By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil
Fairytales and nursery rhymes are quite popular among the economists. Economists and economic commentators will couch magical thinking in rational sounding phrases — but that doesn’t stop it from being hokum. Some within the profession attack these juvenile tendencies. Paul Krugman, for example, has often lambasted the idea, fostered by some of his colleagues, that the current crisis is due to a lack of confidence among investors. In a flash of irony he labeled this idea that of the ‘confidence fairy‘.
Of course, Krugman is absolutely right; the idea that a lack of confidence is responsible for the current crisis is a fairytale pure and simple. Our current economic problems are caused by a lack of aggregate demand. Investors are absolutely right to lack confidence at this moment in time because, just like in the 1930s, there is no rational reason to invest more because the population lacks the adequate purchasing power to consume more goods and services. Matias Vernengo over at the excellent Naked Keynesianism blog provides a classic quote from Roosevelt’s Fed chairman Marriner Eccles that summarises the situation well:
Confidence itself is not a cause [of economic depression]. It is the effect of things already in motion. What passed as a ‘lack of confidence’ crisis was really nothing more than an investor’s recognition of the fact that new plant facilities were not needed at the time.
Pretty straightforward point, but powerful nonetheless. And I think Krugman and other ISLM-Keynesians would broadly agree with it. That is, peculiarly, until they start talking about inflation targeting.
Proponents of inflation targeting claim that if the central bank sets a higher inflation target investors will react to this by, well, investing more. Krugman sums it up:
If the Fed were to raise its target for inflation "” and if investors believed in the new target "” expected inflation over the medium term, say the next 10 years, would be higher"¦ [and] higher expected inflation would aid an economy up against the zero lower bound, because it would help persuade investors and businesses alike that sitting on cash is a bad idea.
Now, is it just me or does it appear that Krugman has just smuggled the confidence fairy in through the backdoor? Read that passage again carefully. The ‘idea’ here is to trick investors into investing by scaring them into thinking that the Fed will allow inflation to rise higher than it currently is.
Really? Come on. Does Krugman really believe investors are this stupid? Does he really think that they make their investment decisions based on what some central banker says is the target rate of inflation? Sure, the commentariat are eating this garbage up — the usually sharp crew over at FT Alphaville provided a glowing account of why the inflation-confidence fairy should be unleashed from its bottle — but when it comes to putting your money where your mouth is, are smart people really going to buy into this idiocy?
Short answer: no. Krugman and others treat investors like children. But investors — real investors who provide funds for new goods and services — are not children. Instead, they will continue to look at the economic fundamentals when making investment decisions. And if there is simply not enough demand for goods and services they will not make investments aimed at creating more goods and services. Duh! It really is quite obvious.
Now, the financial investment community might well react to this hocus pocus — but that is an altogether different thing. This is not because paper-shufflers are stupider than their entrepreneurial and corporate counterparts, but because they are concerned with perceptions and fairytales — it is largely upon these that their business rests. They do react irrationally to news simply because they think that their peers might react irrationally to the same news. The financial community is, in many ways, a hall of mirrors with everyone trying to guess everyone elses’ reaction to announcements and news. But just because the financial community may react to a higher inflation target by no means entails that their money will end up funding goods and services that increase employment in the real economy.
If you actually look at how the financial community reacts to unorthodox announcements by the central bank the reality — as opposed to what abstractions like the ISLM will lead you to believe — is much different. The likely outcome of such an announcement in the present economic environment is obvious given that we now have four years of experience with these sorts of pseudo-policies: financiers will move their funds into so-called ‘inflation hedges’ like gold, silver and other commodities. What’s more, if the central bank manages to scare them sufficiently they may even move their funds out of government bonds and into these ‘hedges’. This will lead to increased upward pressure on the interest rate at which governments borrow which will, in turn, give the austerity brigade even more of a mandate to cut government spending and engage in other sorts of economic vandalism.
Unfortunately, Krugman and others will likely continue to publish their fairytales and recite their bedtime stories. Why? Because, to put it somewhat bluntly, it gives them something to do. It gives them something to talk about that makes them appear as if they have some specialised knowledge that only a select few Very Sophisticated People understand and have access to. It also gives them the assurance that their abstract models actually tell them something — something a priori and mysterious — about the real world that cannot be gleaned by simply observing empirical reality. In short, it gives them a power to fascinate the general public and policymakers and lull them to sleep. But of course this is exactly the same power of fascination that the parent exerts over the child at bedtime by telling them of faraway lands; of witches and of warlocks; of goblins and… of fairies.
