Nathan Tankus: Krugman von Hayek

By Nathan Tankus, a student and research assistant at the University of Ottawa. He is currently a Visiting Researcher at the Fields Institute. You can follow him on Twitter at @NathanTankus

Mainstream economic discussions employ a false dichotomy. At one “extreme” you have Austrian economists who believe the current Federal Reserve policy is (or should be) causing inflation, malinvestment, and all sorts of other maladies. They think the nominal interest rate set by the Fed is too low and should be raised (For this post I will take the “Austrian position” as the one argued by Hayek in the early 1930s. This rendition is favorable to the Austrians because it is the most coherent and reasonable version of this theory I have seen). At the other “extreme” you have Paul Krugman and “New Keynesian” company, who argue that the nominal interest rate set by the Fed is too high and should be lowered in some way. Further Krugman argues that since the nominal interest rate is already near zero (the dreaded “lower zero bound”), one should use fiscal policy and/or inflation expectations to increase output and thus employment. To the causal observer who is unfamiliar with the history of economic thought, these two positions seem diametrically opposed. They, in fact, are not.

Let us begin with what they agree on:

A central bank that sets a short term interest rate

In contrast with monetarists of many stripes, both camps argue that the short term interest rate (the “Fed funds” rate in the United States) is set by the central bank (In the U.S., the Federal Reserve). This is a major point of agreement. Many more economists (Milton Friedman for a time) believed that they can and should have money supply targets. Whether they think this target is a necessity is another issue (I suspect they do not). However, the case remains that this has generally been a minority position in the history of economic thought, although it is correct.

Money is an endogenous, not an exogenous variable

It follows from the argument that central banks set a short term interest rate that they control the price of settlement balances (sometimes called “reserves” ) and not their quantity. On this Hayek is very clear:

Elasticity in the credit supply of an economic system, is not only universally demanded but also — as the result of an organization of the credit system which has adapted itself to this requirement — an undeniable fact, whose necessity or advantages are not discussed here. (page 178 [‎ ]. see also page 172).

Krugman on the other hand, is often less clear. He defends IS-LM which contains the assumption that an increase in settlement balances will increase the supply of loans and thus economic activity at all points except the “liquidity trap” (more on this later). On the other hand, he has also acknowledged that the views of those who actually control monetary policy contradict this view:

It’s instructive, in particular, to read the minutes of Federal Open Market Committee meetings, which clearly show that monetary policymakers pay little attention to monetary aggregates, and are instead attempting to use discretionary changes in interest rates to stabilize the economy. In the minutes for the 11 December 2007 FOMC meeting, for example (Federal Reserve, 2007), there is extensive discussion of the economic outlook and the possible need for interest rate cuts. There is only one mention of a monetary aggregate — and M2 is treated as an endogenous variable, an indicator of shifts in the financial markets, rather than as a target. (Krugman 2008 [])

This again is contrary to monetarist dogma (that article was in fact a response to an attack from Milton Friedman’s lesser known – but still prominent – co-author Anna Schwartz. As an aside, a statement this clear makes his argument with Steve Keen and company last year puzzling.

A belief in a “natural” rate of interest that generates a full employment “equilibrium”

Both Krugman and Hayek have argued quite consistently that there was a “natural rate of interest” which according to Krugman is “the rate of interest that would match desired savings with desired investment at full employment. “ Hayek makes the same argument in his writing. This interest rate is not the interest rate set by the central bank, indeed it is not an interest rate set on any market. It is a hypothetical interest rate which we will finally know if or when full employment returns.

Disagreeing over the number of angels on a pin

The reader must now be asking, what do they actually disagree on? The answer is a little discussed but crucial point – what distinguishes these two groups – here represented by Friedrich von Hayek and Paul Krugman – economic views is not really their analytical framework but different beliefs about variables in their model.

As noted above, they both agree that there is a natural rate of interest. Their disagreement is over its precise value. In short, Hayek believes the natural rate of interest was positive, while Krugman believes it is negative. It must be emphasized that this concept is completely unmeasurable. It is as much a figment of their imaginations as aliens or ghosts are of the supposedly “Crazy”.

Like astrologists, they even have their favorite measurable variables to tell them what is happening to their invention. Hayek for example says:

…this additional demand [for credit] is always a sign that the natural rate of interest has risen that is, that a given amount of money can now find more profitable employment than hitherto.

Krugman meanwhile points in the opposite direction:

Look, the natural rate of interest (like the natural rate of unemployment) needs to be assessed on a PPE basis — that’s “proof of the pudding is in the eating”. If the economy is depressed due to inadequate demand — and it is — then that fact tells you that the natural rate is below, not above, the market rate.

Both of these positions are quite defensible in terms of the theory by making small adjustments or even emphasizing a different portion. As Hyman Minsky said nearly thirty years ago :

These results indicate that the Walrasian general equilibrium framework is useless as a basis for macroeconomic analysis. In the hands of a skilled practitioner auxiliary propositions can be introduced into the general equilibrium framework to yield well nigh any desired result even as the basic framework cannot assimilate money.

Thus the Austrians and the “New” Keynesians should not be treated as bitter enemies but close cousins. Given that the conclusions Krugman comes to regarding “progressive” policies are all based on his beliefs about unmeasurable and hypothetical inventions, it would be wise for the left to avoid relying on Krugman for intellectual defenses of their pet policies. Or at least pray the natural rate of interest in his mind doesn’t rise.

