Oh My, Paul Krugman

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Q: What do John Maynard Keynes and Steve Keen have in common?

A: They’ve both been misread by Paul Krugman.

In just a couple of days I’ve gone from the privilege of being acknowledged by Krugman to being misread by him, in a way that would have any student failed in a multiple choice exam. In a passage where I specifically referred to DSGE models–which includes both “New Classicals” and “New Keynesians” he interpreted me as referring to New Keynesian models only.

And I said “underlying principles to the DSGE models”, which should have been enough of a clue that I was referring specifically to New Classical models, not New Keynesian ones.

The disparaging references to New Keynesian models came later, when I described them as being like Ptolemaic astronomers adding epicycles to an underlying model that couldn’t explain the retrograde motion of the planets.


Then having misread me, he concludes with “Nick uses a four-letter word to describe this; I can’t, because this is the Times”

Since I don’t work for The Times, I can and will use a four letter word to describe your poor comprehension here Paul:


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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33 Responses to Oh My, Paul Krugman

  1. myopia says:

    What’s that quote “First they ignore you, then they laugh at you, then they fight you, then you win..”

  2. NeilW says:

    “Q: What do John Maynard Keynes and Steve Keen have in common?”

    Let’s park that for a few years and see if the answer changes to “events proved their analysis largely correct”.

  3. barrythompson says:

    Check out this comment on Krugman’s teachable moment post:

    * kbandesz
    Dear Mr Krugman,

    I really adore your work in many fields of economics, but regarding this issue you, together with many academic economists, are wrong. This is not a simple operational question. The shifts in the demand curve you mention are so huge on a daily basis that a CB picking B* would kill the payments and banking system very shortly. And no CB ever really followed a strategy of picking B*. This is a myth (see links below). The only reason the money multiplier story survived is the fact that it is so simple that it can be explained to undergrads. But this doesn’t make it true. An interesting question to think about: if the multiplier story is true how can central banks with zero reserve requirement (e.g. Canada, Sweden) conduct monetary policy?

    I am writing this as a former central bank economist, now teaching at a university.

    There are many works at the BIS, Fed, ECB and other central banks refuting the textbook theory. I like the most Ulrich Bindseil’s work, because he has a historical perspective, but there are many others.

    Here is a paper:

    And a whole book:
    http://books.google.com/books?id=jEe2y00axOsC&lpg=PR7&ots=mrLyJI… monetary policy implementation&lr&pg=PR7#v=onepage&q=bindseil monetary policy implementation&f=false

  4. Krugman really doesn’t understand very much, this is probably why he was hired by the New York Times in the first place. After all, the Times is Dan Yergin’s bully pulpit.

    Give Krugman some credit: he did mention Peak Oil in an article once upon a time. He did it once (and was likely severely reprimanded for it).

    Modern banking is identical to the futures markets. If anyone has bought or sold futures contracts they will grasp modern commercial banking without any difficulties. A bank loan is effectively a long futures contract (on the borrower’s ability to repay the loan). The bank does not need deposits to make any loans just like the Nymex does not need a short to sell contracts to a willing long. The bank issues the loan/ the exchange issues the contracts. The contracts are resold to corresponding bank/ the exchange bank.

    Krugman has not traded futures. He seems to think of banking like the old-fashioned Bailey Building and Loan in ‘It’s A Wonderful Life’. Kapra’s version of banking isn’t too far off the mark. He understood Potter’s bank as the correspondent for BB&L. Without the corresponding bank there is no sense of where the client bank’s lending capacity comes from.

    Krugman misses corresponding banks and their ability to ‘manage’ liabilities, that is one reason why the money-center banks have gotten so large (and integrated with the Fed).

    Good arguing with the Krugman, maybe you should come to New York and challenge him to a duel!

  5. Kristen says:

    Prof. Keen I can’t tell you how much I appreciate your articles – though it is an unbelievable example of how misguided we are as a society and how we become and Stay that way, how sad Krugman still has such an presence.

