A Response to Paul Krugman

by Christopher Carr

Nobel Prize winning economist Paul Krugman’s existence in the popular consciousness largely rests on ideological antagonism.  Krugman’s infamous September 2009 New York Times Magazine editorial, “How Did Economists Get It So Wrong?“, attacking University of Chicago’s John Cochrane and others, was the “Hit Em Up” of economic policy debate.

“How Did Economists Get It So Wrong?” is noted for, among other things, resurrecting the terms “saltwater economics” and “freshwater economics”, and thereby grossly oversimplifying the way economics is discussed in the public sphere and in government.  The two terms originate from 1970s discussions of economic modeling methodology vis-à-vis the rational expectations assumption.

The “saltwater” school was based largely at Harvard, MIT, Princeton, Berkeley, and other coastal schools, and supported the Keynesian-Neoclassical synthesis belief that both monetary and fiscal policy can be used effectively as economic stimulus.  The “freshwater” school consisted largely of economists from the University of Chicago, Carnegie Mellon, the University of Minnesota, and the University of Rochester who rejected the prevailing Keynesian-Neoclassical synthesis and aspired to show quantitatively that monetary stimulus is preferable to fiscal stimulus measures such as jobs creation.  Both groups generally support monetary stimulus, and have found commonality there.

Nevertheless, Krugman’s renovation of the terms for popular consumption on his blog, The Conscience of a Liberal, suggests two irreconcilable and antagonistic schools corresponding to two irreconcilable and antagonistic political parties: one urbane and sophisticated, one backwoods and boorish.  In Krugman’s world, neither heterodox economists nor heterodox politicians can work together to solve problems honestly.  This is hackery.  In reality, the economics discipline is a nuanced conglomeration of disparate ideas.  The unholy marriage of economics and partisan politics which Krugman represents only threatens to undermine the credibility of economics as rational discourse on human behavior.

Krugman recently wrote a blog post, Antipathy to Low Rates, in which he stereotyped his opponents, associated the stereotype with something unpleasant, and then quoted people he doesn’t like as representative of his odious caricature to discredit them.  This is an unacceptable rhetorical device called a straw man which charlatans (and Nobel Prize winners apparently) use when their premises cannot be built on any logical foundation.  Krugman quotes (the dead) F.A. Hayek (way) out of context to characterize today’s opponents of further stimulus as ideologues:

(Krugman:) And Hayek found it

(Hayek:)…still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production.  If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed.  The only way permanently to ‘mobilise’ all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production.

(Krugman:) These days, relatively few economists are willing to say straight out that they regard persistent high unemployment as a good thing. But they find reasons to oppose any and all suggestions to use government policy — including monetary policy — to alleviate the slump. Same as it ever was.

Krugman knows that Hayek was not supporting “persistent high unemployment”, yet here he suggests that Hayek’s opposition to the New Deal was born out of certain disregard for the struggles of the poor.  On the contrary, Hayek’s opposition to stimulus lay in the understanding that the negative externalities of using policy to redirect such a large portion of the economy towards unproductive pursuits would ultimately snowball, and the economy would rot from the inside.

Krugman also conflates the very different oppositions to fiscal stimulus of the Austrian (Hayek) and Monetarist (Friedman) schools respectively.  Austrian economists generally oppose both fiscal and monetary stimulus on the grounds that prices convey information about the relative scarcity of goods.  To interfere with the price mechanism results in consumers making irrational decisions, widespread malinvestments, and bubble economies.  Monetarist opposition to fiscal stimulus is grounded in the idea that both fiscal and monetary policy can be used to the same effect, monetary policy is more efficient and therefore is preferable to fiscal policy as mechanism of stimulus.  In short, Keynesians and Monetarists want to steer markets.  Austrian economists want them set free.

Before this takes on the characteristics of a Krauthammer editorial: economic theories must have demonstrated predictive power to be considered legitimate.  It is often said that World War II, and not the economic growth of the late 1930s, vindicated Keynes.  However, it is more appropriate to say that the war interrupted and contaminated the Keynesian experiment.  Hayek believed that too aggressive policy had progressively distorted consumer preferences throughout the 1920s, only to be met with expansions of credit to further fuel ten years worth of central planner tinkering and malinvestments.  The economy was suddenly and viscerally refocused on reality in 1941 in the form of an economically overwhelming war effort.  Were it not for the war, perhaps only one of the two theories would be standing today.

Keynes believed that, if the war had never happened, the economy would have continued growing steadily, government planners would have compensated for New Deal stimulus during subsequent boom periods, and the economy would ultimately return to equilibrium with the number of people negatively affected by the natural trough of the natural business cycle minimized.  Perhaps he was correct.

Hayek believed that, if the war had never happened, New Deal stimulus would have continued to imperfectly direct production towards probably value-less pursuits, government planners would grow complacent and forgetful during subsequent boom periods or that there would be a change in policy as the result of electoral replacement, and America would suddenly discover that, instead of using the bust to clean house and purge unproductive entities, it had merely prolonged a disaster made worse by the further concentration of economic power in either corporate or government hands.  Perhaps he was correct.

Whatever shape the economy was in when the United States entered World War II, whether steady recovery as Keynes hypothesized, or deceptive crash course as Hayek hypothesized, this all changed when the nation’s resources were redirected towards the (very real) war effort.

World War II was effectively a reset button, and for this reason, economists still remain divided on the efficacy of intervention.  Paul Krugman at least knows this, and despite the need to pander to his audience, should not assume malicious intent, indifference to the struggles of the poor, or stupidity in those with whom he disagrees on the efficacy of interventionism.  Paul Krugman should stop being a ringmaster and go back to being an economist.

Today, as we in the United States debate the merits of additional stimulus measures and watch asEurope vascillates, intellectual honesty takes on a new importance (as if it wasn’t important before).  One doesn’t have to agree with Hayek to value his insight.  One doesn’t have to agree with Krugman to know he’s one of the brightest minds in economics.  But there is room for economists and non-economists alike to disagree amicably, recognize the absurdity of orthodox opinions on stimulus, realize there is a trade-off, and work together to effectively solve problems in pragmatic and dispassionate ways.