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:

http://www.econlib.org/library/YPDBooks/Walker/wlkWQ.html

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):

 http://archive.org/stream/principleseconom01tausuoft#page/n23/mode/2up

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: http://andrewlainton.wordpress.com/.

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.
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