Wednesday, December 7, 2011

Krugman's Intellectual History is Found Wanting Again

There has been much notice on Paul Krugman's dismissal of the importance of the work of F. A. Hayek in macroeconomics. Excellent responses can by found by Peter Klein and Robert Wenzel

When I read of Krugman's non-dealing with Hayek I was reminded of Ronald Reagan's favorite quip against Jimmy Carter in their presidential debate, "Well, there you go again."  The first piece of writing by Krugman I ever read was a column by Krugman, written for Fortune magazine. That was back in 1998 and the piece was "Why Aren't We All Keynesians Yet?" In the piece, Krugman not surprisingly sings the praises of Keynes essentially for being the great prophet and founder of macroeconomics.

Back then, referring to Keynes, he said,
But however eventful his resume, only one item on it really matters: his 1936 publication of The General Theory of Employment, Interest, and Money, which was to depression economics what The Origin of Species was to biology. Before the General Theory, economists could not explain how depressions happen or what to do about them. (I've tried going through the pre-Keynesian business-cycle literature; it's a vast wasteland.) After 1936, they could.
Of course, part of the "vast wasteland" of pre-Keynes business-cycle literature included the work of Hayek. I wrote a letter the the editor of Fortune, which they never published. An extended version was, however, published in The Free Market with the title "Keynes the Great?" To get a picture of Krugman's level of scholarship as a historian of thought, I encourage to you read the whole piece. About pre-Keynesian business cycle theory I said the following:
Additionally, Krugman's claims regarding Keynes' General Theory are repeatedly in error. Krugman states that he "tried going through the pre-Keynesian business-cycle literature" and found it to be "a vast wasteland." If he did, he did not try hard enough. In 1912, Austrian economist Ludwig von Mises's The Theory of Money and Credit, was published. Among other things, Mises did explain, more coherently and correctly than Keynes did, why depressions occur and what should be done about about them.

Keynes cited "insufficient aggregate demand" stemming from unstable business investment as the cause of depression. He offered no explanation for why an economy should suddenly experience insufficient aggregate demand. Mises, on the other hand, explained that the business cycle is due to credit expansion stimulated by the central banking authority. Such expansion lowers the interest rate below the market rate, encouraging investment that will not be met by future demand. Such investments are bound to fail. The only way back to economic prosperity is to allow market forces to liquidate unwise investments. Further credit injections will only start the process over again.

Keynes wrote a generally favorable review of Mises's book but criticized it for being unoriginal. He later admitted that he could not understand German well enough to understand original ideas. Such was the integrity of Mr. Keynes.

Mises followed his first great work with two monographs and an article in 1923, 1928, and 1931, respectively, that more fully described the cause and nature of, and the remedy for, economic crises. In 1931 his student F.A. Hayek published his Prices and Production outlining and developing Mises's theory. Hayek then followed in 1941 with The Pure Theory of Capital. Hayek's contributions to Krugman's "vast waste-land" were rewarded with a Nobel Prize in economics in 1974.

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