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  1. psychohistorian

    Nice theory but I don’t see much connection with reality.

    We have a plutocracy that owns the govt. of most of the Western world and they make the big economic decisions (car culture, throw away consumption, environmental arrogance, who to hate next, what to consume, etc).

    The invisible hand of Plutocratic inheritance around the neck of our social organization stifles any sort of reason based theory about how to effectively interact as a species.

    I think both the Austrians and New Kenesians provide propaganda and smoke screen cover for our class based system that is failing us. They are failing society with their posturing BS about a theory of reality that does not exist in our current world…..and in the interim, lots of people are seriously suffering and its getting worse in a world of plenty.

    1. Bud

      “Nice theory but I don’t see much connection with reality”

      Not much connection with theory, either. The Austrians would say the principle malinvestment occurred before — not following — the crash. What comes after is TPTB desperately doubling down on that vast malinvestment in vain hope that bad investments already made can somehow be made good, like turning lead into gold.

      The contraction will continue, regardless. Krugman and other cranks will also continue to bleat that more credit (they mean public debt) is the sole solution to a problem created by prior careless issuance of way too much credit.

      What resources there are will continue to be bled into the feckless crony banks and away from real businesses serving real needs of real people. A Nobel prize will surely follow to bless this trainwreck as a victory by clueless crackpots. And the bankers will enjoy even greater bonuses as they harvest and consume even the seed corn.

      1. Anon

        The main difference between Austrians and Krugman is that while both employed self-consistent economic models and made predictions, only the predictions from Krugman (low inflation despite Fed QE, austerity hurts growth and worsens debt, etc.) turned out to match reality

        Not only that, Austrians predicted the exact opposite outcome of what really transpired in the real world. (High inflation, pro-growth austerity, etc.)

        So the above piece is really like arguing: “The Flat Earth Society makes a compelling, articulate argument, and so does the Round Earth Society – they are like minded gentlemen and should really make friends.”

        It’s really disappointing to read such unscientific confusion on Naked Capitalism.

        1. PaulArt

          WHOA! Very true! And this also sounds eerily like Krugman himself. I would have sworn you are Krugman under a psudonym.

          1. Anon

            Thanks for the flattery – but I think Ives could confirm it from the logs that I’m not Krugman.

        2. borkman

          Uh, not so fast.

          Krugman has been endorsing austerity too as in long-term deficit cutting. The only time running a government surplus does not produce a recession (in a country not running a trade surplus) is when businesses are net borrowing MORE than households are saving. Thanks to rampant short-termism in big cos, we didn’t get that even in the last expansion (pre the big bust). He’s not argued with the Peterson crowd in substance, just in terms of timing.

          By contrast, the Minsky types argue you need government to be the swing factor and accommodate what households and businesses want to do. If they don’t spend enough to produce enough demand and home, or attract it from overses by running a surplus, government needs to deficit spend or the economy contracts. If the economy contracts, debt to GDP ratios get worse and repayment is much more difficult. If businesses are investing enough (or you do have a big enough surplus) then you do need government to run a budget surplus.

          So Krugman is locked into an austerity framework too, just not as extreme a one as the Hayekians.

          1. Anon

            The contradiction you outline disappears if you look at the specific arguments:

            “austerity in current circumstances” is what Krugman opposed – and he correctly predicted the negative consequences of the various austerity policies implemented in the U.S. and in many places of Europe.

            Austrians made pretty much the exact opposite policy suggestion and prediction: they said that an increase in the monetary base would drive up inflation (it didn’t) and they said that decreased government spending would be counter-balanced by increased private spending (it didn’t – instead economies contracted, in many cases dramatically).

            Krugman supported cuts to government spending in other economic circumstances, when such moderation is helpful: for example he warned about trillion-dollars deficit spending during the 2003-2007 boom.

            So Austrians and Krugman are pretty much the same, except that they are different.

          2. E. Gerry Spaulding

            I do agree that there needs to be more distance between Krugman’s long-term perspective and that of the Peterson school of well-being.

            The modern Minsky-ites draw this deficit-spend-to-prosperity construct without great detail as to how Minsky’s instability hypothesis so relates.

            While a read of Minsky’s Working Paper No. 127 at the Levy Institutes library would show that Minsky had indeed come around to potential solutions to the hypothesis, the proposals recommended therein never really enter the modern Minsky monetary dialogue.

            He rediscovers Fisher’s 100 Percent Money proposal, and its potential positive effects on the cycle of financial instability (pro-cyclicality), and recommends a new National Monetrary Commission to deal with this new reality.

            When it comes to these truly advanced thoughts of Minsky, both Hayek and Krugman are just on another monetary economic planet.

          3. jsn

            As the Minsky quote in the main post observes, “the basic framework cannot assimilate money”. Think about that for a moment: the idea of a capitalist economy without money. Money is the assumed motive of all capitalists and yet our dominant economic models pretend it does not exist: DSGE and IS-LM don’t bother to look at the role of money in the economy making them doubly blind to its role in power. I think it is safe to assume they are paid well for this blindness (and more importantly, paid quite poorly, or not at all, when they see).

