Krug­man doesn’t under­stand IS-LM (Part 1)

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This is a post in at least 4 parts; for part 1, click this link to the Busi­ness Spec­ta­tor arti­cle.

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Krugman doesn’t understand IS-LM–Part 1

Krug­man describes him­self as a “sorta-kinda New Key­ne­sian”, and explains in his book End This Depres­sion NOW! that New Key­ne­sian macro­eco­nom­ics evolved in reac­tion to the fail­ure of the new clas­si­cal approach to “explain the basic facts of reces­sions”.

His “sorta-kinda” qual­i­fi­ca­tion is because both New Key­ne­sian and new clas­si­cal mod­els are derived from apply­ing assump­tions about the behav­iour of indi­vid­u­als and mar­kets at the level of the macro­econ­omy, and he has a healthy scep­ti­cism about these assump­tions:

 “I don’t really buy the assump­tions about ratio­nal­ity and mar­kets that are embed­ded in many mod­ern the­o­ret­i­cal mod­els, my own included, and I often turn to Old Key­ne­sian ideas, but I see the use­ful­ness of such mod­els as a way to think through some issues care­fully – an atti­tude that is actu­ally widely shared on the salt­wa­ter side of the great divide.”

This is one aspect of Krug­man that I gen­uinely applaud: the aware­ness that mod­els aren’t real­ity. At best they are rep­re­sen­ta­tions of real­ity, but some neo­clas­si­cals show an amaz­ing capac­ity to believe that their mod­els are real­ity – as in this piece by French econ­o­mist Gilles Saint-Paul which the blog Unlearn­ing Eco­nom­ics deservedly flogged recently – in a way that leads to truly delu­sional think­ing about the real world.

Of course, we need mod­els to think about the econ­omy in the first instance, because it is such a com­plex entity. Even those who deride mod­el­ling in eco­nom­ics are using a model when they talk about the econ­omy – it’s just a ver­bal (or even unar­tic­u­lated) one, as opposed to an aca­d­e­mic con­struct.

One might hope that expe­ri­ence and exper­i­men­ta­tion over time would weed out unre­al­is­tic mod­els in eco­nom­ics, but that hasn’t hap­pened. In many ways, the mod­els that dom­i­nate eco­nom­ics today are less real­is­tic than those which pre­vailed as much as sev­enty years ago.

Krug­man alludes to this by his ref­er­ence to “Old Key­ne­sian ideas” above. In par­tic­u­lar, he cham­pi­ons John Hicks’ IS-LM model as an expla­na­tion of our eco­nomic cri­sis today.

This model, first pub­lished in 1937, seeks to explain the rela­tion­ship between inter­est rates on one hand and real out­put in goods and ser­vices and money mar­kets, on the other.

Click here to read the rest of this arti­cle

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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  • Steve Hum­mel

    Ann Pettifor’s link to this video is utterly apropo.…..except for one thing.

    Pre-Key­ne­sian eco­nom­ics does not have to be under­stood as a regres­sion. Why? Because C. H. Dou­glas was one of the first indi­vid­u­als to under­stand the “loans cre­ate deposits” real­ity. That plus his ground­ing in engi­neer­ing, and his knowl­edge of dou­ble entry book­keep­ing as well as its sub­set cost account­ing gave him an excel­lent under­stand­ing of both micro and macro eco­nom­ics. Dou­glas wasn’t nearly as bur­dened by the ortho­dox myth that mar­kets are sta­ble and equi­li­brat­ing or that cap­i­tal­ism was sacro-sanct in and of itself con­ceived of by most in Amer­ica and else­where. His ground­ing in cost account­ing enabled him to see the micro-eco­nomic prob­lem lack of money for the indi­vid­ual and his under­stand­ing of the ex nihilo/creditary nature of money enabled him to envi­sion a macro-eco­nomic solu­tion like the retail dis­count.

    Key­ne­sian­ism was utterly supe­rior to its neo-clas­si­cal dece­dent, but Dou­glas (whom Keynes prob­a­bly only uncon­sciously pla­gia­rized) was in fact both eco­nom­i­cally and eth­i­cally supe­rior to Key­ne­sian­ism.