Paul Krugman Makes No Cents

How the economic guru of the Left went off the rails

By JOHN H. COCHRANE

Last Updated: 8:17 AM, October 4, 2009

Posted: 12:15 AM, October 4, 2009

In his weekly column and recent New York Times Magazine story, “How Did Economists Get It So Wrong?” Paul Krugman blasts economic theory, argues against free markets and says that the country needs more taxpayer-funded “stimulus,” not less. He also faults economists for not predicting the crisis. In an essay on his web site, John H. Cochrane, finance professor at the University of Chicago Booth School of Business, wonders “How did Paul Krugman get it so wrong?” An excerpt:<p> </p><br> It’s fun to say we didn’t see the crisis coming, but the central prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going — neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics. This is probably the best-tested proposition in all the social sciences.<p> </p><br> Paul Krugman writes as if the volatility of stock prices alone disproves market efficiency, and efficient marketers just ignored it all these years. But there is nothing about “efficiency” that promises “stability.” “Stable” growth would in fact be a major violation of efficiency.<p> </p><br> Crying “bubble” is empty unless you have an operational procedure for identifying bubbles, distinguishing them from rationally low-risk premiums, and not crying wolf too many years in a row. Krugman rightly praises Robert Shiller for his warnings over many years that house prices might fall. But advice that we should listen to Shiller, because he got the last one right, is no more useful than previous advice from many quarters to listen to Alan Greenspan because he got several ones right. Following the last mystic oracle until he gets one wrong, then casting him aside, is not a good long-term strategy for identifying bubbles.<p> </p><br> This difficulty is no surprise. No academic, bureaucrat or regulator will ever be able to fully explain market price movements. Nobody knows what “fundamental” value is. If anyone could tell what the price of tomatoes should be, let alone the price of Microsoft stock, communism would have worked.<p> </p><br> More deeply, the economist’s job is not to “explain” market fluctuations after the fact, to give a pleasant story on the evening news about why markets went up or down. Markets up? “A wave of positive sentiment.” Markets went down? “Irrational pessimism.” (“The risk premium must have increased” is just as empty.) Our ancestors could do that. Really, is that an improvement on “Zeus had a fight with Apollo”? Good serious behavioral economists know this, and they are circumspect in their explanatory claims.<p> </p><br> But this argument takes us away from the main point. The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse.<p> </p><br> Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital. He can’t quite come out and say this, but he does say “[John Maynard] Keynes considered it a very bad idea to let such markets . . . dictate important business decisions,” and “finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a ‘casino.’ ”<p> </p><br> Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.<p> </p><br> To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent “In Fed We Trust” makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts.<p> </p><br> Regulators are just as human and irrational as market participants. If bankers are, in Krugman’s words, “idiots,” then so must be the typical treasury secretary, fed chairman, and regulatory staff.<p> </p><br> *<p> </p><br> Krugman calls for even more fiscal stimulus, and a return to Keynesian economics.<p> </p><br> But Keynesian economics requires that people make logically inconsistent plans to consume more, invest more, and pay more taxes with the same income. It requires that the government is able to systematically fool people again and again. It presumes that people don’t think about the future in making decisions today.<p> </p><br> If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar-and-a-half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt.<p> </p><br> If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up.<p> </p><br> If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.<p> </p><br> The biggest and saddest news of this piece is that Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and advice to spend like a drunken sailor are pretty superficial compared to all the fascinating things economists are writing about it these days.<p> </p><br> *<p> </p><br> So what is Krugman up to? Why become a denier, a skeptic, an apologist for 70-year-old ideas, replete with well-known logical fallacies, a pariah? Why publish an incoherent vision for the future of economics?<p> </p><br> The only explanation that makes sense to me is that Krugman isn’t trying to be an economist, he is trying to be a partisan, political opinion writer.<p> </p><br> Alas, to Krugman, as to far too many ex-economists in partisan debates, economics is not a quest for understanding. It is a set of debating points to argue for policies that one has adopted for partisan political purposes. “Stimulus” is just marketing to sell Congressmen and voters on a package of government spending priorities that you want for political reasons. It’s not a proposition to be explained, understood, taken seriously to its logical limits, or reflective of market failures that should be addressed directly.<p> </p><br> Krugman wants people to swallow his arguments whole from his authority, without demanding logic, or evidence. Those who disagree with him, alas, are pretty smart and have pretty good arguments if you bother to read them. So, he tries to discredit them with personal attacks.<p> </p><br> This is the political sphere, not the intellectual one. Don’t argue with them, swift-boat them. Well, good luck, Paul. Let’s just not pretend this has anything to do with economics, or actual truth about how the world works or could be made a better place.<p> </p><br> Read the whole essay at:<p> </p><br>http://faculty.chicagobooth.edu/john.cochrane/research/Papers/krugman_response.htm<p> </p><br>

But this argument takes us away from the main point. The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse.
Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital. He can’t quite come out and say this, but he does say “[John Maynard] Keynes considered it a very bad idea to let such markets . . . dictate important business decisions,” and “finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a ‘casino.’ ”

P Anastasselis / Rex USA

"The saddest news is that Krugman has no interesting ideas about what caused our economic problems, or what might help us in the future."

Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.
To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent “In Fed We Trust” makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts.
Regulators are just as human and irrational as market participants. If bankers are, in Krugman’s words, “idiots,” then so must be the typical treasury secretary, fed chairman, and regulatory staff.
*
Krugman calls for even more fiscal stimulus, and a return to Keynesian economics.
But Keynesian economics requires that people make logically inconsistent plans to consume more, invest more, and pay more taxes with the same income. It requires that the government is able to systematically fool people again and again. It presumes that people don’t think about the future in making decisions today.
If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar-and-a-half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt.
If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up.
If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.
The biggest and saddest news of this piece is that Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and advice to spend like a drunken sailor are pretty superficial compared to all the fascinating things economists are writing about it these days.
*
So what is Krugman up to? Why become a denier, a skeptic, an apologist for 70-year-old ideas, replete with well-known logical fallacies, a pariah? Why publish an incoherent vision for the future of economics?
The only explanation that makes sense to me is that Krugman isn’t trying to be an economist, he is trying to be a partisan, political opinion writer.
Alas, to Krugman, as to far too many ex-economists in partisan debates, economics is not a quest for understanding. It is a set of debating points to argue for policies that one has adopted for partisan political purposes. “Stimulus” is just marketing to sell Congressmen and voters on a package of government spending priorities that you want for political reasons. It’s not a proposition to be explained, understood, taken seriously to its logical limits, or reflective of market failures that should be addressed directly.
Krugman wants people to swallow his arguments whole from his authority, without demanding logic, or evidence. Those who disagree with him, alas, are pretty smart and have pretty good arguments if you bother to read them. So, he tries to discredit them with personal attacks.
This is the political sphere, not the intellectual one. Don’t argue with them, swift-boat them. Well, good luck, Paul. Let’s just not pretend this has anything to do with economics, or actual truth about how the world works or could be made a better place.