    Could you clarify a point for me? What happens to deposits when loans go belly up …(or Large banks are allowed to fail?) Do the deposits created by these loans still exist or are they both wiped out? Thank you! Kristen

  6. Robert K says:

    Where is Max Planck when we need him? (I am afraid I know the answer to that

  7. RJ says:


    Can you explain why the deposit would be affected in any way just because a loan goes belly up

    Just follow the journal entries


    This deposit is then paid to Sue etc

    This is one advantage with banks as opposed to one person dealing with another one privately.

    Banks guarantee deposits. They do not trace the deposit back to the loan (and likely could not anyway) if the loan goes belly up.

    As Bob may pay Sue who then uses this money to pay Tim who then pays Mary etc etc etc.

  8. Steve Keen says:

    Hi Kristen,

    They still exist. What happens though is that the bank has to make good the loss from its equity. So it transfers funds from its equity account to its capital account (I may not have described these properly for accountants, but that’s the basic idea). This reduces the bank’s capacity and willingness to make future loans–if it becomes a systemic thing. Banks plan for a certain fraction of loans to go bad like this even in good times.

  9. jon_w_h says:

    It seems Mark Thoma thinks the failure to understand is yours:


    Can’t say I quite understand what the debate is all about but would be interested in your response?

  10. alainton says:

    My head was in my hands over Krugmans ‘teachable moment’ post – although a update + two (strike threehttp://krugman.blogs.nytimes.com/2012/04/02/things-i-should-not-be-wasting-time-on/) more posts in a day – ooh it must be getting to him.

    So after in three days trying to dust off the cobwebs of loanable funds, the wages fund, monetary base theory circa 1979 what does Krugman have up his sleeve ta da a rehashed IS/LM curve !!! Embarrassed silence from audience. At the moment being taught economics by Krugman is having the same effect as being taught comedy by Sarah Teather http://www.huffingtonpost.co.uk/2011/09/19/sarah-teathers-awful-stan_n_969945.html

    Come on Paul you can do better than that, why not hunt around at the back of the fridge for the lump of labour theory, Says Law, or just head over to John Quiggan for Some more Zombie ideas to dust off – oh dear you already hold to three of Quiggan’s top five fantasies http://www.foreignpolicy.com/articles/2010/10/15/five_zombie_economic_ideas_that_refuse_to_die

    Seriously though Krugman is attacking a straw man is his ‘refuation’ of Scott Fullweiller

    ‘banks…can create unlimited amounts of inside money’

    Now there may be some MMT’s who claim this (not all) but as far as I remember Steve has always refused to endorse this as the credit theory of money has since its origins always accepted that there is a cash flow constraint on the rate at which money can be created by banks

    Primer Inside Money -: The qualifiers inside and outside refer to the
    asset counterpart of the money v classic definition ‘The qualifier inside is
    short for (backed by debt from) inside the private sector.’ – – John G. Gurley and Edward S. Shaw Money in a Theory of Finance 1960.

    Now there is a strand of thought from Gurley Shaw through Kiyataki-Moore (the later theory Krugman has backed) that inside and outside money exist in an equilibrium, which a central bank can influence with its operations. Now this idea is not obviously bad – although you would have to substitute dynamic disequilibrium as Nick Rowe does. Indeed most of the key thinkers who have held a credit theory of money have said something similar. But Krugman is not referring to ‘outside money’ but base money – not the same. It would also seem that Rowe and Krugman are arguing very different things but with the same policy conclusion which is very confusing.

    Ultimately though Krugman seems to be acknowledging that central banks must be accommodationist but that the ISLM curve can survive if the causation is reversed. Now agree with this not that’s quite a revolutionary concession and should be acknowledged gracefully. In fact im only slightly unfair because his new model is really IS only.

