Krugman's dangerous idea (It worked for me too!) By Scott Sumner

In a recent post I argued that Paul Krugman had started out as a critic of intellectuals who ignored economic models—the sort of person who argued that the laws of supply and demand do not apply to the minimum wage debate. Of course now Krugman himself argues the laws of supply and demand do not apply to the minimum wage debate. I suggested that his new stance had an appeal to non-economist intellectuals that was roughly comparable to the appeal of John Kenneth Galbraith in the 1950s and 1960s.

Commenter Roger pointed me to a fascinating essay written by Krugman in the 1990s, called “Ricardo’s Dangerous Difficult Idea.” This passage reminded him of my post:

I once had a very unpleasant, but ultimately useful, conversation with the editor of one of America’s leading intellectual magazines. He was in the process of refusing to print a piece I had written at his request, and his dissatisfaction with what I had written was the main subject at hand. But along the way I somehow mentioned the need to represent economic ideas with carefully thought-out models, and he responded with a mixture of bafflement and asperity. Clearly the idea that economic ideas could benefit from being modeled was new to him, even though his journal frequently publishes articles on economic affairs; and he suggested to me that in future I would do well to explain why models are sometimes useful and why they usually are not. At the time I was fairly flabbergasted: to question the usefulness of economic models at this late date seemed rather strange. But the economist’s idea that economic theory for the most part consists of models has by no means been accepted by intellectuals outside our field. In fact, if one looks at the favorite economic writers of the non-economist intellectual — Robert Reich, Lester Thurow, John Kenneth Galbraith — one realizes that they have in common an aversion to or ignorance of modeling. There are model-oriented economists, like Alan Blinder, who also write for a broader audience, and they don’t put their equations in their books and articles; but the skeleton of the models that structure their thought is visible under the surface to those who know how to look. By contrast, in the writings of Reich or Galbraith what you read is what you get — there is no hidden mathematical structure to the argument, no diagram one might draw on a blackboard or simulation one might run on a computer to clarify the point.

Just to be clear, even today Krugman’s essays are much more informed by mathematical models than Galbraith’s ever were. But he has certainly moved in a direction where he is much more appealing to the sort of intellectuals who like Galbraith.

Rereading Krugman’s essay after many years I was stunned by just how good it is. I could not recommend it more highly; indeed I don’t recall ever reading anything better in this genre. Toward the end of the essay he has 4 recommendations for public intellectuals. Here’s one that caught my eye:

(ii) Adopt the stance of rebel: There is nothing that plays worse in our culture than seeming to be the stodgy defender of old ideas, no matter how true those ideas may be. Luckily, at this point the orthodoxy of the academic economists is very much a minority position among intellectuals in general; one can seem to be a courageous maverick, boldly challenging the powers that be, by reciting the contents of a standard textbook. It has worked for me!

Hmmm, “contents of a standard textbook.” So let’s see how that would work. Let’s take three key concepts that Frederic Mishkin emphasized (in 2008) at the end of his best-selling textbook on Money and Banking:

1. It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates. 2. Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms. 3. Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero.

So the fact that interest rates were low and falling in 2008 does not imply that money was easy. OK, but it also doesn’t mean it was tight. But all the other asset markets were also suggesting—no not suggesting, they were all screaming—that money was very tight. And point #3 suggests that even when interest rates hit zero at the end of 2008 the Fed still had the ability to engage in monetary stimulus. Hence money was tight during 2008-09 and it was the Fed’s fault. Or at least that’s what the number one textbook implies. The Fed caused NGDP to fall at the sharpest rate since the 1930s, and this caused the Great Recession.

Now suppose that back in early 2009 some completely unknown economist at an unknown college took these boring, conventional textbook ideas and boldly presented them as if they were daring, dangerous, rebellious ideas, smashing the conventional wisdom on the Great Recession. I wonder how far he’d get before they arrested him?

Again, I can’t emphasize enough how good Krugman’s essay is. If you haven’t done so you should read it carefully. Don’t be put off by the fact that you might find Krugman’s recent stuff to be irritating. It’s a masterpiece.