Krugman Gets it Wrong

By L. Randall Wray

In his column in yesterday’s NYT, Professor Paul Krugman rose to the defense of Paul Samuelson. He argued that Michael Hudson’s piece, originally published in 1970, not only misunderstood Samuelson’s theories but also wrongly asserted that he was not deserving of a Nobel. Krugman’s main argument was that Samuelson’s version of “Keynesian” economics offered a solution to depressions that pre-existing “institutionalist” theory did not have:
Faced with the Depression, institutional economics turned out to have very little to offer, except to say that it was a complex phenomenon with deep historical roots, and surely there was no easy answer. Meanwhile, model-oriented economists turned quickly to Keynes — who was very much a builder of little models. And what they said was, “This is a failure of effective demand. You can cure it by pushing this button.” The fiscal expansion of World War II, although not intended as a Keynesian policy, proved them right. So Samuelson-type economics didn’t win because of its power to cloud men’s     minds. It won because in the greatest economic crisis in history, it had something useful to say.

This claim is bizarre, to say the least. First, Roosevelt’s New Deal was in place before Keynes published his General Theory, and it was mostly formulated by the American institutional economists that Krugman claims to have been clueless. (There certainly were clueless economists—those following the neoclassical approach, traced to English “political economy”.)

Second, it was Alvin Hansen, not Paul Samuelson, who brought Keynesian ideas to America. And Hansen retained the more radical ideas (such as the tendency to stagnation) that Samuelson dropped. Further, Hansen was—surprise, surprise—working within the institutionalist tradition (as documented by in a book by Perry Mehrling).

Third, many other institutionalists also adopted Keynesian ideas in their work—before Samuelson’s simplistic mathematization swamped the discipline. For example, Dudley Dillard—a well-known institutionalist—wrote the first accessible interpretation of Keynes in 1948; Kenneth Boulding’s 1950 Reconstruction of Economics served as the basis for four editions of his Principles book—on which a generation of American economists was trained (again, before Samuelson’s text took over). It is in almost every respect superior to Samuelson’s text. I encourage Professor Krugman to take a look.

Fourth, Hyman Minsky (who first trained with institutionalists at the University of Chicago—before it became a bastion of monetarist thought) took Samuelson’s overly simplistic multiplier-accelerator approach and extended it with institutional ceilings and floors. He quickly grew tired of the constraints placed on theory by Samuelsonian mathematics and moved on to develop his Financial Instability Hypothesis (which Krugman has admitted he finds interesting, even if he does not fully comprehend it). I ask you, how many analysts have turned to Samuelson’s work to try to understand the current crisis—versus the number of times Minsky’s work has been invoked?

And fifth, Samuelson’s “button” approach to dealing with the business cycle has been thoroughly discredited since the late 1960s—when he announced that we would never have another recession. In truth, as Minsky argued, it is not possible to “fine-tune” the economy because “stability is destabilizing”. The simplistic “Keynesian” approach propagated by the likes of Samuelson leaves out the behavioral and institutional analysis that is necessary to deal with instability and crisis.

Sixth, as has been long recognized, Samuelson purposely threw Keynes out of his analysis as he developed the “Neoclassical Synthesis”. The name dropping was intentional—Keynes was too radical for the cold warrior Samuelson. At best, what Samuelson presented was a highly bastardized version of Keynes—as Joan Robinson termed it, a Bastard Keynesian approach (we know the mother was neoclassical economics but we do not know who the father was).

Finally, and most telling of all, whose work is universally acknowledged as the most insightful analysis of the Great Depression? Might it be John Kenneth Galbraith’s The Great Crash? I have never heard anyone refer to any work of Samuelson in that context.

So Professor Krugman has got it wrong.

13 responses to “Krugman Gets it Wrong

  1. Well spoken and very enlightening.

  2. I'm waiting with bated breath for Professor Krugman's rebuttal of your response and Michael Hudson's, too. I expect I'll suffocate before it comes though. Nice work.I give Professor Krugman credit for a heart in the right place with respect to values in comparison with the neoclassical crowd, but he is also intellectually captured, I fear, as Professor Hudson observes.