This is maybe a little unfair: all that Krugman is saying, is that the real interest rate is too high for current circumstances, which I think, all economists can agree with. The only way to get the real interest rate to fall, is by pushing inflation expectations up. But that isn’t his recipe for pushing up AD. Krugman wants a fiscal expansion to push up AD. And with real interest rates negative thanks to slightly higher inflation, investment will react faster to expanding consumption.
That’s actually not what he’s saying. Look at the quote. He’s saying that by raising the inflation target the Fed will increase inflation expectations which will, in turn, lead to investment.
My thinking is that it instead lead to financial investors pouring into inflation hedges like gold, silver and other commodities.
My thinking is that it instead lead to financial investors pouring into inflation hedges like gold, silver and other commodities. Philip Pilkington
Yep. Particularly essential commodities like food and fuel. And you can bet that leverage (“credit”) will be used.
The irony is that “credit” was meant to help the general population with new goods, services and jobs. But now it will be used to starve the population it dis-employed.
Chase has hijacked the commodities markets from what I have heard. Blythe Masters has been roaming around South America doing to commodities what she did with the mortgages. Chase is an outlaw.
shsh. As I stare retirement in the face, I want Bernanke to think that raising the federal funds rate would save the economy. Look, right now Ts are paying about 2%. Maybe, Paul is worried that that Princely Princeton Pension won’t give him the lifestyle he wants once they tag the emeritus on the end of his title.
In all fairness you should mention that Krugman also advocates measures to increase the spending power of consumers, and that higher inflation would help with deleveraging.
How exactly will inflation help us to deleverage? The assumption is that debt becomes cheaper relative to income. But this is a specious assumption because with inflation, the cost of living rises while wages DO NOT rise. The fact that economists assume inflation leads to rising wages is just one of their thousand destructive and backwards notions. The old canard was that rising wages caused inflation, hence the justification for crushing workers’ wages. Now apparently its the other way around. Or better yet, both are “true”. Of course wages haven’t risen in quite some time, and in many cases they’ve dropped. This despite all sorts of inflation on energy, food and other commodities, as well as the white elephant in the room — real estate. The more the economists tinker with things, the more of a muck up they make. And no, if prices inflate it doesn’t make it any easier for me to pay off my debts. In fact it means I am more likely to take on further debt just to eat and feed my car. This country is in for a long, sad decline. Idiots like Krugman with their entrenched privilege and status will have to be completely discredited, or buried before those with sense can replace them. The sad thing is he isn’t even the worst, not by a long shot. Yet he is still so wrong about so much. It really shows how hopeless the situation is that we have nobody who actually knows what is going on in positions of influence.
Is it just me or do other people think Krugman looks crazed?
But thank God for Adblock!
It’s so governemnt can pay off debt in cheaper dollars too. They tax your cheaper dollars you earned – even tho your reduced purchasing has resulted in less of them after cost of living. But taxes are withheld before you pay cost of living, so it’s not a problem.
But we know MMT says this will make you deflate. So eventually you will force the economy to deflate – after a while – which will make everything revert back to the mean, eventually.
This may sound super naive, but aren’t wages a huge block of the price basket we use to measure inflation? Without a change in the wage level, the consumption level falls, and this offsets rising prices (the recessionary gap position). In order for true inflation to exist, the consumption level has to remain the same in aggregate. This implies rising wages or a falling unemployment rate. But maybe, like in chemistry, the ball and stick model can’t always get you a full answer. Any thoughts?
What I got from reading Krugman was that he was arguing for a meaningful stimulus. When he did that he drew fire from people who claimed that spreading money around in any way at all would cause inflation. So he countered that some inflation, if it happened, would be tolerable. Now he’s drawing more fire from people who claim that tuning the economy by setting the inflation rate is wrong. If that were the question at hand, they would be right.
Meaningful stimulus might keep American society alive long enough to cure it’s real problem — an economy structured to make profit without any production. Finding that cure is an additional task.
In the meantime, I might give up. This whole game of “Choosing Sides” is ridiculous.