            Krugman fared better as a prognosticator than the Austrians because IS-LM appended a model of economic impacts of money as the interest rate approaches the “zero bound”. Their “liquidity trap” is your and my depression. But at least IS-LM has the decency to admit the obvious: poor people can’t spend in a depression because they have no money. Austrians insist the poor are all on a labor holiday, they don’t suggest why: DSGE on the other hand insists the poor chose this early in life because they have perfect knowledge of the future and make rational decisions.

            So Krugman and his IS-LM cohorts are at least a modicum more humble than the Austrians, but once they exit the trap they succumb to the “money illusion”, though not quite the one Fisher described. Fisher’s argument was that people confused the face value of money with it’s purchasing power so the fixed number obscures variations in purchasing power. The lesson post Sameulson economists have taken however, is it is better to model the economy without money lest they confuse themselves about values (rest assured no surviving capitalist makes this blunder). And once out of the “trap”, Krugman and his ilk are happy to revert to that mythical utopia of moneyless capitalism with all its built in deflationary, austerity bias and lilly pure altruistically motivated capitalists.

            Purchasing Power. Money is mutable into any value, and power remains not the least of them. Unrestrained money power is like any other power that in absoluteness will tend to overcome the morals of those who wield it. Like the Austrians, IS-LM for the most part leaves it out of the equation. Conceding the obvious in a depression it appends the “liquidity trap” as a token gesture, but without any explanatory power as to how the system arrived at the state. So Krugman may be a good companion in the fox holes of depression, but once out, watch your back.

        3. Nathan Tankus

          I never said they didn’t make different predictions and Krugman’s haven’t come closer to what has transpired. I said that the major difference between them is different beliefs about the natural rate of interest. As Krugman himself has said over and over and over again, his entire suite of ideas and predictions about our current morass are based on the belief that the natural rate of interest is negative.

          He will be the first to tell you all the orthodox bs holds for him in the “long run” and in periods when the “real” (inflation adjusted market) rate of interest is at or below the natural rate.

          1. Anon

            Let me take issue with your approach.

            You ridicule the notion of a “natural rate of interest” in your article, on the basis that it’s not measurable. You also seem to question the concept of ‘full employment’.

            But the natural rate of interest is measurable empirically: if, given a specific Fed rate, the economy grows faster than inflation, all other things equal, then the Fed rate is probably below the natural rate.

            If the economy shrinks or grows below inflation, then the Fed rate is above the natural rate.

            By changing the Fed rate you can approximate and converge to the natural rate. Under this view the Fed’s job is to hit the natural rate at full employment.

            It’s not easy to measure it in an intemporal world and there’s differing views on how to measure it – but still it makes sense to talk about it because based on what that value is relative to the current Fed rate it gives useful policy prescriptions.

            Let me give you an analogy from other scientific areas: for example the average annual air temperature of our planet. Does it exist? It does not exist in any ‘real’ form, because air temperature varies by location, altitude and time of year. It’s an average which can only be measured by making lots of measurements, making educated guesses about the composition of the atmosphere, etc.

            Does the fact that it’s difficult (I’d say impossible) to measure it to 5 sigmas, does the fact that it’s probabilistic and noisy make it any less real? Not at all – and it’s also a very useful value to climate predictions.

            Back to economics and Krugman, is IS-LM a simplified framework with flaws? Certainly, and he’s expressed that numerous times.

            Just like the laws of Newtonian gravity are inaccurate and won’t give you important things like a working GPS system (which needs relativistic corrections to work properly).

            But there’s a big difference between crude approximations and simplifications that give a pretty good predictive answer in a number of key scenarios (Krugman’s use of IS-LM) and totally incorrect views of the world that mis-predict it in key scenarios (Austrians).

            Also, it would be nice if you outlined your own framework (or at least linked to it) that you regard as superior. That way it can be contrasted with the other approaches.

            It would also be nice if you outlined recent economic episodes where your framework gives a different answer to what Krugman gave – that way a track record can be built.

            Finally, I think you should recognize that for something so fundamentally complex as the interaction between a couple of billion humans (economics, roughly), some sort of Occam’s Razor approach has to be used: use the simplest model possible that still explains the key phenomena you are interested in and offers the right predictions even with difficult, unusual, unprecedented parameters.

            Will most elements of the model be inevitably ‘false’, with little or no foundation in microeconomic foundations? Inevitably – but as long as it’s all above board and not treated as dogma, it’s a very valid, empirical scientific approach that has been honed for hundreds of years.

  2. Hugh

    To recapitulate, the Austrians believe the angels dancing on the head of the pin are wearing red shoes while the new Keynesians maintain the shoes are blue. Meanwhile as psychohistorian says and Nathan Tankus implies, those who are really calling the shots continue their looting.

    1. JGordon

      I have always prided myself on being ahead of the curve on this stuff, but I like that NC commenters are starting to see beyond the Star-Trek style techno-babble spread liberally by the media and universities. The only thing that anyone really needs to know is that governments are totally corrupt, and that they’ll do anything they can to keep this miserable, failing system they parasitize going even one day longer, up to and including stealing your life savings, dissappearing you to one of the internment camps they’re building, or taking you out with a drone. As Dmitry Orlov said in his most recent book “The Five Stages of Collapse”, “May you die today so I can die tomorrow”. That is their mindset, and it makes perfect sense to them. Anyway here is another quote from Dmitry, regarding formerely taboo topics and still taboo topics:

      “The end of the American Empire is also quite acceptable as a topic of conversation now, and university faculty can now expound on it without facing any negative repercussions. But that’s a boring topic; as I witnessed in Russia, there is nothing quite as boring as an empire right before its collapse.

