Lunchtime Must-Read: Paul Krugman: The Temporary-Equilibrium Method

Paul Krugman: The Temporary-Equilibrium Method: “David Glasner has some thoughts… that I mostly agree with, but not entirely. So, a bit more…

Glasner is right to say that the Hicksian IS-LM analysis comes most directly not out of Keynes but out of Hicks’s own Value and Capital, which introduced the concept of ‘temporary equilibrium’… using quasi-static methods to analyze a dynamic economy… simply as a tool…. So is IS-LM really Keynesian? I think yes–there is a lot of temporary equilibrium in The General Theory, even if there’s other stuff too. As I wrote in the last post, one key thing that distinguished TGT from earlier business cycle theorizing was precisely that it stopped trying to tell a dynamic story…. The real question is whether the method of temporary equilibrium is useful. What are the alternatives? One… is to do intertemporal equilibrium all the way… DSGE–and I think Glasner and I agree that this hasn’t worked out too well…. Economists who never learned temporary-equiibrium-style modeling have had a strong tendency to reinvent pre-Keynesian fallacies (cough-Say’s Law-cough), because they don’t know how to think out of the forever-equilibrium straitjacket…. Disequilibrium dynamics all the way?… I have never seen anyone pull this off…. Hicks… often seems to hit a sweet spot between rigorous irrelevance and would-be realism that ends up being just confused…. Glasner says that temporary equilibrium must involve disappointed expectations, and fails to take account of the dynamics that must result as expectations are revised…. I’m not sure that this is always true. Hicks did indeed assume static expectations… but in Keynes’s vision of an economy stuck in sustained depression, such static expectations will be more or less right. It’s true that you need some wage stickiness to explain what you see… but that isn’t necessarily about false expectations…. In the end, I wouldn’t say that temporary equilibrium is either right or wrong; what it is, is useful…