Krugman doesn’t understand IS-LM (Part 3)
This article is the third piece in a four-part series. Read part one here and part two here.
But first, a word about my Kickstarter campaign to raise funds to develop Minsky, a tool for designing strictly monetary macroeconomic models:
There are only 3 days left to help Kickstart Minsky! We've raised $63,200 now, which puts us within striking distance of our first stretch goals:
$100,000
About 1400 hours of total programming time will enable Russell to complete the "Mun" release, which will focus on improving the graphics and presentation aspects of the program.
Nathan will also be able to develop a version of Minsky for iPad and Android Tablets.
I'm also not about to give up hope that we might make the second stretch goal:
$250,000
With twice as much as the original INET Grant, we should be able to complete stage 2 of Minsky—the "Quesnay" release named in honor of the person I regard as the world's first dynamic economist, Francois Quesnay—in which the platform could support the construction of multi-bank model of the financial sector, and a multi-commodity model of production.
Krugman doesn't understand IS-LM (Part 3)
Krugman's explanation of our crisis today is straight from the pages of John Hicks's 1937 explanation of the Great Depression (though curiously, Hicks himself didn't mention the actual state of the global economy at all in his 1937 paper), which attempted to explain the relationship between interest rates, and real output in goods and services and money markets. Firstly, the LM curve, (representing Liquidity Preference – Money Supply) is horizontal at the "zero lower bound", since when nominal rate of interest reaches zero, there's no point in buying bonds – it's wiser to keep your money in cash. And secondly, during a Depression, private demand can fall so much that the intersection of IS (representing Investment – Saving) and LM occurs at a level of GDP well below the full employment level. The economy is in an equilibrium with involuntary unemployment (see figure 7).
Steve, thought you ought to know, your work (through another source) appears to be getting some attention in the main stream news. check out this quote from ABC news online:
“It would also mean borrowing would stop growing and likely head into reverse, causing the rate of economic growth to drop because the amount households and businesses have available to spend and invest is determined by their income plus the change in their debt levels“
article: http://www.abc.net.au/news/2013–03-14/bankers-winning-the-battle-losing-the-war/4573260
OzLeroy and all:
“…the amount households and businesses have available to spend and invest is determined by their income plus the change in their debt levels.”
I think this idea already has been well understood in the accounting and bookkeeping realm for centuries. It is the idea of “cash flow” and cash balances.
In accounting terms this is “cash flow” or cash basis accounting. Cash flow and cash balance is just like your check register and recording currency transactions with your wallet or purse.
If you get a loan, suddenly you temporarily have more currency or bank credit. Of course, the problem is that your “net worth” has not increased because one is obligated to pay the debt back plus interest. The debt is subtracted from assets to get net worth. So, either your investments have to pay more than the principle and interest, inflation happens and your income keeps up or grows (may not happen), or the “net worth” you have will decrease.
One day, one has to return the principle and interest for the loon. Better to figure out how to do that before borrowing.
Double entry accrual accounting where you would also record the “values” of the things bought along with the amount gotten from the loan. But, the loan is never income. Double entry will give a measure of “net worth”, usually ignoring inflation, which is different than cash flows and cash available.
Accounting gives weight to to Keen’s observation that borrowing effects spending.
Correction:
Correction from 2nd to last paragraph of 2nd to last comment should read:
One day, one has to return the principle and interest for the loan. Better to figure out how to do that before borrowing.
In double entry accrual accounting you would also record the “values” of the things bought along with the amount gotten from the loan. But, the loan is never income. Double entry will give a measure of “net worth”, usually ignoring inflation, which is different than cash flows and cash available.
Excellent! Finally getting some traction. Thanks OzLeroy.