      But there are some other topics that are still considered beyond the pale. One of these is the idea that the industrial nation-state is a doomed institution throughout much of the world, and that we are headed toward a world of slums run by criminal warlords.”

      1. PaulArt

        Like Dharavi in Bombay. It is a slum of immigrant South Indian economic refugees who moved to a section of Bombay and built their own shantytown. Not unlike the droves of immigrants who now crowd the western world in search of livelihood.

      2. skippy

        The problem with Dmitry Orlov is… he reads like every other mystic, fortune teller, cough…. folks that stare too hard at one point in the distance… for too long and opine.

        When the only problem our species has ever faced is – belief fueled ignorance – about whom i/we/us are and the universe we live in and how we can – collectively move – in rational direction.

        skippy… any system is only as good as the people that inhabit it and how well they are informed… en fin~

  3. jake chase

    There is a fundamental reality ignored by all economists since Keynes: savers are interest rate takers. They have no choice but to deploy money in a range of available alternatives. Meanwhile, the central bank is a tool which enables looting by large banks and their executives. The large banks drain all the reserves maintained by small banks and pay the Fed Funds rate for the privilege. The large banks make loans to large scale speculators in stocks, bonds, business assets, real estate. The speculation drives up prices, and the leverage employed produces crashes when unexpected events disappoint expectations. There is no equilibrium, no natural rate of interest, no confidence fairy, only confidence men in expensive suits.

    1. jake chase

      The economy would probably work better if wealth were more equably distributed and financial power did not exist. Nobody knows for sure, because this has never happened. America’s interlude of prosperity (1946 to 1970) was caused by the destruction of European and Japanese industry in WW II, defense spending to erect the National Security State, Eisenhower’s interstate highway spending, and the GI bill. Suburban land speculators and auto makers and home builders plunged in to capitalize on these one off factors.

    2. jake chase

      Of course, the defense establishment had its own agenda, and the result was Vietnam. The Fed panicked and crashed the stock market. The bankers were dissatisfied with their reduced influence, and they contrived with the major oil companies to bootstrap OPEC into a tool for funneling industrial wealth to themselves, running it through some Arabs in funny headgear to deflect scrutiny. The major culprits were David Rockefeller and his stooge, Henry Kissinger. The front man was arch crook Tricky Dick.

      1. jake chase

        The economy has staggered from one speculative lurch to another for the past forty years, and the only real result has been that people now work much harder and see their living standards and their wealth evaporate as finaglers in and out of Gomint grab and tap dance and toady their way to riches beyond the dreams of avarice. Two paragraphs of history are worth ten tons of economist prattle.

        1. jake chase

          And most of the foreign corporation which undermined the American labor movement was created by technology transfers by US corporations in the Sixties and Seventies. Off shoring in the Eighties and Nineties finished things off.

          Corporate power doesn’t necessarily depend upon cheap labor. Think about IBM up to 1980. But executive aggrandizement and looting does require cheap labor. That in a nutshell is what American business education and the consultancy racket are all about.

          1. Susan the other

            +100. Is this a recap of your lost comment yesterday? Good rundown of the fall of American capitalism c. 1970 and the struggle to continue breathing after death. How a natural interest rate can be determined in a completely irrational economy is beyond me. At this point it should reflect a liquidation of debt by going so negative that the money purveyors pay you 20% interest just to take their money. Why don’t interest rates ever have to adhere to the rules of reality?

          2. ragaq45

            How do people possibly put up with the draconian censorship employed on the comments of this site? How is a meaningful conversation supposed to be even possible? Or is preventing meaningful discussion the entire point?

            Are the site owners so afraid of ideas that they disagree with or that discredit their positions? Why do people waste time posting comments that will either be deleted, or disappear into the ether? How can anyone take anything written here seriously if no meaningful feedback nor discussion is allowed?

          3. Yves Smith


            Get a grip.

            We don’t have censorship here. Comments are not moderated (unlike on Big Picture, where all comments are approved and some are even edited before being posted). Nor do we require readers to “prove” who they are via Twitter or FB or Google IDs nor do we even use captchas. That makes this site FAR more open than most comment sections.

            We do have anti spam software (Akismet, bog standard and widely used) and certain moderation tripwires. If you act like a troll, your comments go into moderation. If it’s reasonable, we approve it when we get around to it. This is a one person plus some irregular help blog, and new posts, not comments, are the top priority. I don’t begin to have the time or energy to “censor”.

            We do have an intermittent problem with the occasional comment disappearing randomly. We’ve asked tech people repeatedly about it. No one can find them, we have no idea why this happens. It may be a weird accident of timing. We have a much bigger problem with spam getting through. For some reason Jake Chase gets hit something like once a week and he is getting (understandably) paranoid, which is too bad, since his comments are good. He might have an ISP used by a spammer in the past but we don’t usually find his comments in the spam filter when they go missing.

