David R. Henderson  

Krugman on Inflation

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Paul Krugman writes:

I've been writing about how macroeconomic reality under Ronald Reagan didn't actually match the myth, and many people are inevitably upset. And one of the things they tend to bring up is the hoary old myth that the 80s success in taming inflation was somehow a terrible shock and surprise to Keynesians, who had no explanation.

This is, as it happens, completely wrong: what actually happened in the 80s was, quite literally, a confirmation of the validity of textbook Keynesian economics.


He then goes on to make his case. But back in 1982, Paul didn't see it that way. In his famous memo to Marty Feldstein, co-authored with Larry Summers and written on his, Larry's, and my third day on the job at the Council of Economic Advisers under Marty, he wrote:
As real intrest [sic] rates decline and the economy recovers, we can expect the real exchange rate and real commodity prices to return to approximately their historical levels. Our very rough guess is that correction of these distorted relative prices will add five percentage points to future increases in consumer prices and about two percent to the GNP deflator. This estimate is conservative in that it assumes stable oil prices.

The section of the memo from which this quote is pulled is titled, "The Inflation Time Bomb?" In other words, Paul thought at the time that inflation would increase. It didn't, as his own graph shows. At the time they wrote, the annualized inflation rate (measured by the Consumer Price Index) for January through August, was over 6 percent.

Back then, we all got to read each other's memos in a bound volume called "The Weekly Reader." At the time I found Paul's and Larry's memo implausible. I remember talking to two other colleagues, Lincoln Anderson, the CEA's macro forecaster, and Ben Zycher, the energy economist, and, if memory serves, we all thought that Krugman and Summers were too pessimistic on inflation.

So if he's saying that what happened in the 1980s was "quite literally, a confirmation of the validity of textbook Keynesian economics," is he saying that he didn't buy into "textbook Keynesian economics" back then? Or is it just possible that what happened in the early to mid-1980s doesn't confirm Keynesian economics?


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CATEGORIES: Macroeconomics



COMMENTS (15 to date)
mark writes:

I don't think anyone anticipated how the velocity of money would accelerate in the 1980's, due to the interplay of unprecedented technological progress and the effect of RMN fiating the currency a few years earlier. I remember when banks used to settle their daily balances with each other by flying sacks of paper currency to some place in the midwest, maybe South Dakota. I also remember the day Texaco paid off Pennzoil in 88 and the Fed had to tell all the banks in its wire transfer system they could not send any wires that day until the Pennzoil payment had cleared.

pyroseed13 writes:

David, I've heard Krugman repeat the claim once before that the Fed's interest rate cuts and subsequent housing boom were responsible for the strong economic growth in the 1980s, not the tax cuts. Do you think this claim has any merit? I can't seem to find a chart of historical housing prices, but I believe that the economy had already recovered before the housing boom.

It's also worth noting that many Keynesians at the time believed that the deficits would cause real interest rates to skyrocket, though these continued to fall throughout the 1980s.

David R. Henderson writes:

@pyroseed13,
I've heard Krugman repeat the claim once before that the Fed's interest rate cuts and subsequent housing boom were responsible for the strong economic growth in the 1980s, not the tax cuts. Do you think this claim has any merit?
Aside from whether it has merit, I don’t think he made the claim. Also, I don’t think there was a housing boom in the 1980s.

AC writes:

Is it possible to come up with evidence that Krugman wouldn't consider to be confirming Keynesianism? I don't think I'm exaggerating, he can tell a story for any conceivable data. If he ever responded, I'm sure he can find an excuse for that memo. But don't worry, it's science.

pyroseed13 writes:

David, here is Krugman's post with the appropriate graph. He claims that "Reaganomics was basically irrelevant":

http://krugman.blogs.nytimes.com/2010/08/04/what-reagan-didnt-do/

Housing starts did boom in 1984, reaching 2007 levels. But then they fell for the rest of the decade, while the economy continued to boom. For the record, I do think that Krugman severely understates the positive effects of 1981 and 1986 tax reforms on economic growth, but I think we need to examine monetary policy as well.

Emily writes:

In the interests of increasing the degree of trust among people who do not agree with each other, you could ask people to clarify their positions/address what you believe to be inconsistencies before blogging about them. I don't know if Paul would return your phone calls, but it might be worth a shot.

Tom West writes:

Paul Krugman has made it pretty much abundantly clear that at this point in his career he is part of the political side of the politics/policy-wonk divide and thus can no longer be reasonably expected to publicly admit mistakes, concede points, or acknowledge trade-offs.

A pity, as I had found him fairly interesting, but not a career move I will fault him for. After all, if you're a lawyer, you also give up the right to say, "You know judge, I think my client *is* guilty." As a politician, frank policy discussions are for behind closed doors.

BRKelley writes:

Reading Krugman for lo' these many years, its not unusual for him to use the same data sets to justify today's position, whatever that may be, even if it contradicts yesterday's position, but is in now way binding him when he formulates tomorrow's.

Joe Cushing writes:

Tom West

Then we need to stop calling him an economist. Economists try to be as scientific in their methods as conditions allow. Part of that involves being open to changing a position based on evidence. If he is a politician then he needs to be a politician. If he is an economist then he needs to have his frank policy discussions in out in the open.

perfectlyGoodInk writes:

Given how easily it is to categorize macro schools of thought as either conservative or liberal, economists don't try nearly hard enough.

Tom West writes:

Then we need to stop calling him an economist.

I have yet to see any politician (or more accurately, someone operating in the political arena) who does not use their economic/military/medical/education/law enforcement background to claim authority in any sphere remotely connected to their previous expertise.

After all, as a politician, your job is to use *all* the tools at your disposal to advance the policies you support.

And it's not as if politicians stop thinking. It's why "off-the-record" conversations are fundamental to many politicians sanity. It's just the public cannot be exposed to your actual thoughts without destroying your side.

Bob Murphy writes:

Great catch, David. My Spidey Sense was tingling when reading Krugman's post on this, but I had forgotten about his memo.

Glen Smith writes:

Joe Cushing,

The primary job of a political economist is to spray economic perfume on the machinations of his master and economic stank upon the machinations of his masters opponents even when the tactics of his master and his master's opponents are basically the same. In the early 90s, I was told that if I wanted to continue as an economist, I needed to pick a master (preferably a successful one) and stick with him. That was the end of my dream.

David R. Henderson writes:

@Glen Smith,
In the early 90s, I was told that if I wanted to continue as an economist, I needed to pick a master (preferably a successful one) and stick with him. That was the end of my dream.
Glen, that was really bad advice.

Karl Smith writes:

I don't know about this memo but Paul has previously asserted that he found the true Keynesian faith after attempting and failing to prove mathematically that japan could solve its problems with QE alone.

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