Keynes’s difficult idea

Great piece by Martin Wolf today. I particularly liked this:


That’s the point of my favorite Keynes quote, where he declared of the Great Depression, “we have magneto trouble.”

What’s been striking me lately is how many people who talk and write about macroeconomics just don’t get Keynes’s essential point — the fact that economies can suffer from insufficient aggregate demand because people want to acquire liquid assets rather than real goods. Not to single out any one commentator, but this morning I read this:

Government spending doesn’t increase aggregate demand. All it does is transfer spending power from one party to another by borrowing from or taxing the public.

That’s exactly the infamous “Treasury view” from the 1920s, against which Keynes had to struggle. And it’s still out there.

Anyway, good for Martin; we’re going to need every possible voice to counter the niggling nabobs of negativism.

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Oooh, so close on the quote — it’s “Nattering nabobs of negativism”

Oft attributed to Agnew, who paired it with a wonderful slew of alliteration to give us

In the United States today, we have more than our share of the nattering nabobs of negativism. They have formed their own 4-H Club — the “hopeless, hysterical hypochondriacs of history.”

But the original attribution is William Safire

Dear Professor Krugman,

Does the “magneto” analogy still hold if production is mainly offshore? When an American decides to do the “right” thing by buying a new TV, rather than being so lacking public spirit that he pays down his mortgage instead, does this assist the US economy or simply exacerbate the trade deficit while providing employment in Sichuan?

Are you going to explain why you think the treasury view is wrong? Or just tell us it is in the hope we will blindly believe you?

Maybe that view is still out there because it is true.

the same is true when you expand the economy to include biophysical elements — energy transformation, resource availability, biodiversity, cyclicality, waste streams. “nature” as a romantic poetic construct shrivels and dies under inattentive technical pressure.

That’s NATTERING nabobs of negativism! :-)

I have so much difficulty with the notion that an economy must grow forever and that people must spend and spend after they have everything they want and need. As Robert Reich has noted, there’s only so much room on the planet; so many resources; so much room for pollution, climate change, etc.

And our current economic models are products of our history and experience in western post-Enlightenment settings. They aren’t representative of universal truths.
So our economic system in fact grew out of history, the values that accrued as it passed. Mathematicians didn’t “discover” it as they discovered the eternal proofs of mathematics. It doesn’t exist except as we have created it and continued to embrace it and continue to operate within it. And even if we try to look at it dispassionately, we should still be looking at it from an ethical and scientific view: a scientific perspective which allows us to evaluate it, yes, dispassionately: how does this system affect the life of the planet? And ethically: how does this system provide in a just manner for life on the planet?

Obviously we can’t just completely dismantle the whole kit and kaboodle. But do you not think we need to be, as they say, thinking outside the capitalism/socialism/whatever box?

Life and systems grow and die. I’m sure you’ve heard people say many, many times that it is cancer pretty much alone that grows and grows and grows. Perhaps our economic system, along with Keynes himself, is dying. What new seeds are sprouting?

The rich could just give those big bonuses out to the poor, or raise their wages, and then there would be plenty of money of money to spend.

When are we going to address the real issue of why our economy cratered — inequality?

Reply to Carlos Graterol:

Longevity of an idea says nothing about its validity. There are still flat-earthers out there.

If people want liquid assets, then it is upto the government to pay for real goods. By borrowing – selling treasuries – the government satisfies those who want liquid assets and by spending what it borrowed on real goods, the government increases aggregate demand.

David Merkel has a piece in his Aleph blog today ‘Waiting for the death of the Chicago School, and the Keynesian School also”. He says Keynesian remedies work as long as we can tax or borrow to provide the stimulus, but we will have borrowing problems.

We need an economic theory that accepts as necessary moderate booms and busts. Easy money cures moderate busts temporarily; but it leads to a big bust later.
Fiat money requires smarter regulatons. We have had too much and too little regulation.

Your blog and Merkel’s make a lot of sense to me, but sometimes they conflict.
I would like to read your views on what he said. Thanks.

For me, what really allowed me to understand Keynes is the realization that his argument is actually very simple : a depression ensues whenever everyone all at once wants to hold money. The result of people wanting to hold more money is that people’s barriers to purchasing everything suddenly rises: goods and services need to be cheaper in order to buy the same quantity. It’s as if the demand curve for every product/service suddenly shifted to the left. And the result is an immediate depression as the quantity of what’s sold must drop. Hence a drop in real GDP, which measures the quantity of goods/services sold.

