Wednesday, September 1, 2010

Krugman, Keynesians, the Austrians, and the Housing Bubble

In a blog post, Paul Krugman points out that a number of "austerians" (people who believe we need to have fiscal and monetary responsibility) did not see the "housing bubble" approaching -- and he did. Therefore, according to Krugman logic, "austerity" must be bad.

As I see it, the logical construct goes this way:

1. The "austerians" were wrong on the housing bubble;
2. Krugman was right on the housing bubble;
3. Therefore, we need lots more government spending because Krugman believes that is what we need.

This is a classic non sequitur, and I hate to say it, but Krugman's correct view of the bubble does not mean he is correct today. The rightness or wrongness of his argument depends upon both the application of laws of economics and the current situation, period.

Now, in looking at the whole housing bubble business, let me say that I am not going to jump on Krugman's 2002 comment about Alan Greenspan needing to create "a housing bubble to replace the NASDAQ bubble." Krugman has denied that he was advocating such a bubble, and I am willing to take him at his word.

Nonetheless, there are two things that need to be discussed here. The first is the fact that the Austrians, and specifically Mark Thornton, were out in front to call the housing bubble what it was. Thornton wrote in 2004 that the housing market was "too good to be true," and also had this article in February 2004 that buttresses his claims.

Yet, Professor Thornton also is an "austerian," at least in Krugman's definition. He also predicted and recognized the housing bubble long before even Krugman made mention of it. So, there seems to be a crack in Krugman's rejection of "austerity" measures for the economy.

Before going further, however, I need to point out that Austrians are not "austerians" in the mainstream (or statist) view of economics. Austrians believe that the market should be free to sort out the malinvestments that came with the boom, and for the necessary liquidation and repositioning of assets to occur. This is quite different than the view that GOVERNMENT should be IMPOSING austerity. In the Austrian view, the government role is passive while in the mainstream view, government is active in its imposition of policies.

(I need to point out that Krugman rejects both viewpoints. Government needs to be active, showering new money, encouraging spending, and doing lots of borrowing and spending itself, according to Krugman.)

My second point is more theoretical. Keynesians deal solely in aggregates, because they believe that if government both engages in generalized spending (and encourages consumers and businesses to do the same), the economy will recover and grow to full employment -- provided the spending is great enough. However, Keynesianism does not have any kind of coherent capital theory, and I don't see how one can have a bubble, which constitutes a malinvestment in the Austrian view, AND, at the same time, claim that all that is needed is spending.

As I have written many times before (and I am hardly the only Austrian to be saying this), the Keynesian view implies that factors of production are homogeneous, and that it does not matter what kind of spending takes place, just as long as there is adequate spending. This cannot logically square with the creation of bubbles, since asset bubbles are specific and they clearly are malinvestments, yet Krugman continues to deny any theory that includes malinvestments.

Furthermore, Krugman knows that one cannot sustain a bubble, since bubbles by their very definition are not sustainable. Yet, he seems to be arguing that we need to both try to sustain this bubble, or at least not let housing prices fall, and, at the same time, recognize what a bubble really is. These two views are mutually exclusive.

So, in both sets of arguments, I believe that Krugman is using a non sequitur, nor does it surprise me he is doing so.

25 comments:

Bob Roddis said...

The only difference of opinion I might have here is the claim that “the Keynesian view HOLDS that factors of production are homogeneous”. I agree that such a view is implicit in what the Keynesians believe just as it is implicit in the rantings and ravings of the Chartalists. However, this is only by default because critics of the Austrian School meticulously evade and avoid discussing or even thinking about such topics. Similarly, they will evade and avoid related and more fundamental topics like acting man, subjective value, economic scarcity, ethics and economic calculation. Only the dream world of their superficial aggregates is real to them while the real world of acting humans is a “religion”.

Krugman and his minions are smart enough to know that they are misrepresenting the Austrian view and Austrian history. I see no difference between these misrepresentations (which is really just a form of changing the subject) and the Glenn Beck crowd’s phony harping about “eeek a Mosque” in the face of the collapse of support for the war-monger paradigm in the public mind.