The new fad among economics pundits is bad mouthing Krugman. NC has manifested real diversity by allowing Pilkington, Stoller and others to opine on the financial world on which, it appears to me, they are only marginally informed. That is par for the course for pundits.
Krugman is right most of the time and I am sure he will readily admit to some mistakes. That doesn’t justify Pilkington’s jihad.
I can not stop laughing.
Krugman, masquerading as a Keynesian, is a neo-liberal and a partisan Democrat. Any differences between he and the “conservative” economists he criticizes are superficial. Ultimately his prescriptions will fail to change, essentially, the crony capitalism that owns our polity and destroys democracy around the world.
Face it, how can any economist who supports this loathsome Democratic Party and its fraudulent leader, Barack Obama, be anything but a shill?
With all due respect, Krugman is an economist. That does not make him an expert in finance. In fact, economists in general are allergic to getting their hands dirty and understanding how financial institutions and financial markets work. Krugman is the first to admit that he prefers models, the more sparse the better, as the way to understand reality (as opposed to empirical observation first and abstraction later). I discuss this problem at much greater length in ECONNED.
And Krugman has turned hugely partisan this year. That is not to say that Romney is not deserving of criticism, but he keeps pretending that there is a sharp contrast between the Dems and Republicans, when the Republicans are simply more up front about their intent to screw everyone but the rich. He’s trading on his brand to promote Obama is a particularly open way, and that isn’t sitting well with a lot of people who are normally sympathetic to him. He has ALSO been intellectually dishonest in his attacks on modern monetary theory, in that he hasn’t bothered to understand it, and makes arguments against it that are pure straw man.
I suggest you get more familiar with Krugman’s record. He has done some invaluable work, like being skeptical of Iraq when that was a risky and isolated stand. But he seems to have been running on brand fumes for a while, which I’d hazard is the real root of the recent attacks on him.
Yes, I think Krugman has been carrying a lot of water for the party recently. Mainstream Democrats gave up on expanded fiscal activism early in the game for two reasons: (i) they decided they wouldn’t be able to get it past the Republican House any way, (ii) Obama sent out the message that he wanted to position himself as a deficit hawk and member of the party of responsibility seeking a Grand Bargain on shrinking the budget.
People always blame the President for bad economic performance. Since no significant action would be coming from Washington politicians on the economic front, and economic indicators continue to stagnate as unemployment remains very high, Democrats have chosen to throw most of their energies into a campaign targeting the Fed and Ben Bernanke. They hope the Fed can accomplish what Obama can’t and won’t. And even if the Fed can’t really accomplish what the these neo-monetarist Dems claim it can, by attacking Bernanke incessantly they are setting up a scapegoat for Obama’s failure, and can use that in the fall campaign.
Krugman has been good about mixing in sincere calls for additional fiscal action with the Fed-bashing, but he has also become the leading spear carrier for the “the Fed can do it” campaign. This undermines his own fiscal message. And he undermines his fiscal message in other ways too. In his recent interview on NPR, he turned at the end of the interview toward the “responsibility” message, suggesting that fiscal action now is some kind of debt imposed on the future, which will have to be paid back later. This is wrong, and making that claim empowers all those who are trying to put the Federal government out of business, including Social Security.
Yes, that is absolutely the key point. In addition to this his neo-monetarist ‘inflation targeting’ stuff is now being understood to be some sort of Keynesian response (as is QE and all that). If it were ever implemented and it simply led to more commodity price inflation we would have yet another incident in which Keynesianism was supposedly being discredited.
Krugman provides the Austerians with ammo daily. He should just stick with fiscal stimulus. He might also find some allies rather than some adversaries in the central bank community — I’m hearing some very interesting stuff coming out of the Fed from behind the scenes right now…
“Krugman provides the Austerians with ammo daily.”
Ah, no one is more dangerous than a fifth columnist, eh? Perhaps that’s why for every line of criticism of, say Mankiw, on this site, I see at least ten lines criticizing Krugman. Even circular firing squads have their justifications.
Alex, I think the focus of the left on Krugman is partly because Krugman is someone the left thinks they can ultimately influence if they keep up the criticism. Nobody thinks there is any hope of turning Mankiw, who has made a career of defending the rich, into a force for progressive change.
But Krugman has a prominent position and straddles the fence between progressive aspiration and centrist caution. It’s worth the effort to try to pull him over to our side.
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