However, I’m still not sold on the idea that having the government just supply people with additional money is the solution. It feels like that’s just creating a deception that can only be short-lived. The first time you give everyone more cash, they would spend some of it. But then prices would rise, making people again poorer, causing spending to drop back. And once people start to expect price increases, you will have to give even more money to persuade them to spend. Eventually, followed to an extreme, you will get hyperinflation.

Nor am I convinced that having the government spend money ‘counter-cyclically’ is the solution either. For starters, one must just assume that the government can somehow raise money without reducing consumption/investment. If people want to hoard money, then whatever they lend to the government might be considered ‘spent’ and thus additional hoarding will be required to make up what has been lent to the government. But, here’s where there seems to be a stroke of luck: people see lending to the government as safe. Thus, it may be likely that they won’t need to hoard what’s been provided to the government — people will feel confident they can — when needed — get that money back. Under those conditions — and only those conditions — a government has the opportunity to make up for the shortfall in consumer/business spending with its own spending.

But the government has two choices in how to spend:

(1) reduce taxes, (2) increase spending.

In terms of spending more, if the government spends on something we actually want or need, it’s going to waste resources . A little waste wouldn’t be terrible. But I think, given the amounts involved, you are likely to get a lot of waste. If the spending can be restricted to things that we know we need/want but we were delaying — then it definitely makes sense. You are just really redistributing growth from the future to the present.

But when trying to spend a LOT, my guess is that a broad-based tax cut which reduces the cost of things people buy would be more effective. This tax cut should reduce the cost of EVERYTHING — labor, retail goods/services, production goods/services. In a depression, people are willing to buy a certain quantity but now only at lower prices. So one must reduce the price of everything. So that means reducing sales taxes, VATs, investment taxes, company-paid payroll taxes. Even income tax reduction can work — if it can be incorporated into withholding so it effects people every week — not just a one time payment or check. Once the price of everything drops, people/businesses will start to consume a higher quantity of goods/services. This will then increase GDP.

Of course, government will see increased deficits, but it can always raise taxes or reduce spending later, once hoarding levels have again gone back down. That would be easy to see — the interest rates on T-bills that the government uses to raise money would again begin to rise.

As Paul’s concern shows, contemporary Americans much prefer the morality-tale mode of thought, to the more rigorous sorts of thinking required to separate the truth, from the merely plausible. These sloppy thinking habits extend far beyond the profession -or the commentary about, economics. I have some hope that if the Obama administration can be seen as being startlingly competant, that perhaps we can begin to turn the corner into a more intellectually rigorous style of thinking.

Meanwhile, the chance that “morality-tale” inspired economics thinking will thwart the needed large-scale stimulus is very real.

Re: EKB’s post

Krugman is not a fan of Robert Reich, but I think you’ve made some good points. The notion that we have “inalienable rights” to recklessly consume resources and procreate needs to be modified. Economists in the U.S. are primarily apologists for our system of capitalism. They start with popular assumptions, for example that everyone wants to be rich, and then build their mathematical models from that. This is not an empirical method.

What’s happened recently is that we’ve had another spat of “irrational exuberance,” and the economists are here to tell us how to rebuild our aggregate demand, as if that’s all we need. This is in-the-box thinking. As far as I know, economists don’t have much to say about long-term sustainability, the limits of population growth, the desirability of increased global competition, etc. People like Reich do question some of our assumptions, but they’re ignored by the economics establishment because they don’t have Ph.D.’s in economics.

To echo Donna above, how are we supposed to spend more when no one (except C-level executives) has gotten a real pay raise in 35 years? We put the women to IRS-taxable work. Then we borrowed far more than was wise. We speculated in stocks and real estate in a desperate attempt to come up with more spending money. And now we have hit the end of the road with a profound thump.

To borrow or spend more, wages must go up. But the “global wage arbitrage” (love that phrase) ensures that won’t happen in the US. So, the old ways are dead, and the cart of bodies is off to the graveyard, although a few may need a whack with a shovel to shut them up.

So what does a zero-growth (steady-state, in engineering terms) economy look like? In a few years we’ll all know, but an outline would ease the transition.