    Now this model isnt new, indeed Narayana Kocherlakota – President
    Federal Reserve Bank of Minneapolis presented it at the 2nd Annual Minksy lecture a couple of weeks ago http://www.minneapolisfed.org/news_events/pres/speech_display.cfm?id=4839

    His conclusion
    ‘The first implication of the model is that monetary policy can offset the impact of the product demand shocks on employment, but it cannot offset the employment loss due to the fall in labor demand and any associated slow real wage adjustment. As a result, the level of “maximum employment” achievable through monetary policy is less than the “full employment” of labor resources.
    A second implication is that non-monetary policies specifically designed to stimulate the demand for workers (such as government subsidies for hiring) can offset some of the employment loss due to the labor demand shocks, but only if accompanied by monetary easing. That is, monetary and non-monetary policy must work in concert to reduce the impact of a decline in labor demand; neither can do it alone…. this model suggests that the Federal Reserve is performing about as well as it can on both mandates. The Federal Reserve’s accommodative policy has offset much of the impact of product demand shocks and so has kept inflation near target. However, this policy has been unable to offset the large adverse shocks to labor demand. The model implies that, in terms of employment, there are limits to what monetary policy can achieve on its own.’

    Now the reaction of many central bankers was – aghast he’s gone to the dark side. Monetary policy can achieve everything.

    Now if you substitute Kocherlakota’s ‘shocks’ for Steves aggregate demand functions in Kocherlakota’s model you get something rather interesting – a tool which might completely junk ISLM and which really would be a teachable moment – just a thought. Perhaps SK and PK arnt that far apart at the macro level as the heat of the argument suggests

  11. Robert K says:

    The only constraint on a bank’s lending is its’ SOLVENCY, as determined by the
    quarterly bank examinations. (If they are honest) The solvency is a function
    of TCE (tangible common equity) as Steve indicates, its’ capacity to absorb loss.
    At the point where TCE falls below a certain threshold, the bank must either
    raise equity, either through new share sales, or from selling off loans. If neither
    option is viable, the bank is closed and its’ assets transferred to a new bank. If
    deposits are insured, depositors are spared losses. Krugman would be correct,
    amusingly enough, under a Gold Standard, where reserves ARE indeed limited,
    but where other problems (bank runs where the people at the end of the line get
    nothing) leave many depositors INSOLVENT.

  12. alainton says:

    woops sorry meant IM only model of course

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  14. TruthIsThereIsNoTruth says:

    re Steve’s post April 3, 2012 at 7:43 am

    That’s interesting because you are starting to scratch the surface of the topic of risk. From a practical perspective the whole banking operation revolves around the concept of risk management. Leads me to think that yes banks can create money out of thin air, but if they do things blow up. I would look to banks that didn’t blow up as to why in a properly functioning financial system the notion of creating money out of thin air is far from accurate.

    Following on from the Copernican anecdote, the research into risk management and to a large degree risk management in practice employs mathematics pioneered by Einstein. The debtcentric model explains a very tiny fraction of the known universe.

  15. alainton says:

    Krugman takes his ball home

    ‘Update: OK, I’m done with this conversation. I’ve had enough back and forth, including off-the-record stuff, to confirm for myself that there’s no there there. And there are more important battles to fight.’

    It was probably right for him to withdraw from the field, because as one poster on NYT put it ‘in doubling down on each new post’ has was beginning to look quite foolish. Now at least he can go away and think.

    ‘More important battles to fight’

    In the last week Krugman has
    -abandoned the textbook view of the multiplier and exogenous money
    -accepted that there is no cash constraint on the creation of bank inside money
    -abandoned the IS-LM model which he was famous as the most vociferous advocate of in favour of an IM only model with reversed causality where the influence of monetary policy alone is weak

    So there is ‘no there there’ – rather there is little left there. And if there was no there there why has Krugman in a matter of days scrapped and hastily rewritten his hole macroeconomic framework.

