Paul Krugman: Holding Economic Logic Hostage to Keynesian Nonsense, Part I

I must admit I enjoy reading Paul Krugman's material on the NY Times page if for no other reason than he does a good job of explaining bad "economic theory" in the form of what Robert Higgs calls "vulgar Keynesianism." While today's column primarily is political in nature (and no one politicizes economics more than Krugman), he also lays out the keys to understanding how Keynesian "logic" actually works.

Now if one were to have a conversation with Krugman, one would find that he actually believes in the Law of Scarcity, the Law of Demand, and the Law of Opportunity Cost. Furthermore, I doubt seriously that he believes these things can be repealed, even by a mythical President Krugman.

Yet, when put into a macroeconomic framework, Krugman's economic thinking is based upon a view that the "rule" somehow are different at different stages during the business cycle. For example, when things are relatively good, then one set of rules apply, and when the economy is in the tank -- as it is now -- one goes by another set of rules. And so it goes.

I will take the liberty to say that Krugman believes that a capitalist economy suffers from what might be "internal contradictions" (I use that term carefully, as Marx used it and Krugman is not a Marxist) that tend to bias economic performance downward. The logical progression goes in the following manner:

• People produce goods and are paid;
• They take that money and "buy back" the goods that they make.

As long as people are able to "buy back" everything they have created, then all is well. However, the "internal contradiction" tends to be seen here:

• People save part of the income they receive;
• Savings tends to be greater than investment (the banks and other savings institutions tend to invest less than they take in as deposits);
• Not enough money is available to "buy back" the created products;
• Therefore, this "underconsumption/overproduction" cycle leads to layoffs as firms quit making goods so that they can sell off their inventories.

That pretty much is the Keynesian explanation of what is happening, and if one reads Krugman, one finds that he is operating on two fronts regarding any cut in tax rates for people he calls "the rich."

• Wealthy people do not consume their entire paychecks at one time, so they have a greater "marginal propensity to save" than do people with lower incomes, which means that their spending/savings ratio creates problems for the economy;
• Wealthy people tend to be more responsible for economic downturns because they don't spend everything at once, which is why they need to have large portions of their income taxed away so that government can do the responsible thing and spend.

Keynesians refer to the "multiplier," which is 1 over the MPS (Marginal Propensity to Save, or 1-MPC, the Marginal Propensity to Consume), and the greater the "multiplier," the better the economy performs. Obviously, the less that is saved, the greater the "multiplier," although Keynes adds that zero savings would bring about hyperinflation.

However, in the Keynesian view, the more government can drive down the savings rate to as close to zero as possible, the better off we will be, and the only way to do that is for government to make saving money as unattractive as possible. This noble goal of government can be accomplished in the following ways:

• Inflate the money supply by enough to discourage present savings, as the value of money depreciates so quickly that to hold any money to spend in the future would be pointless;
• Have high progressive tax rates to confiscate "idle money" from the wealthy so that government can quickly spend and bring the economy back to full employment;
• Have government aggressively borrow money in order to lap up any other idle funds.

As for capital, well, in the Keynesian view, capital simply happens. Furthermore, capital investment at a time like this is useless because of "excess capacity."

There are a number of other implications in all of this, and when one adds Krugman's own belief that a society that is based upon a cradle-to-grave welfare system along with other restrictions is preferable to what he sees as a society governed by the "animal spirits" of capitalism, the logical progressions are obvious. Furthermore, in Krugman's view, markets that are not boxed in by rules set by government agencies always run off the cliff, as all investors are short-term oriented (as are Keynesians) and are not deterred by changes in relative prices, since Keynesians don't believe that prices have any significance except when aggregated in to various price indices.

Furthermore, in Krugman's view, no one would be willing to invest in new capital, given that the economy already suffers from "overcapacity," so any cut in tax rates for wealthy people would be pointless and most likely would further drive down the economy. Only government can make things right, and that government must be run by people who think like he does.

So, when one reads Krugman's columns, these are things that are under-girding his statements. Now, I think that Keynesian thinking was wrong in the 1930s, it is wrong today. I'll address my concerns in my next post.