Monthly Archives: April 2014

Paul Krugman, Gattopardo Economist, Part 2

As mentioned in my previous blog, Paul Krugman tries his best to put down heterodoxy. His claims that nobody predicted the crisis is deeply unintellectual when someone such as Wynne Godley and other heterodox economists had warned about it. Moreover, Jan Hatzius who uses Wynne Godley’s approach also had made a case for a severe deflation around 2007. There’s a reason I bring in Hatzius because sometime ago, Paul Krugman mentioned Jan Hatzius:

Now, it’s interesting to note that the really smart Wall Street money doesn’t buy into this canon. Jan Hatzius and the rest of the economics group at Goldman have an underlying macroeconomic framework pretty much indistinguishable from mine, and have consistently talked down the risks from easy money and deficits.

[emphasis: mine]

There are two things dishonest about this. First, Jan Hatzius pays tribute to Wynne Godley when he writes for Goldman Sachs about the sectoral balances approach and obviously doesn’t mention Krugman. Second Wynne Godley was a heterodox economist and strongly against orthodoxy. Jan Hatzius uses Wynne Godley’s approach and Krugman claims it is indistinguishable from his and sidelines heterodoxy.

What’s going on here?

Paul Krugman, Gattopardo Economist

In response to Thomas Palley’s op-ed, Paul Krugman has written a couple of pieces on his New York Times blog (here and here)

I have seen many heteredox economists defending Krugman but these pieces should now make it crystal clear that Paul Krugman himself is the head of Gattopardo Economics. Consciously or subconsciously, Krugman’s strategy has been to sideline heteredox, in the hope that pages of history sing praises of him. Unfortunately for him, whenever he gets into a technical argument with heteredox economists on money, he makes the silliest mistakes.

Rather than giving many examples of why Krugman is the part of the problem, let me illustrate one example where he pushed very hard on the issue of free trade. It is a lecture paper for Manchester conference on free trade, March 1996 titled Ricardo’s Difficult Idea.

The following quote is clearly a strategy for propaganda:

5. What can be done?

I cannot offer any grand strategy for dealing with the aversion of intellectuals to Ricardo’s difficult idea. No matter what economists do, we can be sure that ten years from now the talk shows and the op-ed pages will still be full of men and women who regard themselves as experts on the global economy, but do not know or want to know about comparative advantage. Still, the diagnosis I have offered here provides some tactical hints:

(i) Take ignorance seriously: I am convinced that many economists, when they try to argue in favor of free trade, make the mistake of overestimating both their opponents and their audience. They cannot believe that famous intellectuals who write and speak often about world trade could be entirely ignorant of the most basic ideas. But they are — and so are their readers. This makes the task of explaining the benefits of trade harder — but it also means that it is remarkably easy to make fools of your opponents, catching them in elementary errors of logic and fact. This is playing dirty, and I advocate it strongly.

(ii) Adopt the stance of rebel: There is nothing that plays worse in our culture than seeming to be the stodgy defender of old ideas, no matter how true those ideas may be. Luckily, at this point the orthodoxy of the academic economists is very much a minority position among intellectuals in general; one can seem to be a courageous maverick, boldly challenging the powers that be, by reciting the contents of a standard textbook. It has worked for me!

(iii) Don’t take simple things for granted: It is crucial, when trying to communicate Ricardo’s idea to a broader audience, to stop and try to put yourself in the position of someone who does not know economics. Arguments must be built from the ground up — don’t assume that people understand why it is reasonable to assume constant employment, or a self-correcting trade balance, or even that similar workers tend to be paid similar wages in different industries.

(iv) Justify modeling: Do not presume, as I did, that people accept and understand the idea that models facilitate understanding. Most intellectuals don’t accept that idea, and must be persuaded or at least put on notice that it is an issue. It is particularly useful to have some clear examples of how “common sense” can be misleading, and a simple model can clarify matters immensely. (My recent favorite involves the “dollarization” of Russia. It is not easy to convince a non-economist that when gangsters hoard $100 bills in Vladivostock, this is a capital outflow from Russia’s point of view — and that it has the same effects on the US economy as if that money was put in a New York bank. But if you can get the point across, you have also taught an object lesson in why economists who think in terms of models have an advantage over people who do economics by catch-phrase). None of this is going to be easy. Ricardo’s idea is truly, madly, deeply difficult. But it is also utterly true, immensely sophisticated — and extremely relevant to the modern world.

[Highlighting: mine]

Keen’s Reply To Palley

Steve Keen has replied to Thomas Palley’s critique of him with an article How not to win an economic argument.