    As a teachable moment perhaps Krugman can take some of this wonderful advice from the University of Sussex on how not to win arguments (one to cut out and keep)

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  18. creditdefaultswap says:

    Thanks Steve for keeping up this educational process. I learned through these internet blogs of how the US FRB reserve requirements were gutted starting in the 1980s to where it is today about 1 percent of US bank deposits are required reserves at the FRB.
    I am just amazed by how many comments still talk about US 10 percent reserve requirements, as if they only thing they know is their Samuelson economics text from the 60s or 70s.
    Yes the FRB did buy and sell Treasuries to play with short term interest rates, when the FRB should have been raising rates to limit the US debt bubble, they ran far short of the mark.

    Since in the US, the US banks own the FRB and elect the local FRB board of directors, it is not surprising that the FRB has been run to support the banks as opposed to safeguarding the US economy from the debt bubble and financial crisis.

  19. Dannyb2b says:

    I rekon money can be endogenous or exogenous. It just depends on the laws that limit the monetary system. I like the idea of exogenous money with strict rules on the monetary authority relating to inflation and distribution of newly created funds.

    A system were the CB is the only entity capable of creating money and wereby private banks have to source funds before lending would be really stable.

    Remember its not all about money its about real economic activity with the monetary system just facilitating an efficient economy.

  20. RJ says:

    “A system were the CB is the only entity capable of creating money and wereby private banks have to source funds before lending would be really stable”.

    I think this would be a disaster. But interestingly when I ask people advancing this solution how this would work in detail including all the journal entries. I never get a detailed answer. Can you provide one?

  21. Steve Keen says:

    He’s making a Tweedledee vs Tweedledum distinction Jon–a piece of localised “Talmudic” scholarship, which is ironic given the “I Don’t Care” position on reading the literature that Krugman opened with. Only a rabidly Neoclassical economist could argue that NK, DSGE and NK models are fundamentally different. To any outside observer, it’s a round pea trying to distinguish itself from a smooth one. They’re still both peas.

  22. Luke Davis says:

    I have to laugh at this. This is like watching two physicists arguing about whether gravity exists while the 10 year old asks what holds his feet to the ground. As the 10 year old I picked a bank at not so random, The Commonwealth Bank in this case. Looked up their annual report and found the two lines showing whether they had more loans or deposits.


    Page 100 – Balance Sheet

    Deposits and other public borrowings 307,844

    Loans, bills discounted and other receivables 377,195

    QED they have lent out more than they have deposited.

  23. Dannyb2b says:

    “I think this would be a disaster. But interestingly when I ask people advancing this solution how this would work in detail including all the journal entries. I never get a detailed answer. Can you provide one?”

    The central bank is an entity owned by the citizenry. When it prints money it is printing a share in the monetary system. Look at notes as if they are something people own not owe.

    The point of origination is what matters. After this in the private sector anyone can lend or borrow money like now thats fine.

  24. TruthIsThereIsNoTruth says:

    Add the debt issues to that LD, but then it is really not as simple as looking at a balance sheet i’m afraid.

    I’m really interested as to how this notion is seen to work in practice. The mechanism that I’ve seen proposed so far is that on any given day the loans that a bank creates is balanced out with the central bank account. This is no more than a guess at how it would work if reality fit the theory.

    If you start with reality, you have a mechanism in place where the forecast growth in loans is pre met with funding. Liquidity is what ultimately determines solvency, banks generally try not subject themselves to avoidable liquidity risk. It’s not just a matter of risk management, it’s also a matter of cost, if a bank is running a tight liquidity position it means firstly that this will be factored into their credit rating and secondly they get their funding in a more desperate state and ultimately end up paying a higher price. Having a liquidity cushion allows for some more favourable price selection.

    If reality cannot be taken into account and continues to be ignored how is that any different to what neo-classical economics is being critised for? Except perhaps that the false assumptions are more transparent and therefore much easier to actually criticise.

  25. NeilW says:

    “If neither
    option is viable, the bank is closed and its’ assets transferred to a new bank. ”

    To do that there has to be somebody in the system prepared to take that decision and enforce it.

    Because the other option is to weaken the capital ratio requirements under vociferous lobbying.

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