Recently, Paul Krugman, Nobel prize winner, doyen of Keynesian economics and the world’s leading economic blogger, attacked yet again the monetarist-Austerian wing of mainstream economics for claiming the Keynesian macroeconomics theory had been proved wrong. On the contrary, according to Krugman, Keynesian theory and its policy prescriptions had been triumphantly right, http://krugman.blogs.nytimes.com/2015/03/14/john-and-maynards-excellent-adventure/.
“When I tell people that macroeconomic analysis has been triumphantly successful in recent years, I tend to get strange looks. …I stand by my claim, however. The basic macroeconomic framework that we all should have turned to, the framework that is still there in most textbooks, performed spectacularly well: it made strong predictions that people who didn’t know that framework found completely implausible, and those predictions were vindicated.”
What does Krugman mean by this framework? Well, he says, it is the version of Keynes’ monetary theory developed by John Hicks back in 1937. According to Krugman, Hicks’s book Value and Capital “was a seminal work on the economics of general equilibrium – that is, getting past one-market-at-a-time supply and demand to the interactions among markets. Hicks didn’t invent general equilibrium, of course, but he sought to turn it into a useful tool of analysis.” Hicks realized that a minimal model of macro issues involves three markets: the markets for goods, bonds, and money (or, better, monetary base) and as Krugman puts it, “What we already have here is an understanding that there isn’t that kind of clean separation, that money can affect interest rates and spending affect output.”
The monetarist theory (as best expressed by Milton Friedman’s quantity theory of money) is that, if changes in the money supply exceed real output growth, inflation will follow as ‘too much money chases too few goods’. Well, the revelation from the Hick-Keynes model is that when interest rates get close to zero, “the rules change… Even huge increases in the monetary base won’t be inflationary. Large budget deficits won’t raise rates. However, changes in spending, positive or negative – e.g., harsh austerity — will have an unusually large effect on output, because they can’t be offset by changes in interest rates.”
And so, according to Krugman, it has proved. In this current depression, interest rates are near zero and there has been a huge increase in credit injected by central banks but there is no inflation, indeed even deflation and government bond yields are at all-time lows. “All of this was predicted in advance by those of us who understood and appreciated Hicksian analysis. And so it turned out. I call this a huge success story – one of the best examples in the history of economics of getting things right in an unprecedented environment.” Thus the Hicks-Keynes money and income model remains secure in every macroeconomic textbook.
There are a few things to say here on this great success of macroeconomics, Hicks-Keynes style. The first is that, contrary to Krugman’s history, the idea that in a capitalist monetary economy, money, in particular the hoarding of money in a depression, can play a significant role in explaining a slump, did not first come from Hicks. As Fred Moseley has pointed out,
“Keynes was given the credit of having demolished the theories of 19th century economists who had taught that, if left to its own devices, capitalism would always and of its own accord tend towards full employment. What was little noticed was that most of the ground covered by him had been treated in detail by Marx three-quarters of a century earlier. While Marx dealt with this reluctance to spend to expand production, under the heading of “hoarding” ; Keynes coined the term “liquidity preference”, meaning that the capitalist prefers in that situation to keep his money in cash.”
Here is what Marx said in Volume one of Capital, “Whenever these hoards are strikingly above their average level, it is, with some exceptions, an indication of stagnation in the circulation of commodities, of an interruption in the even flow of their metamorphoses. Whenever there is a general and extensive disturbance of this mechanism, no matter what its cause, money becomes suddenly and immediately transformed, from its merely ideal shape of money of account, into hard cash. Profane commodities can no longer replace it. The use-value of commodities becomes valueless, and their value vanishes in the presence of its own independent form. On the eve of the crisis, the bourgeois, with the self-sufficiency that springs from intoxicating prosperity, declares money to be a vain imagination. Commodities alone are money. But now the cry is everywhere: money alone is a commodity! As the hart pants after fresh water, so pants his soul after money, the only wealth. “
To me, there are two big differences between Marx’s view of money’s role in crises and Keynes-Hicks. First, in the latter’s model of liquidity preference (the desire to hold cash rather than spend it), an economy enters a ‘liquidity trap’ in the form of a new equilibrium of supply and demand (investment and saving) at less than ‘full employment’. It is an underemployment equilibrium, which in some interpretations (New Classical) of Hicks-Keynes is due to ‘sticky wages’ i.e. workers keep wages up so that they price themselves out of jobs. The Hick-Keynes model still assumes all the fallacies of neoclassical economics that the capitalist economy, if left to its own devices, will find an ‘equilibrium’.
In contrast, as Moseley puts it, in Marx’s conception capital is nothing other than value in motion, and capitalism only exists in and through constant movement to accumulate, any stock of money is nothing other than a hoard waiting to be thrown into circulation at a convenient time, i.e. as capital; and equally, any expenditure of money as capital is nothing else but a dishoarding of money, whether in cash or in credit, for the purpose of accumulation. As a result, money’s potential role as capital makes it contradictory in nature: it is always “held in order to be spent, and spent in order to be held by another”. Since there exists uncertainty about future investment and future circumstances in the market, the hoarding-dishoarding role of money necessarily implies the possibility of disequilibrium; it is subject to changes in the expectations about future investment.” There is no equilibrium, except by accident.
The other difference is even more significant. For Keynes-Hicks-Krugman, there is no explanation of why a capitalist economy gets into a ‘liquidity trap’ in the first place. It just does; it does so because a change in ‘animal spirits’ or business ‘confidence’ about the future. See my posts on Krugman’s explanations of crisis here, https://thenextrecession.wordpress.com/2012/05/27/krugman-and-depression-economics/ and
In contrast, Marx stressed that the credit crunch is actually a symptom of problems in the underlying productive economy. “What appears as a crisis on the money-market is in reality an expression of abnormal conditions in the very process of production and reproduction.”
The monetarists may have got the causality backwards. They think that lower rates are what’s messing up the economy, rather than reflecting the fact that it’s already messed up. But the Keynesians are little better when they say an economic slump is the result of a liquidity trap. They have no causal explanation for this. As such, they are merely describing a slump in monetary terms (hoarding of money and avoiding spending even at zero borrowing rates), not explaining it. And if you cannot explain something, you cannot expect to find the right solutions to changing it. Krugman may argue that the Keynes-Hicks model has been vindicated because increasing the money supply has not led to inflation as the monetarists expected. But then neither has central bank quantitative easing led to a ‘return to normal’, or a new equilibrium of growth and ‘full employment’. All it has done is fuel yet another credit bubble in the stock and bond markets for the rich.
Sure, Krugman would retort that this is why governments must adopt the second weapon in the Keynesian armoury, government spending. End austerity and spend. I have argued in previous posts why even Keynesian-style fiscal injections won’t restore growth and employment if profitability in the capitalist sector remains low or starts falling, or if the debt burden remains high (see my posts, https://thenextrecession.wordpress.com/2012/06/13/keynes-the-profits-equation-and-the-marxist-multiplier/).
The example of Japan is confirmation of that, where monetary easing, fiscal stimulus and neo-liberal structural reforms have been applied under Abenomics (see my posts, https://thenextrecession.wordpress.com/2013/06/11/abenomics-a-keynesian-neoliberal/ and
https://thenextrecession.wordpress.com/2014/10/13/japan-the-failure-of-abenomics/), with miserable results.
So it’s a very small victory to claim for mainstream Keynesian macroeconomics that inflation has not returned when interest rates are low and credit expansion is high.