  3. I'm an economics skeptic, and even so, it just boggles me that at a time like this Krugman (one of the less-bad guys among the orthodox) would put that much energy in a chickenshit little factional dispute. Especially if he was wrong, as you say here, which I have no trouble believing.Academic indoctrination produces the pettiest people in the world.

  4. Michael Hudson's response convinces me this is much more than a chickenshit little factional dispute.

  5. I'm coming late to this, but because of some comments on another blog I was re-reading Prof. Krugman's piece where he says: "So Samuelson-type economics didn't win because of its power to cloud men's minds. It won because, in the greatest economic crisis in history, it had something useful to say". "Samuelson-type economics" is a strange phrase to use. I suppose Prof. K. means Keynesian economics, but why use such a strange reference? Prof. K. couldn't be claiming that Keynesian economics was really invented by Paul Samuelson, could he? No, impossible; Samuelson was still an undergraduate when FDR was inaugurated in 1933. So is Prof. K. claiming that Keynes is famous because he preceded Paul Samuelson, sort of like John the Baptist preceded J. Christ?

  6. From Samuelson's, Foundations of Economic Analysis:"With every economic problem, (1) reduce the number of variables and keep only a minimum set of simple economic relations; and (2) if possible, rewrite it as a constrained optimization problem."And down the rat hole the profession went.

  7. I followed links here from Naked Capitalism, discussion of economists in thrall to the Fed. It has puzzled me for some time that leftist economists, particularly Brad DeLong–continually cited approvingly by Krugman–completely endorsed Greenspan (see DeLong's review of Greenspan's book in the L.A.Times in Dec 2007), seeing him as the same wizard that the popular press did. (Wizard, indeed, as in Oz.) Krugman too has said nothing to fundamentally criticize the Fed. Krugman and DeLong have both endorsed the repeal of Glass/Steagall, saying the repeal has had little to do with the collapse. Krugman whom I cherish for his lone stance against Bush and his wars has turned out not to be a relevant critic in his own sphere of expertise.

  8. It is awesome to read Prof. Wray always! No doubt Samuelson's "Keynesian-like" "Daddieless" theories have misled generations of economists.Meanwhile, should Kansas City try to make friends with Prof. Krugman though? He's sticking to that Textbook-MIT Keynesian theoretical tradition,true, but he's also reading Minsky, friends with the EPI and the New America Foundation where Prof. Jamie Galbraith, Prof. Black and Dr. Tom Palley all hold great influence in economic policy alternatives, and where Prof. Wray's ELR proposal even appeared in the "Job's Deficit" conference. It is hard to shed skin, even JMK had that problem. Prof. Krugman could very well become a powerful ally if we convert him nicely, softly and slowly.

  9. Thanks for the comments. Very briefly, Brad DeLong is certainly no "leftest". I suppose that for an orthodox economist he is left of center. I have seen a number of his blogs (and particularly some debates he had with Warren Mosler) that convince me he has virtually no understanding of monetary operations. He might be good on other topics–I just don't know. Paul Krugman's anti-Bush writings would probably qualify him as a liberal–without a caveat–and as a far left among orthodox economists. And yes, I agree, he is making effort to understand Keynes (he wrote a good introduction to the new edition of the General Theory) and Minsky. So please be assured that I do agree that he often gets things right–and occasionally even gets macro theory and money mostly right. But these are not his fields of expertise as an economist. And he is dead wrong in his assessment of Samuelson vs Institutionalists.LRWray

  10. Krugman is a smoke screen for the NY elite. Don't let the prize and his waffling from one side of the equation to the other sway you. His statement that the depression was a failure in aggregate demand should be enough to enlighten many. The depression was a failure of the credit system due to massive overindebtedness. We evidently saved ourselves into bankruptcy, aided and abetted by the Federal Reserve, Ponzi financing on Wall Street and international debts piled up from WW I. I had no idea that Hudson went back so far. I found Hudson on Steve Keens site. I think I found this site because I linked it to William Black, one of a very few voices in the wilderness calling out for investigation of one of the great crime syndicates of all time. Hudson has my attention because he knows what the problem is and the mainstream economists don't even dare raise the issue. The solution threatens the fictional wealth of most of us that own anything, but the real wealth will still be there. Guys like Krugman would rather chase points on graphs around in circle under some theory than point out the fact that the Wall Street money machine is cranking out more phony debt as we speak, under the auspices of Mr. Bernanke and Tiny Tim.