In both cases, it’s an admission that our side would win the debate if a debate were allowed. And it’s an admission that their paradigm is collapsing.

William L. Anderson said...

I like that. OK, I will change the wording.

Ben said...

"Abundant credit at bargain rates of interest causes housing prices to soar, especially in growing communities, which fosters not only feverish construction activity but also enlarges the mountains of debt, even consumer debt. Fannie Mae, the publicly owned and government-sponsored Federal National Mortgage Association, reports that soaring housing prices and falling mortgage rates are allowing homeowners to refinance $1.4 trillion of mortgages in 2002, up from $1.1 trillion last year. In both years homeowners are estimated to take out some $100 billion in equity.

The real estate bubble is bound to burst as soon as the distortions become visible to ever greater numbers of participants"

-Hans Sennholz, 2002

http://mises.org/daily/1089

Anonymous said...

krugman's article says:

"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."

how scary it is that people actually listen to him when he speaks.

Anonymous said...

Anon, see this for the context behind the quote.
http://krugman-in-wonderland.blogspot.com/2010/08/what-can-fed-do.html?showComment=1281826858913#c5818296945242818522

Anonymous said...

Guys:

You can recognize that your way of making the patient bleed until he clots would work, and in a certain sense, I'd agree with you.

Or, to torture another metaphor, one cure for a headache might be aspirin, the other may be to cut off your head. Both work. One is slightly less damaging than the other.

If we simply let the housing market unwind on its own, a lot of innocent people would get bloody. People who have paid their mortgages and were responsible with their debt loads are getting washed out, too. I talk to these people almost every day.

The position we are now in is one that Keynesians have worked through before: up against the zero lower bound, the only thing left to do (if indeed you acknowledge something should be done, and I know you don't for ideology reasons) is to spend to help cushion the fall, while the productive part of the economy sorts itself out and eventually restarts growth.

Given time, mortgages will be refinanced with the lower rates now available, and the people worst off may see some of their principle forgiven, which accomplishes at least some of the wiping of bad debt off the books.

Lots of people saw this housing market bubble. In fact, I was reading one of Soros' books (don't remember which one) and he was pretty strongly saying get to the sidelines. Only wish I had taken his advice. Timing, as they say, is everything.

Jonathan M.F. Catalán said...

I think it's important here to remember that not all austerians are Austrians, and I think Krugman recognizes this (even if he doesn't know what an "Austrian" really is). For the record, there are many austerians who did not see the bubble coming (i.e. many chicago school economists and monetarists, such as Bernanke and Greenspan). There are many austerians who don't believe in the concept of bubbles (i.e. Fama).

jason h said...

@ Anon 12:30

Unfortunately the actions taken to 'cushion the fall' actually prevent 'the productive part of the economy [from sorting] itself out'.

Anonymous said...

Did you seriously just delete my post because it offered an argument to your own?

Now I understand why all of the comments are in agreement with you.

Anonymous said...

I'm surprised Krugman or his NYT handlers didn't cheekily capitalize 'austerians'...

Anonymous said...

@ Anon (September 1, 2010 12:30 PM).

The only context needed is the entire paragraph that Krugman wrote, which I have pasted below (this line: "To fight this recession the Fed NEEDS more than a snapback; it NEEDS soaring household spending to offset moribund business investment.")

Are you (or Krugman, or Joe the Plumber) going to tell us next that Krugman wasn't REALLY advocating we double our "stimulus" and that he was just making a rhetorical statement about what would be NEEDED for a country in our exact predicament? Unfortunately, that argument would be dishonest to say the least, as Krugman has been advocating we double the "stimulus".


Full paragraph is right here:

"The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."

Anonymous said...

"The only context needed is the entire paragraph that Krugman wrote, which I have pasted below"

So you rather bury your head in the sand than see what Krugman was quoting and what it actually meant? Okay. There's no need to debate this anymore. Seems like you're the type of person who only wants to confirm their own beliefs and not hear the other side. You already made up your mind.