Thank you for your comment, Paul Dorell.

I can think of a number of peculiar assumptions modern economics is based on, beginning with the notion of people as rational choosers.

It does seem that it is time for some outsiders to get into the act — to point out that the Emperor has, if not no clothes on, then not a complete suit. It is characteristic of humans to believe they have The Truth. When within a system one sees rational calculations, it’s hard to see that those calculations are resting on a rickety structure. Same thing happened with Freudian analysts who thought they had us all figured out. And of course the Pope thinks the same way.

So it would be good for Obama to listen to the likes of smart non-economists like Robert Reich, or even try to put himself in the shoes of Angela Merkel who I think has good reason not to want to jump into a Keynesian world with her country’s economy.

We need some discussion about the underlying problems: not the solutions, but the problems themselves. We do need a variety of economies, I think: small scale under the radar ones, for instance, but certainly not exclusively. We have to examine where, even in a liberal free market world, we have arrived in terms of social connectedness. How can we not only employ but make accountable members of society all these people wandering the streets of gigantic third world (and first world) cities?

Part of what’s so good about the piece by Martin Wolf is that it considered the global economy, and each individual economy ib the international economic context. This (as Markwell’s book on Keynes shows) is very much part of the genius of Keynes – including his interest in the maintenance of an open trading system.

So how’s keynsianism working out for iceland then. It seems to me that economists assume away the problems with blindly applying Keynes/Adam smith/Austrian school to suit their politics and not the other way around. Keynes’ worked in the 1930’s because the inevitable deleraging process after the crazy 1920″s had already pretty much run its course by 1933. Today, economists think Keynesian policies can be used to prevent the deleveraging process, It can’t, so what we are actually doing is transferring irresponsible private sector debt, to the tune of 300% of GDP, onto the government so that when the time comes that would be ripe for Keynes’ approach to work (when debt is destroyed and animal spirits are extremely low), the government won’t be able to restart the economy because we’ll be paying more taxes and higher interest rates to pay off irresponsible debt, originally taken on by unproductive sectors of our economy.We are bailing out the money men at the cost of our own long term financial well-being.

Indeed, there is nothing inherently “technical” about economics, despite all the pretty math one sometimes sees. All of our economic and monetary systems are purely inventions of humans, for their own purposes, constructed according to the social desires (or at least, the desires of those who’ve grabbed decision-making power for themselves) for allocating resources. Only occasionally does actual physical reality intrude. (In fact, some economists seem downright put out at the notion that physical reality has to be accounted for.) It’s essentially a branch of politics. You can’t cheat physics, but any human-made system can (and will) be broken by human corruption.

Hello mr. Krugman,

I’ve read this blog for a year now and I still keep checking it out almost every day. I’m a student of IPE at a Finnish university.

I agree with you (and Keynes and Martin Wolf ) that mainstream (neoclassic) economists fail to see the very basic paradox of capitalism:

A single firm can benefit from the cutting of wages, but all firms combined will suffer due to diminishing purchasing power.

Of course we can try to increase spending by making people use their credit cards to the max… which – through different phases – takes us to present day.

So, bye bye Milton, bye bye laissez faire and welcome new non-indoctrinated and post-autistic economics and public policy.

I hope economists such as yourself and Joseph E. Stiglitz can lead us to a better path.

The quoted passage is idiotic – it would mean that all borrowing is futile.

Government can transfer spending power from those who aren’t using it – typically the rich, to those who will – the currently unemployed. It can’t do this by cutting taxes on the rich – if they’re not using what they have, why is it good to give them more?

If Keynesian policy is not understood then it is either because: 1) the teaching of economics has only been producing parrots, 2) economists are still being victims of the ideological battles of the past, or 3) economic theory concepts and rhetoric are being deliberated used as vehicles to legitimize agendas and value systems.

Keynes central idea is about the possibility of the system’s auto corrective devices leading to a new point of equilibrium below full employment when preference for liquidity is such that monetary intervention (the pulling on a string) becomes irrelevant.

But if the notion of fiscal rectitude prevails then lets tax labor (the ideal input due to the preponderance of the service sector in the economy) or, if that is politically impossible, then all commodities and spend the proceeds in public infrastructure, better education and health, etc. At least in this way there is a chance of creating cost-push inflation and, consequently, of being able to destroy the perverse preference for liquidity, specially at the point when the monetary authorities cannot any longer be of any consequence as pointed out by Mr. Krugman in one of his papers.