            And we have house rules. People who are abusive or engage in ad hominem attacks or are de facto spammers (post long, irrelevant promotional material) are banned. We will usually give a warning but don’t count on it. Really out of line conduct leads to immediate banning.

            If you think requiring a minimum level of civility is tantamount to censorship, 4Chan is over there.

  4. The Rage

    NSC-68 baby!!!!(to the post above about the national security and military industrial complex)………those were the “reasons” for the “McCarthyism” witchhunts and why Republicans were pushing the pedal on “communist spies” at home……uh yeah, duh. There were Czarist spies in 1888 as well goofs, how do you think they got the metal press?

    Krugman von Hayek is hilliarious. Somebody ought to tell Paul that right to his face………

  5. Ignacio

    I would like some discussion on the issue of interest rates (cost of capital) and the share of labor income as Bartlett did in Economix.

    It is quite interesting to note that the labor share of incomes has decreased along with interest rates.

    1. Yves Smith

      I have not read the Bartlett piece. However, any list that puts interest rates as a major contributor to income inequality is sus. Correlation is not causation.

      Andrew Haldane has done a large study that says that investors are demanding overly high returns. That leads to underinvestment. It is ALSO what leads companies to squeeze labor costs. Higher prevailing interest rates will only make this worse.

      See Haldane on returns:

      See us on cost squeezing, this is a long-standing problem:

      Summary of and link to excellent study on ineuality:

      1. Anon

        Indeed. Interest rates are primarily a function of the business cycle as the Fed perceives it – which repeats every 10 years or so and which process has very little memory left from the previous business cycle.

        Income inequality changes much, much more slowly (it’s a many decades process that takes input from many factors), so any comparison to interest rates is fundamentally suspect based on getting the time scale absurdly wrong.

        (Connecting income inequality to the recursive self-reinforcing of concentration of wealth and power would be a far more successful assumption: treating it as closely related to the net bargaining power of the work-for-hire population…)

  6. craazyman

    this is too complicated and it needs an edit. Nathan give it a look with a fresh mind and make a few tweaks and it’ll be fine.

    I think Krugman should get the Montezuma award. Not for diahrrea but for being the organizing center of conscious attention, like in the Aztec communal mind. If the Left don’t rely on Krugman, then all hell breaks loose into total chaos because there’s no structure of thought that they can organize themselves around, since it’s all total nonsense in every direction. the foci of this ellipse isn’t rationality but it is an imaginative point-form of willingly suspended disbelief embodied by the Big K sittin there with feathers on his head.

    it occurred to me the other day that inflation and deflation are the same thing. if your income goes down faster than prices, that’s inflation to you. the only difference between inflation and deflation is the people it’s happening to. So if inflation happens to 50% of the people, that’s mathematically equivalent to deflation happening to 50% of the people. there’s no difference unless you introduce the idea of individual persons. when you do that, it changes everything

    1. jake chase

      90% of the wealth is owned by 10% of the population; 50% of the wealth is owned by 1%; 25% by 0.10%. Inflation and deflation both matter to all those wealth owners, to the extent they are unable to capitalize upon whichever is happening. But inflation is easier to game, because bank money can be used to leverage wealth increases. Deflation is death to speculators, apart from a handful of maverick shorts.

      The ultra rich will always opt for inflation, while constantly sermonizing against it. This is economics as theater.

    2. Dan Kervick

      A lot of truth in that. These days it seems like the default position on the left is “I can’t tell you what I think about that until Krugman tells me.” They’ve swallowed all of the IS-LM and natural rate business, all of his back-and-forth hemming and hawing on public debt and his ambivalence about inequality.

      1. craazyman

        They ought to appoint professor Kelton as the Queen Bee and formulate some mind waves around her and MMT. She is hot and probably would look very attractive in a Cinderella outfit. But we have to make sure that no hunta elbows there way in and gets control of the budget. That’ll mess things up totally no matter if it’s MMT or some Austrian Dictator with a mustache. With THE LONE RANGER about to open in theaters this is a time for imaginative inspiration. If it’s half as good as Pirates of the Carribean it will be fantastic.

  7. E. Gerry Spaulding

    I applaud the presentation of contrast between competing monetary economic perspectives. We are well served by such
    attempts for comparison and contrasting ideas around the fog of money.

    I don’t feel this statement is sufficiently accurate to draw out the real contrasts between the ‘monetarist’ and market-based options.

    “”Many more economists (Milton Friedman for a time) believed that they can and should have money supply targets. Whether they think this target is a necessity is another issue (I suspect they do not). However, the case remains that this has generally been a minority position in the history of economic thought, although it is correct.””

    It sounds like you support the idea of money-supply ‘targets’ as advocated by many monetary economists throughout history. Friedman never abandoned this policy.

    But Friedman went much further in his money-supply management proposals, to the point where exogenous money becomes the vehicle for achieving the economic goals associated with monetary policy.

    His early joining of fiscal and monetary activities under a sovereign fiat money system was much more radical than anything proposed by Keynes or any of the neo- or post-keynesians of the day.

    Direct monetary authority determination of the amount of money in the system, brought about by deficit-spending of the required amount of new money into existence, marks this truly revolutionary ‘proposal’ of Friedman in his 1948 “Fiscal and Monetary Framework for Economc Stability”.

