles and investing relatively less (see my post, Why is US recovery so weak?- look at profitability, 3 April 2012).
The Austrian school of economists argue that the slump in investment
is due to previously excessive credit expansion that is now bursting.
The Minsky school says much the same (as does Steve Keen – see my last
post). Those who believe this have attempted to measure the point at
which excessive credit or debt becomes the tipping point for a crisis.
The economists Reinhart and Rogoff have done so; the IMF has done so
and apparently so has Steve Keen (see my post, Riccardo Bellofiore, Steve Keen and the delusions of debt, 7 October 2011).
Irving Fisher was the ‘debt deflation’ economist of the interwar
period. He reckoned that there were waves of excessive credit or debt,
which eventually led to ‘debt deflation’ ie falling prices drive up the
real value of debt and so painful deleveraging must follow to reverse
the excess. This is the main reason for booms and slumps. So debt
matters. Krugman seems to recognise that there could be “debt-driven
slumps”. In 2010, he wrote a piece with Gauti Eggertsson (Debt, deleveraging and the liquidity trap, 16 November 2010) that argued an “overhang of debt on the part of some agents who are forced into deleveraging is depressing demand.” From that debt deflation (Fisher-style), the liquidity trap and the Keynesian multiplier emerge. And this provides a “rationale for expansionary fiscal policy”.
Krugman called it a Fisher-Minsky,Koo approach to the crisis, although
Steve Keen has remarked that he could find little of Minsky in the paper
(remember Krugman has little time for Minsky’s financial instability
Yet more recently, Krugman appeared to deny the role of debt in
crises. Krugman says it does not matter in a ‘closed economy’ i.e. one
where one man’s debt is another’s asset. It’s only a problem if you owe
it to foreigners. But the IMF disagrees. In its latest World Economic
Outlook, April 2012, IMF researchers take Krugman to task. The IMF
outlines the evidence that debt does make a difference both to the depth
of the crisis and the strength of the recovery: “recessions preceded by economy-wide credit booms tend to be deeper and more protracted than other recessions” (p96) and “housing
busts preceded by larger run-ups in gross household debt are associated
with deeper slumps, weaker recoveries and more pronounced household
Indeed, there is no guarantee that an economy will come out of a
slump. That’s why Fisher misread the slump of 1929. He thought would
be over in a moment, once debt had been cleared. Instead, it took a war
ten years later to do it. This time too, the clearing of both ‘dead
capital’ in production and fictitious capital in finance is going to
take a long time. So we are in what is really a ‘long depression’ as in
the 1880s in the UK and the US. The great boom then (or ‘great
moderation’ now) of 1850-73 (1982-97 now) came to end in a big crash
(1873 then, 2007 now), and subsequently it took a series of slumps
(1879, 1883, etc or 2008-9) to clear the decks for renewed profitability
before capitalism entered a new period of growth from the 1890s
onwards. The long depression of the 1880s did not lead to a world war,
but to the massive extension of imperialism that helped to get
capitalism going (that later ended in war).
So it is no surprise to find that the best way to clear this
excessive debt is to default. A recent study by the IMF on private and
public sector debt found that the easiest way to get debt under control
in the absence of fast economic growth (current conditions) was to
default! (IMF special paper, Default in today’s advanced economies, 2010).
So let’s sum it up. What is the cause of booms and slumps or
economic recessions or depression? The dominant neoclassical school of
economics says any slump is due to imperfections or ‘frictions’ in the
market place (namely trade unions or governments disturbing the labour
market or monopolies distorting product markets). In other words, when
so-called ‘efficient markets’ are no longer efficient.
Keynesians reckon it is caused by the lack of ‘effective demand’,
which happens by chance or by ‘irrational’ behaviour on the part of
‘economic agents’, who suddenly hoard money rather than spend it.
Sometimes this can lead to a ‘liquidity trap’ at ‘zero bound levels’ of
interest-rates and so prolong a recession into a depression.
The Minsky school says the cause is an inherent instability in
financial sector due to excessive risk-taking that generates a build-up
of debt that cannot be honoured. The Austrian school says this
excessive credit is caused by government and central banks creating it.
Both say deleveraging of this debt prolongs a slump.
Some Marxists reckon crises and slumps are not caused by a lack of
effective demand or excessive debt or financial instability, but by
falling and low profitability in production. The impact of falling
profitability can be postponed by credit (fictitious capital) expansion,
but then the eventual slump will be exacerbated by the need to clear
this excessive debt. This is my view. Other Marxists reckon the
crisis is due to ‘the anarchy of capitalist production’ (that’s too
vague and too high a level of abstraction as an explanation for me). Or
some say it is due to ‘underconsumption’, or a lack of spending power by
workers. That’s pretty much the Keynesian view (just a description of a
slump not an explanation).
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