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Monday, April 2, 2012

Krugman: The Internal Struggle

Krugman is airing his internal struggles with understanding the monetary system for the world to see.
He responds to Fullwiler's blog post: here, and then decides he's not done digging , here.

What I find fascinating is his apparent own admission (and seemingly contradictory from earlier statements) that he believes the endogenous theory is correct.  He admits the following, even if he only admits it over a period of 6 week stretches: 
"the central bank will always supply as much monetary base as the markets demand, at a fixed interest rate."
Unfortunately, his quote above is a bit of a mi-characterization of what someone like Steve Keen would say and is not wholly accurate since the central bank doesn't supply base necessarily at a 'fixed' rate...but they do supply it insofar as it is inline with their target rate of interest.

The other thing I find fascinating about Krugman's new posts is the way he draws the money market model:
Here's the new Krugman:

and here's the old Krugman from his economics textbook "Economics, 2e":

So I guess the new Krugman is a bit more uncertain about the money supply.   I guess he concedes that increases in some fixed, federally set, money supply don't 'cause' interest rates to fall, after all.  Maybe he should update his textbook then.

He would argue today though that there is no difference between assuming the Fed sets the interest rate and assuming the Fed set money supply.  The problem is, there is a difference.  It's not just 'management technique' ---Krugman imagines far more power of controlling the economy at the Fed than exists, when in reality the power is in the hands of the market.  The Fed, whether they meet every 6 weeks or every year or whatever to set major policy, they can change their target interest rate and that may in fact have some moderate affect on the willingness to borrow (no one is disputing the demand curve), but the Fed's limited control on short-term interest rates do not an entire economy make.   There are many reasons to lend and borrow other than interest rates:  expected future profits, expected future inflation, business and consumer confidence, speculation, etc.  Bubbles don't need low interest rates, in and of themselves, to form.   The Fed can't easily control those things just as they can't control the markup over short-term interest rates that lenders/borrowers decide in aggregate.

In some way, this obsession with simple supply/demand diagrams is partly to blame.  By including only one factor that can affect lending/borrowing decisions (interest rates), it obscures the bigger picture.

14 comments:

Anonymous said...

This would all be so much easier to follow if economists would put their graphs "right way around" with the independent variable on the X-axis like everyone else does.

Honestly, this may be the source of the utter confusion among most economists regarding what variables are causes and what variables are effects. These aren't scatterplots, folks, these are cause-and-effect functions, and drawing your graphs backwards is a recipe for confusion.

Paul Fagan said...

Blame Alfred Marshall

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