Paul Krugman Was Right. I, Ken Rogoff, Marty Feldstein, and Many, Many Others Were Wrong

The question is: Why were we wrong? We had, after all, read, learned, and taught the same Hicks-Hansen-Wicksell-Metzler-Tobin macro that was Paul Krugman’s foundation.

Yesterday I wrote: New Economic Thinking, Hicks-Hansen-Wicksell Macro, and Blocking the Back Propagation Induction-Unraveling from the Long Run Omega Point: The Honest Broker for the Week of May 31, 2015

And now I see Paul Krugman writing:

Paul Krugman: Backward Induction and Brad DeLong (Wonkish) – “One more thing: Brad says that we came into the crisis…

…expecting business cycles and possible liquidity-trap phases to be short. What do you mean we, white man?

Again, we had the example of Japan–and even aside from Reinhart-Rogoff, it was obvious that Postmodern business cycles were different, with prolonged jobless recoveries…


Yes, Paul Krugman is right.

And, yes, at least since the mid-1990s one of the two rules for understaning the economy is: “1. Paul Krugman is right”. And the second is: “2. If you think Paul, Krugman is wrong, see rule #1.” And I really wish he would either become more optimistic about things, or stop being right. As it is, things are depressing and have been depressing for a while.

But even Paul underestimated how depressing things would get and remain:

The post-2008 slump has gone on much longer than even I expected (thanks in part to terrible fiscal policy), and the downward stickiness of wages and prices has been more marked than I imagined…

And Paul was pretty much out there on his own, with his late-1990s Return of Depression Economics.

When those of us who said we expected a “jobless recovery” did so, it was because we thought the task of recovery was more difficult after a financial crisis-driven recession. After a monetary-policy inflation-fighting recession, asset prices return more-or-less to their old configuration and firms can reknit the division of labor in its old pattern because what was profitable is profitable now. After a financial crisis-driven recession, asset prices are in a do configuration and the division of labor has to be reknit in a new pattern. That proceeds slower and takes longer. Thus we expected a slower and more painful recovery. We did not expect no recovery at all. We did not expect output gaps relative to pre-2007 trends to be the same in mid-2015 as in late 2009.

Paul Krugman can say:

simple Hicksian macro–little equilibrium models with some real-world adjustments–has been stunningly successful…

But it was people like Marty Feldstein and Ben Bernanke and Ken Rogoff who taught me simple Hicksian macro. And Paul quotes Ken Rogoff as incorrectly arguing back in 1998 that simple Hicksian macro cannot be the story:

No one should seriously believe that the BOJ would face any significant technical problems in inflating if it puts it mind to the matter, liquidity trap or no. For example, one can feel quite confident that if the BOJ were to issue a 25 percent increase in the current supply and use it to buy back 4 percent of government nominal debt, inflationary expectations would rise…

And we have Marty Feldstein in mid-2010 puzzled at why the simple Hicksian story is doing so well:

Martin Feldstein: Inflation or Deflation?: “While inflation is very likely to remain low for the next few years…

…I am puzzled that bond prices show that investors apparently expect inflation to remain low for ten years and beyond, and that they also do not require higher interest rates as compensation for the risk that the fiscal deficit will cause real interest rates to rise in the future.

And I quoted ???? on Ben Bernanke’s late-2009 confidence that the economy’s non-Hicksian equilibrium-restoring forces were about to kick in, even at the liquidity trap, and so additional stimulative policies were not appropriate:

????: Person of the next five to ten years: “[His] conclu[sion] that 10% unemployment is acceptable…

…that having averted a Depression-style 25% unemployment scenario, his countercyclical work is complete… that the risk of sustained high unemployment is outweighed by the risk of… efforts to boost the economy… by asking for more fiscal stimulus… targeting nominal GDP or… committing… to some [higher] level of inflation…. He simply seems to think that leaving his primary job half done is acceptable. That’s a pretty momentous choice, affecting millions of people directly and billions indirectly. It will shape American politics and economics for the next decade, at least…

And Bernanke’s policies in late-2009–refusing to raise the inflation target to 3%/year (or higher), refusing to call for any baseline catch-up in the price level, failing to strongly request congress to pass fiscal expansion in the form of Recovery Act II, reluctance to back Christina Romer in her “no 1937s–no premature withdrawal of economic stimulus” campaign–make no sense at all unless he, like Marty and Ken, really did not get what was going on.

And there is, well, me. Even in late 2009, I would have given very good odds that the economy would be in much, much better shape than this. Remember: I bet Noah Smith that as of next month the inflation rate would be less than 5%/year, not less than 2%/year. On policy I was with Paul, but on the intellectual issues IRRC I was oscillating between Paul and Ken to a greater degree than I really want to admit right now.

Now here we–Marty, Ken, Ben, I, and many others–and Paul were all working in the same Hicks-Hansen-Wicksell-sticky-price-short-run-plus-full-employment-flex-price-long-run. (It is true that Paul’s version was different in two ways: he took Japan seriously, while we tended to dismiss it as a unique and peculiar situation with too many institutional differences from the North Atlantic to be relevant data; and his was the Yale-Tobin version while ours was the MIT-Dornbusch-Fischer version of the sticky-price-short and flex-price-long run problematic. The difference? Roughly, his version was 80% Hicksian short-run and 20% ocean-is-flat long-run; ours was 40% Hicksian short-run, 30% interesting-transition-dynamics medium-run, and 30% ocean-is-flat long-run.

Krugman’s version was a superior guide in 2007, just as Friedman’s “inflation expectations are deanchoring now!” was superior to MIT’s “lots of things shift Phillips Curves up and down and left and right: we see no strong pattern here” back in 1970.

But Krugman and the others who were right in 2008-9 were in a relatively small minority even of those who had read and remembered Hicks. The Return of Depression Economics was not in any sense the center of gravity of New Keynesian macro in 2007.

There’s lots more to chew on, but that will have to wait a little while…

June 3, 2015

Connect with us!

Explore the Equitable Growth network of experts around the country and get answers to today's most pressing questions!

Get in Touch