    That work was recently picked up by Lord Adair Turner and advocated at the recent INET conference with much fanfare.
    See here – On Macroeconmic Policy and Economic Stability.

    Friedman was in the special group of ‘monetarists’ who knew that the only way to have the proper amount of money in existence was to take away the ex-nihilo money-creation powers – a.k.a. endogenous money – from the private bankers.

    Time to catch up with the wisdom of the most often bashed-upon free marketeer, and restore monetary sovereignty.

  8. Benoit Essiambre

    This made me think about the natural rate. I tend to side with Krugman that it is bellow zero (bellow -2% in real term) but this begs the question, what is keeping it so exceptionally low for so long despite relatively aggressive monetary stimulus.

    Other than the fact that this stimulus might not be aggressive enough, the only thing I can think of is that the continued deleveraging of all levels of governments plus the financial sector has been keeping the natural rate artificially low.

    Now that this seems to be mostly over, it is possible that the natural rate will rise, that we will get natural stimulus from the reduction in the pace of deleveraging, and maybe even that Bernanke is right (and the market overeacting) about the plan for tapering.

    Anyways, this would be the optimistic macroeconomic perspective and come to think of it, there is supporting evidence for it at least in the US as long as Europe and China don’t screw up the global economy by under stimulating since they are clearly not in this enviable position yet.

    1. Anon

      Yes, government spending cuts (both no the federal and on the state level) created a drag on spending and kept the natural rate low.

      (This cut in spending was not automatically counterbalanced by increased private spending – which puts to rest the neoclassical and Austrian notion that public spending always crowds out private spending.)

      Furthermore, the Fed reached 0% interest rate about 5 years ago – after that it could not get more aggressive than via QE which is not really a cut in interest rates.

      So the natural rate remained depressed, irreversibly destroying parts of the U.S. economy in the process.

      Something similar happened in Spain and Greece as well, just on a much larger scale: due to forced austerity being much more severe, which was forced on them mostly because they do not have their own currency.

        1. Nathan Tankus

          as Dan said, there is no evidence for the existence of a natural rate. It is as real as the tooth fairy or santa claus.

          Krugman does provide the most interesting explanations for the precise position of the tooth fairy rate. In his “Minsky” (spoiler alert:nothing to do with Minsky) paper last year he says the natural rate is endogenous and responds to the level of private debt.

          1. Susan the other

            I’m wondering how clear debt is if interest cannot be defined. Then there is the whole definition of what you end up with when you translate an interest in something material (land, factory, health) to digits. And how can any of this be established beyond some unilateral contract?

  9. F. Beard

    Common stock is an endogenous money form that requires no borrowing or lending, much less at interest.

    So tell me again, why we need a government-backed credit cartel to drive people into debt?

    1. Benoit Essiambre

      When people increase their purchase of stocks all at the same time, they reduce their buying of products, which is what gives the value to these very stocks. A stock in a company with a dropping customer base is not worth much. It’s a vicious circle problem that has to be solved in some way. Right now, monetary stimulus seems to be the only way.

      1. F. Beard

        The common stock itself would be used as money so purchasing power would not decrease even if it were bought with fiat.

        Btw, we need more than just some stimulus; we need a metered, equal, universal, including non-debtors bailout, at least until all deposits are 100% covered by reserves. That would allow us to abolish government deposit insurance (and the Fed) and provide a risk-free Postal Savings Service so that the banks cannot leverage our deposits without our permission.

    2. Massinissa

      Simple: Because without that it would be harder for the elites to stay on top of the dogpile. And clearly that’s what’s important.

      The status quo is always preferred by those it benefits.

  10. Massinissa

    We could always get rid of capitalism entirely and replace the current dictatorial corporate stock model with some form of worker owned cooperative model…

    1. Nathan Tankus

      I have actually. multiple times. would you like me to quote the General Theory?

      “I am now no longer of the opinion that the concept of a “natural” rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such.”

      1. Jon

        Krugman uses quotes around “natural” just as Keynes does in that line you’ve pulled out. None of the links you provide to his blog assign any astrological meaning to a natural rate.

        Keynes states that a “natural” rate is one that maintains the status quo, and in each of those posts you link to, Krugman says the same thing. To Krugman, the “natural” rate is negative, and thus that ‘status quo’ is a bad thing (and he wants to boost demand).

        So when Keynes says “we have no interest in the status quo”, how is that different from Krugman saying we need to change the current status quo of a negative ‘natural’ rate?

        1. Nathan Tankus

          and so does Hayek. what is your point? are you claiming they aren’t really referring to the concept of a natural rate of interest because there is quotes around the natural part?

          did you actually click the link and read the section in full? If you did you would understand he’s rejecting the concept of a unique natural rate of interest (which he also says in the part quoted). Krugman by claiming that it is “negative” is still claiming that there is a unique rate of interest that will bring about full employment. hence why he argues for increasing inflation expectations when nothing of that sort can be found in Keynes.

          on the astrology point: is that a joke? The fact that people peddling ideas take their own ideas seriously is somehow evidence that a comparison is invalid? Astrologers also take themselves seriously.