William L. Anderson said...

To the 6:26

I have no idea about this alleged deletion of your post. I don't delete anyone's posts, and that includes the critical ones. A large number of people who leave comments do not say complimentary things about what I have written or me.

To be honest, I don't mind the criticisms, because it shows people are reading the blog and taking part in the discussion.

So, if you are going to accuse me of deleting your post, you should be specific: What post? What did you write? At what time did you post that comment?

My sense is that you made up this "incident" out of whole cloth in an attempt to make a false allegation against me.

Bob Roddis said...

For the record, there seem to be computer gremlins in the comments. I had a pro-Austrian comment last week on my “donut eaters” theme that appeared and then disappeared. I also saw the referenced “Anonymous” comment on this post that appeared at first and then disappeared. It was so weak as to be flaccid.

On a related topic, I managed to post a comment on the “Austerian” Krugman post.

This managed to draw out a “brilliant” contrarian, who wrote:

Their point of view may be appealing because human beings have fortunately build institutions since at least 40.000 years and mankind has survived since yet. Let follow the Austrian ideology and remove all economic instituions from Planet Earth and, five minutes later, you'll see people rioting in the streets and, after a while, human civilization is dead -and Austrian economists too!...The Austrian message would be: go back to the caves and everybody will be happy!

Dennis said...

Perhaps Krugman has never heard of Peter Schiff? Not only did he publicly predict the meltdown, he was vilified and ridiculed in the mainstream media for doing so.

Anonymous said...

@ Anon (September 1, 2010 7:56 PM)

If you read the entire paragraph (which is not taking anything out of context, as it is his ENTIRE paragraph), you will see that he is in FACT endorsing this idea. He is saying the Fed "NEEDS" to do something... something that Paul M. from Pimco had suggested or proposed. What else could he have possibly meant? Who is burying their head in the sand now? Yes, I have made up my mind, after 1) reading Paul Krugman for years, 2) believing that Paul Krugman was extremely intelligent for years, which is quite funny now, and then 3) eventually realizing that - although he is the most influential "economist" in the US - he is nothing more than a political hack who is cashing in (books, speeches, etc) on the fact that the more he skews reality, the more money he makes and attention he gets from other political hacks. I am willing to hear Keynesian debates - even though I will probably disagree, as I usually tend to agree with Austrians. However, reading a socialist or a statist and those that blindly follow them is pointless. Cheers.

William L. Anderson said...

There are times when I have seen comments disappear, at least for a while, but I think that is a Google thing, not my actions. I do not take down comments, period. I prefer the wild give-and-take to a comment board that simply agrees with me. Don't want that, period.

vitu said...

Mr. Krugman has not a hunch what he is talking about. For example: In a German newspaper I read an interview with Krugman were he encouraged Germany to do more (spend and print more money) against the rescession. On the other hand in the very same interview he warned German policy makers not to devaluate the Euro to get an advantage in exports! I guess he really thinks that all the printing of money doesn't have anything to do with the purchasing power of a currency?! Otherwise I can't explain these two statements (in the very same interview!!!).
So I'm not very surrprised about his conclusion that austerians didn't predicting the housing bubble so their economic view must be wrong.

Anonymous said...

@ vitu - what in the world are you talking about? Do you generally just make things up? The Euro is not Germany's currency. They have zero authority to print, devalue, etc. They have zero control over the currency.

Anonymous said...

"
@ Anon 12:30

Unfortunately the actions taken to 'cushion the fall' actually prevent 'the productive part of the economy [from sorting] itself out'.
"

Well, if that were true, then recessions would never end, right?

Bob Roddis said...

Well, if that were true, then recessions would never end, right?

Well, recessions don't end if Keynesian policies of further debt and money dilution plus price supports and bailouts of malinvestments are instituted.

Why don't you at least make the slightest attempt at understanding the basics of Austrian theory such as acting man, subjective value, economic calculation and capital structure? You know - the things that real world human beings necessarily do in order to live and survive.