All models are incomplete because they ignore many complications in order to highlight a few key concepts. In other times, a simple model is a starting point with the aim that the modeler adds more complications to make it more realistic. So it is sometimes not a good critique to point out what the models misses. But Steve Keen is making it look as if Palley’s critique is of what his models do not have.

This is diverting attention. For about two years or more, Keen has given all sorts of definitions of aggregate demand. The reason Palley’s critique is so solid is that it again points out that Keen’s definitions are wrong. Keen has repeated statements on aggregate demand and “change in debt” many times, making it sound like a universal law. Palley has shown via very straightforward arguments as quoted in my previous post Thomas Palley’s Nice Critique Of Steve Keen’s Models that the definition is incorrect. Moreover, Keen has changed his definitions as highlighted by a nice blog article by JKH. In my opinion Keen himself is confused on which definition is right and uses all of them together many times without realizing that they are different. His earlier definitions were simply incorrect on basic flow of funds accounting.

In short, there is no simple expression for changes in aggregate demand with changes in debt, a point mentioned by Nick Edmonds on his blog. Even if not, one could argue that it is useful but that is not the case because even at the theoretical level, there are conceptual issues, a lot because Keen doesn’t do his accounting right. Such things are not mere technicalities but the concepts of flow of funds is highly important to make some progress in analytic modeling.

Keen says:

My approach was to take the other side’s model, and show that if their assumptions were correct, they were right: banks could be ignored in macroeconomics, and changes in private debt had only a miniscule effect on demand.

Then I made one realistic small change, and hey presto — banks were essential to macroeconomics, and changes in private debt were the main game (but not the only one) in changing aggregate demand.

True neoclassical economists do not incorporate money and debt in their analysis but Keen has all this while given hints that Post-Keynesians themselves have not if you see his videos. Even the above quotes suggests as if nobody has done this before Keen. That coupled with the fact that Keen considers anyone having issues his models to be sinful of the loanable funds model. There is an irony here because Keen himself makes errors of the loanable funds approach when distinguishing bank debt and non-bank debt.

In my opinion Keen should completely get rid of this aggregate demand/change in debt slogan. Rejection of this does not mean debt is unimportant and all that. There are nice and realistic models such as that of Wynne Godley and Marc Lavoie (G&L) in which money and credit are central to the analysis and with no need at all for Keen’s fondness of aggregate demand/change in debt. These models have a very important role for aggregate demand and credit and feedback effects and so on but there is no need for inventing new definitions.

Neither is there any need for Lebesgue integrals. If one repeats Keen’s analysis where an economic unit pays for a good with a debit card or cash instead of a credit card, then it violates his own aggregate demand/change in debt definitions.

Profits And Borrowing

I think Marshall Auerback is seriously mixing up different parts of the flow of funds accounts of an economy. He is heteredox, so it will be good if he gets these things right.

In his latest, he asks Why Are US Corporations Borrowing So Much If Profits Are At A Record Percentage Of GDP? (original link no longer works, replaced by web.archive.org alternative), i.e., the reported profits seems contradictory to the fact that borrowing is rising. As mentioned in my recent blog post Massive Overstatement Of Profits?, Auerback attributes it to firms cooking the books. In his latest, he says:

 … debt is once again rising relative to GDP.  That shouldn’t be happening if corporate savings (profits) are booming.

Funnily, his question precisely has the answer: because profits are rising, so has liabilities of U.S. firms, because increased profits has led them to increase investment. This can easily be shown via a few national accounts/flow of funds identities. For the nonfinancial production firms sector, we have:

Net Lending = Undistributed Profits − Investment

Profits is undistributed profits plus dividends, and net lending is net acquisition of financial assets less net incurrence of liabilities,

Net Lending = NAFA − NIL

so,

NIL = Investment − Profits + Dividends + NAFA

where NIL and NAFA are firms’ net incurrence of liabilities and net acquisition of financial assets, respectively in the language of the flow of funds or the system of national accounts such as the 2008 SNA.

This suggests that if profits rise, firms may incur less liabilities but assuming other things in the equation stay the same. But if other things are themselves changing — such as if investment is rising, profits can rise simultaneously with rising liabilities. It is slightly paradoxical at first but CFOs generally know that firms’ borrowing requirement may rise when it is growing fast and the same is possible even if firms are taken as a whole. Firms may also buy back shares by borrowing from banks and this adds more interesting things to the story.

Of course, it is possible that the rising debt may move into an unsustainable territory but this story is a bit different than cooking the books interpretation of Auerback.