          1. Jon

            Is he rejecting it? These next two paragraphs come after the one you pasted in…

            “If there is any such rate of interest, which is unique and significant, it must be the rate which we might term the neutral rate of interest, namely, the natural rate in the above sense which is consistent with full employment, given the other parameters of the system; though this rate might be better described, perhaps, as the optimum rate.

            The neutral rate of interest can be more strictly defined as the rate of interest which prevails in equilibrium when output and employment are such that the elasticity of employment as a whole is zero.”

            That sounds like rejecting the meaning of “natural rate” from 1936 by fixing it to say “natural rate that is consistent with full employment.”

            Krugman in the passage you quoted above says the same thing. So “neutral rate” or “optimum rate” you’re cool with, but “natural rate at full employment” is a construct you wholly reject?

          2. Nathan Tankus

            there is a difference between saying the interest rate is consistent with full employment and the interest rate is GENERATING full employment. notice also the “if” in that statement. earlier in the section he describes various different “natural rates” and ones with an “unemployment equilibrium”.

  11. Adam1

    It should be pointed out that in a fiat currency regime with floating exchange rates the natural short term interest rate is ZERO. With out interventions by the central bank and treasury the rate would naturally move to zero.

    1. Nathan Tankus

      neo-chartalists use the term natural rate of interest very differently. they are referring to what interest rate would dominate without t bills, not an interest rate that brings about full employment and price stability.

      the natural rate of interest in the neoclassical mind is precisely one that produces full employment equilibrium (price stability is more arguable. new keynesians argue it would bring about price stability but Hayek argued that the interest rate consistent with price stability was not the one consistent with full employment equilibrium).

      1. Adam1

        Maybe “natural” was not the right word given it has special meaning to some people….

        However, operationally there is no reason for a sovereign currency issuing government with a floating exchange rate to issue debt. It’s a policy choice which means it’s a choice to intervene in money markets. Without that intervention the normal market response would be to drive overnight lending rates to zero.

          1. Adam1

            Hope I didn’t imply you didn’t. I was just trying to clarify myself because you are right that natural does mean specific things to various people and I also wanted to clarify my perspective was from an operational perspective and not theoretical.

  12. Hugh

    In both capitalism and kleptocracy, interest rates are wealth concentrators. Wealth concentration left to its own devices will run until the system from which this wealth has been extracted collapses. This collapse can only be stayed through offsetting fiscal policies, trade surpluses, taxation, legislation, and regulation. In a just society, banking would be a public utility and the natural rate of interest would be zero.

  13. F. Beard

    Aristotle said something to the effect that interest is UNNATURAL since money does not reproduce the way that cattle, for example, do.

    That is by no means the only criticism of lending for interest.

    In any case, the use of common stock as a private money form renders the concept of interest as archaic as slavery.

    1. LifelongLib

      What happens in your common-stock-as-money scenario if the company that issued the stock goes under? Or on the other hand gets acquired? Wouldn’t that kind of money be a lot more volatile than government fiat? Why would anyone want it?

      1. F. Beard

        One should diversify, of course, to minimize risk.

        Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth. Ecclesiastes 11:2

      2. F. Beard

        Wouldn’t that kind of money be a lot more volatile than government fiat?

        A lot of volatility in the stock market is driven by the current, crooked money system. Who can deny the (disgusting) effect of the Fed on the stock market?

  14. F. Beard


    The ancient Hebrews were allowed to enslave foreigners and to charge them interest but were not allowed to enslave fellow Hebrews* or charge them interest.

    So it’s clear that interest is by no means friendly or neighborly. Yet our society is built on it.

    *Fellow Hebrews could be kept as indentured servants for up to 6 years but had to be treated well and to be well-provisioned for their return to freedom.

  15. circuit

    Nathan, your final quote by Krugman is proof enough that he’s skeptical of the usefulness and reliability of the NRI concept. IMHO, he only applies it to his commentary because it’s part of the everyday lexicon of central bankers.

    1. Nathan Tankus

      I’m not a mind reader. All I can do is take his public statements seriously. his rationale for believing the recession is caused by inadequate demand that government spending /inflation expectations can alleviate is based on a negative natural rate of interest. if he wants to get rid of the natural rate of interest and base it on a different theoretical grounding, he has to actually do it. we shouldn’t just give him credit because we think we see his “true beliefs”.

      1. circuit

        Fair enough but I don’t think mind reading is really necessary in this case. The very sentence you quote by Krugman shows that he associates the NRI, a non-observable concept, with something more directly observable, the level of demand.

        Now, don’t get me wrong, I agree entirely with your column and I think focusing on the NRI is the way to go. All I’m saying is that if you’re trying to get any traction with policymakers, it’s a good idea to speak their language and apply their models.

  16. Thomas McGovern

    Re: “Let us begin with what they agree on: A central bank that sets a short term interest rate.”

    This is misleading and, perhaps, a disingenuous attempt to confuse the issue. Austrians accept the fact that the US Fed, since starting in business in 1914, sets short term interest rates.

    However, Austrians, as a matter of economic theory, believe that a central bank is not needed to set interest rates or for anything else. A monetary system in which the currency was 100% redeemable in gold would be self-regulating and short-term interest rates would be set by the free market.

    If a central bank is needed, how did the US do without one from 1836 until 1914? It did it with a currency that was 100% redeemable in gold.