These uneducated ad hoc critiques are getting tiresome.

vitu said...

@ Anon

You should read carefully what I wrote. I wrote about an interview with Krugman! He was the interviewee.

So you can blame Krugman for not knowing who is in charge of monetary policy in the EU. That's what KRUGMAN said.

Anyway, you don't seem to know who is in charge of monetary policy in the EU. It is mainly Germany and France because they have most influence and their economy is most important in the euro zone. That's the simple reason. And the EU has NO democratic structure - they are bureaucRATS.

jason h said...

@ Anon 7:15

"Well, if that were true, then recessions would never end, right?"

Well, if it wasn't for the artificial expansion of credit in the first place the booms and subsequent busts wouldn't happen.

However, given the artificial booms, the market can sort itself out in about 18 months if the Keynesians leave it alone. It's when they stimulate that we get Great Depressions (which didn't end until after the rest of the world was rubble and gov't spending significantly dropped).

Now, we are 2 years into this Great Recession with no end in sight. No 'traction', no sustainable lines of production, only wasted spending.

Perhaps you could explain how buying up toxic assets from incompetent firms, and funding a bunch of public work projects are sustainable.

Anonymous said...

@Bob Roddis:

"
Well, if that were true, then recessions would never end, right?

Well, recessions don't end if Keynesian policies of further debt and money dilution plus price supports and bailouts of malinvestments are instituted.
"

So, without a bailout, the entire US auto industry shuts down, including a fair amount of the supply chain also supporting foreign manufacturers, and instead,
we have a new GM that has strung together 3 profitable quarters, along with the entire supply chain?

And a whole bunch more people who aren't being counted in unemployment statistics?

Sounds good to me.

"
Why don't you at least make the slightest attempt at understanding the basics of Austrian theory such as acting man, subjective value, economic calculation and capital structure? You know - the things that real world human beings necessarily do in order to live and survive.

These uneducated ad hoc critiques are getting tiresome.
"

Well, sir, these are places where you could put your obviously awe inspiring knowledge to work providing light, instead of heat.

Your choice. You may also ignore my postings. I'm sure my feelings won't get hurt.

Anonymous said...

"
@ Anon 7:15

"Well, if that were true, then recessions would never end, right?"

Well, if it wasn't for the artificial expansion of credit in the first place the booms and subsequent busts wouldn't happen.
"

Agreed.

"
However, given the artificial booms, the market can sort itself out in about 18 months if the Keynesians leave it alone. It's when they stimulate that we get Great Depressions (which didn't end until after the rest of the world was rubble and gov't spending significantly dropped).
"

Most sources put the end of the Great Depression at the beginning of WWII, with full employment reached in 1943.

All with the government performing a heroic amount of MASSIVE deficit spending and debt creation. So, you can look at WWII as an example of massive spending ending depressions, just as Keynes would have predicted, no?

I don't know why you think Keynesians leaving things alone solve problems: Hoover had from 1929 to 1932 before FDR came on scene, and he proposed an implemented an austerity program, just as is being proposed today.
That didn't work out so well.


"
Now, we are 2 years into this Great Recession with no end in sight. No 'traction', no sustainable lines of production, only wasted spending.
"

Hey, many sources think we're out of the Great Recession. GDP is up, corporate profits are up, and happy days are here again. Only that lagging unemployment indicator still out there. Many argue that this is a structural unemployment problem: there is no longer demand for the skills of the majority of the unemployed, since their jobs no longer exist or have been moved offshore.

That's a different problem.


"
Perhaps you could explain how buying up toxic assets from incompetent firms, and funding a bunch of public work projects are sustainable.
"

Removing toxic assets allows the incompetent to survive another day. One might argue the wisdom of doing this without regulation to make sure that the incompetent are either looking for work or not allowed to show their incompetence again, but how many competent, non-toxic assets will suffer if you simply let them fail, after you've allowed them to become too big to fail?