“transfer spending power from one party to another by borrowing from … the public.” is grade 8 idiocy because it not only assumes that “spending power” is “spending” but also because it assumes that one loses spending power when someone borrows from you. One might lose liquidity if that someone isn’t the US treasury, but loaning doesn’t typically reduce one’s spending power (otherwise why would people do it). If I loan my money to a bank by putting it in a checking account, I can still spend it.

Now a bit of brains would have lead Baum to Ricardian equivalence. Then she would have written : transfer spending power from one party to another by taxing the public either now or in the future with interest.

A bit too much would have lead to the full Barro with “or in the future with interest which will cause an equivalent decline in private demand as people who all have active bequest motives (and reproduce by budding) will keep track of the national debt (quick pop quiz what is the national debt rounded to the nearest billion) and figure out how much they and their descendants will pay and reduce their perceived wealth by that amount. Still the point that, given spending, taxes can’t be cut but only shifted should be well known by now.


Well, I agree that it was what Keynes did.
But to us Europeans, after years, nay decades of having the Brits try to impose their neo-liberal ideology to continental Europe, the insertion “a very English one”, opposing English and ideologues as if it they never overlapped is rather unwelcome.

It’s More than Magneto Trouble …

What we are seeing is the popping of a multi-generational debt bubble. A magnitude of debt twice that of the 30s. We have $50 trillion in aggregate debt, that we know of, only God knows what the damage is in the CDS and derivatives markets are.

To make matters worse our economic model of 70% consumerism and 30 % production will never return, the plant and store closings and the layoffs are permanent. Those engines of growth are gone forever, never to come back.

Sorry Paul, this is not magneto trouble, this is the economic engine seizing up while the transmission of credit falls apart. The Fed keeps filling the car with gas but the rust of toxic debt has left gaping holes in the tank.

Keynesian failure is we use Keynesian economic tool too much.
When we have economic slowdown, government is asked by entrepreneur to sustain growth, to sustain wealth and to sustain increasing earning growth. That mean we build the large fiscal deficit and debt for the entrepreneur and investors just only because recession is told that is unfavorable. America is also asked by global producers to sustain consumption when we have Asia crises and now we have too much consumption and too much current deficit and external debt.
Now globally we have huge private debt and public debt because Keynesian taught us only when we have slowdown, we have to stimulate economy but we use Keynesian too much on global economies and cause too much debt left behind for the new generation.
How can we sustain economy with too much debt both private and public debts? When there is recession, we create another debts instrument to sustain too much consumption and overproduction to serve the wealth for entrepreneur.
Like Japan, they have 200% public debt of GDP, and just only 10 years debt has been doubled. If they still expand too much deficit to sustain unsustainable consumption and over production by debt whichever private or public, who is going to pay that debt that will increase to 400% of GDP in the next 10 years ?
US have too much private debt and will cause government to create too much public debt to sustain economy that is not sustainable. Some of debt is from wrong policy of military spending and tax cut for rich.
I do not think US government way to create too much public debt just only to sustain wealth of entrepreneur is the right way. The best way is using capitalism and socialism. For example, we use government money injection for bank but why don’t we try to find other suitable way that is not going to burn the government money. Why don’t we think the capitalism like merger or private funding with incentive rather than using government money that is part of socialism? Another thing is auto industry. Why don’t we think to merge three company or debt-to-equity swap that is part of capitalism before injecting the government lending that is part of socialism? For the mortgage restructuring, why don’t we let banking write-off debt beyond property value for the borrowers with tax incentive that is part of capitalism rather than using government money to restructure loan that is part of socialism? Lasting why don’t we use tariff and non-tariff barrier to sustain domestic manufacturing business that is part of socialism instead of letting free market and using tax reduction incentive for manufacturers.
Rather than creating public debt ballooning like Japan, US should find the other way mixing between capitalism and socialism to solve the problem and I think Keynesian tool especially injecting money in the system is not the tool solve problem because it is the way to sustain economy that is not sustainable by itself.

Prof. Krugman is also witting. Why shouldn’t he be allowed
to replace “nattering” with “niggling” when is it “niggling” the conservatives are now obsessed with? To be witty, or not to be witty, is not the question.