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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  • myopia

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

  • 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”.

  • bar­ry­thomp­son

    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

  • 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!

  • Kris­ten

    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

  • Robert K

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

  • RJ


    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.

  • 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.

  • jon_w_h

    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?

  • alain­ton

    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

  • Robert K

    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.

  • alain­ton

    woops sorry meant IM only model of course

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  • TruthIs­ThereIs­NoTruth

    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.

  • alain­ton

    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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  • cred­it­de­fault­swap

    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.

  • Dan­ny­b2b

    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.

  • RJ

    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?

  • 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.

  • Luke Davis

    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.

  • Dan­ny­b2b

    “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.

  • TruthIs­ThereIs­NoTruth

    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.

  • 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.