    The US Constitution in Section 10 – Powers prohibited of States states that “No State shall… make any Thing but gold and silver Coin a Tender in Payment of Debts.” This constitutional principle was usurped by the Federal Reserve Act. On the face of a Federal Reserve note it states, “This note is legal tender for all debts, pubic and private.”

    The US Constitution in Section 8 – Powers of Congress – The Congress shall have Power…To coin Money, regulate the Value thereof, and of foreign Coin.”

    1. F. Beard

      A gold standard is fascist. Government money MUST ONLY be inexpensive fiat to avoid privileging private interests such as gold owners and usurers.

      That said, fiat should not be de facto legal tender for private debts nor should the government privilege the banking cartel with government deposit insurance or a legal tender lender of last resort to name just two privileges the banking cartel absolutely depends on.

      1. mcgoverntm

        You stated that “A gold standard is fascist.” I had never heard that before. Is that idea a position of a particular school of economics or is it just your personal opinion?

        1. F. Beard

          A gold standard is fascist because it allows private interests such as gold owners to profit off the taxation authority and power of government. It also profits usurers since it is an artificial limit on the government’s ability to create government money.

          The only legitimate place for gold as money is the private sector assuming such an idiot money form could survive in a true free market of private money creation.

          1. Lambert Strether

            Then pre-revolutionary France was “fascist” because it used tax farmers. This stretches a term that is charged to begin with out of any recognizable historical context.

          2. F. Beard

            What? You think fascism was invented by Benito Mussolini? Or that it must involve racism? Or that monarchy and fascism are mutually exclusive?

            Or do you prefer the expression “corporatism” when corporations (excluding banks) are not the problem; the banking cartel is?

          3. F. Beard

            This stretches a term that is charged to begin … LS

            What? You think the gold-standard has not killed millions and caused untold misery?

  17. Timothy Gawne

    Kudos! Well said.

    For too long now Krugman has been getting liberal praise for standing up to austerity. However, when you look at the big picture, Krugman looks a lot like just another corporate shill:
    1. Krugman’s past support of anti-labor trade policies, including his complicity (via silence) on the TPP.
    2. Krugman’s championing of the insurance-company written monstrosity that is obamacare.
    3. Krugman’s utterly anti-Keynesian (and anti-classical!) refusal to acknowledge the role of demographics, witness the lack of opposition to cheap-labor immigration and guest worker (indentured servant) policies.
    If you ever wondered why establishment papers like the NY Times would give Krugman a soapbox, well, stop wondering.

  18. TC

    “Given that the conclusions Krugman comes to regarding progressive policies are all based on his beliefs about unmeasurable and hypothetical inventions, it would be wise for the left to avoid relying on Krugman for intellectual defenses of their pet policies.”

    What are called “unmeasurable and hypothetical inventions” represent an obfuscation. These aspects of the argument are irrelevant to the most critical matter of all: determining whether debts contracted will be easily extinguished, in fact many times over, and the more repeatedly the better.

    The weakness of the Keynesian approach is its arbitrary (and deadly) adherence to monetarist constructs whose effect is to restrict investment capital, rather than the superior notion of credit financing practical investments (not hypothetical inventions) whose broad purpose creates the means of raising the productive power of labor. Commitment to these means (put to practice by credit and tax policy) provides a layer of security to every financial arrangement facilitating the desired, steady increase in labor productivity, and this to the practical effect of likewise increasing the capital base, as well as the value of the currency in which facilitating financial arrangements are transacted.

    Credit offers a practical means to “form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare and secure the blessings of liberty to ourselves and our posterity.” Indeed, these foundational directives form the basis of commitments put to practice via credit and tax policy.

    A national bank issuing bills of credit financing practical investments whose broad effect most assuredly will raise the productive power of a sovereign labor force represents a tried and tested means of creating much something out of nothing and on a grand scale. Tax policy encouraging desired investment facilitating this end (and discouraging investment detracting from it) the other edge of the sovereign sword sharpening commitment to increasing security in all its forms.

    So, what makes Austrians and Keynesians most alike is their common adherence to monetarist dogma enforcing imperial designs, and their disregard for greater, egalitarian causes rightly making finance mankind’s servant, rather than its master. Austrians and Keynesians alike are driven by the principle of scarcity, whereas truth all around us manifests the principle of abundance whose tapping the proven practice of employing a sovereign credit system offers such desirable security as in fact assuredly increases mankind’s bounty of the abundance in which our species finds itself immersed.

  19. KnotRP

    Krugman thinks debt is the patient lending to the impatient (seen Keen).

    The point Keen is making is that Banks act as a facility
    that can transform “the anticipation of future profits from the impatient” into a current loan to the same impatient. Note
    that patient people are not involved at all, now or in the future, until/unless a bag holder is needed where the
    debt was malinvested in large amounts and the Bank is at
    risk of going under…

  20. Pyrite

    It’s natural. Sounds so good. Sounds so correct. Sounds almost empiricly based.

    Well, I was offered a credit card at 20% interest and the fine print says it could be 30%, savings interest of 0%, and the mortgage rate offered on the sign was 4.sometthing %. Apple sold 30 yr bonds that are now discountd by aprox. 20%.

  21. Pyrite

    Ooops. That should have been Swedish bank prize; Sveriges Riksbank Prize in Economic Sciences.

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