  11. BTW, this is an ingenius statement:And fifth, Samuelson's "button" approach to dealing with the business cycle has been thoroughly discredited since the late 1960s—when he announced that we would never have another recession. In truth, as Minsky argued, it is not possible to "fine-tune" the economy because "stability is destabilizing". The simplistic "Keynesian" approach propagated by the likes of Samuelson leaves out the behavioral and institutional analysis that is necessary to deal with instability and crisis.I was talking to a friend last night and explained to him about the idea behind portfolio theory and its cousins the Collateralized debt obligations. The theory of course is the return can be stabilized and absolute should you build the right portfolio, when in fact the idea of guaranteed return becomes the model and the risk then becomes the model. By this, I mean they begin to price the model as if the returns are guaranteed and forget that the price and risk determines the return, not the other way around. Thus, the story was the S&P portfolio would return 10% forever or whatever the number was. Well, that might be true with 1% real growth, a 5% dividend and 4% inflation, but once it is accepted as fact, that owning the portfolio will return 10%, you find it priced to a 1% dividend as in 2000 and 10% is absolutely impossible. To get back to the 10% model so many were using for retirement purposes, not only did the price have to be reduced to reflect a 5% dividend, but the rate of inflation would have had to go up and the 1% real rate of growth hold up as well. I doubt any of these factors would support the other. Thus the stability of holding a portfolio trumped the risk involved in pricing which will cause instabilty because it is now impossible to hold the components of the portfolio and achieve a return that equates to the risk involved. The same idea led to AAA on subprime CDO's, based on a model of stability. Thus the issue of stocks in internet companies with almost no business and the issue of mortgages to people to buy inflated homes with no means to pay back became the model. In this vein, it was assumed the model of stability would take care of the risk on its own. I had written a piece on Prudent Bear back in 2003 I labeled "Who destroyed Portfolio Theory". I think I might have it on an old computer, as those pages are lost and gone forever. In it, I challenged not the real principal behind portfolio theory, which is sound, but the fact that it could successfully be used in a widespread manner by the great uneducated in finance. As I found out, there were more liberal arts majors on Wall Street who were able to layer on an MBA than those with undergraduate finance degrees, it was clear these ideas would never be used properly. The fact that there were trillions in S&P index funds, that companies like JDSU were bid to $150 billion upon their inclusion in the index, though they had never made a penny, was proof enough the theory didn't work in a mania. What it did instead was lock in the loss of inadequate pricing of risk. Thus, once the model was accepted as fact, the risks that prevailed in the past were allowed to run rampant and the model became the risk.

  12. just posted this at the wallstreet pit but .. no telling wether it will go up there: patiently awaiting deserved and due attention: previous issue of me was nostradamus … according to some calcs (dreamspell, as onesidedly interpreting (time) fractions as UvB did gold compared to my photosynthesis rates and diversities ideas), not that i don't have a hard time believing will note that this file has been sitting at a 'free' provider who popped gambling opps into the viewers' sights and if you wanna blame banking for white board gambling blame me or the IT industry with their sleigh of fingertip and disproportionated neoteny turning slitthroat mafiya gangsters into fast traders.gambling that folks wanna go live in the states and have the money to do so is not such a gamble though is it?if asians constitute majorities at all sorts of school in the west why won't thewant to study the human rights perpetraitored on the red races by occupations glorifying and euphemizing folks who issued them with iouz they manage to spend elsewhere less and less easy for the poisons that matter to them? Cynical, me? no architect and construct whole tree!!!!! flakey gang8sters cannot even honour minds like Ulrich von Beckerath. Such a shame tangential mention (via his better known pall Rittershausen) is left up to gold advocates like Fekete. Can't they engage this person at least. Still alive you know. Pointing at advantages of gold (cannot be stretched into war budget, slow increment could parallel mentioned and envisioned and desirable value standard) is like shooting fish in a barrell in this day and age. Too cheap a trick? don't think so.

  13. I really like Marc Linder's two volume treatment of Samuelson. I wish he would write one for Mankiw's text.