Blog observations on Krugman

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I’m rather lucky with the cal­i­bre of my blog mem­bers, and that’s been in evi­dence in the dis­cus­sion over Krug­man here in the last few days. One com­ment by Andrew Lain­ton sim­ply has to be shared more wide­ly:

Wel­come to Lon­don Steve

I hope peo­ple have spot­ted that Krug­man isnt sim­ply propos­ing a loan­able funds approach to banks, where loans are based on the inflow and out­flow of sav­ings by say­ing that banks ‘must buy assets with funds they have on hand’ he is going back to a mid 19th cen­tu­ry wages fund the­o­ry. Krug­mans world isn’t even Ptole­ma­ic, the world does­n’t even turn and time does­n’t exist.

In such doc­trines trans­ac­tions are all paid out of a pot of mon­ey ‘on hand’. A stock. But this doc­trine was dis­proven as ear­ly ago as the 1870s by Krug­mans equiv­a­lent as Amer­i­ca’s most famous econ­o­mist, Fran­cis Amasa Walk­er:

Walk­er proved that it is future antic­i­pat­ed cash flows rather than ini­tial stocks of cash which form the basis for eco­nom­ic deci­sions. Invest­ment deci­sions are based on antic­i­pat­ed prof­its. Fur­ther­more invest­ment allows for the cre­ation of addi­tion­al employ­ment to be employed in activ­i­ties which gen­er­ate growth. Ratio­nal eco­nom­ic deci­sions there­fore are not con­strained by cash on hand but by the abil­i­ty to see cash advanced to be repaid by growth and future cash flows to the investor and his cred­i­tors.

This led to his suc­ces­sor FW Taus­sig Devel­op­ing the mod­ern the­o­ry of cred­it mon­ey ( inde­pen­dent­ly of Hawtry in the same year 1919):

Page 357:  ‘Mon­ey Means are cre­at­ed, and the com­mand of cap­i­tal is sup­plied, with­out cost or sac­ri­fice on the part of any saver’

It is pre­cise­ly because of the pay­ment of inter­est from future cash flows that bankers can cred­it cred­it with account­ing oper­a­tions only, all a bank needs to do is ensure that overnight it remains net cash pos­i­tive, and if it would not be var­i­ous inter­bank and cen­tral bank means are avail­able.

It is if Krug­man had regressed to the mid 19th Cen­tu­ry for­get­ting most of the advances since. Even the most basic bank­ing 101 book pub­lished in the last cen­tu­ry has this bal­ance sheet mod­el of bank­ing. Some with sophis­ti­cat­ed math­e­mat­ics, and yet since the 60s most main­stream eco­nom­ic text­book dont even have a chap­ter on bank­ing.

The ver­sion of the mul­ti­pli­er so vocif­er­ous­ly defend­ed by Krug­man is known as the Fried­man-Swartz-Cagan Mod­el — it is a mon­e­tarist idea and if you read Richard Koo you will see that the research that caused econ­o­mists to use it — the claim that gov­ern­ment high pow­ered mon­ey dri­ves the mon­ey sup­ply is bunkum. Fried­man-Swartz-Cagan is based on a math­e­mat­i­cal iden­ti­ty, but makes a false assump­tion about the direc­tion of cau­sa­tion. It became pop­u­lar pre­cise­ly because it enabled sim­pli­fied treat­ment of mon­ey in macro. Indeed it could sim­ply be assumed away by being fold­ed into the IS/LM mod­el. Thats why Krug­man loves it it is sim­ple but dan­ger­ous and wrong.

Iron­i­cal­ly Phillip Cagan, who per­fect­ed the math of the mod­el lat­er esti­mat­ed that 91% of US mon­ey was endoge­nous rather than gov­ern­ment cre­at­ed.

What Krug­man does­nt like his his favourite macro tools being slagged. But if he could be pre­sent­ed with new tools, or demon­stra­tions of how old ones such as the Cagan iden­ti­ty could be recast he might be less grumpy. Steve needs to con­front Krug­man on his own ground, not Steves, Krug­man ain’t going to go there.

Andrew has his own blog:

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.