Tuesday, 3 April 2012

Keen vs Krugman and why it matters

Wrestling Sideways - ReallyIt seems the first skirmish in the battle for economic minds may be at an end. Krugman has declared the debate at an end.

And thanks to modern technology we've been able to watch and take part in this debate.

A summary has been posted and everybody believes their man won. But you may be wondering why this arcane battle matters at all.

It matters a lot. The Post Keynesian view of endogenous money creation changes the view on the causal relationships within the economy. It brings money and finance centre stage, rather than abstracting it out of existence as the Neo-Keynesians do.

Firstly it allows the build up of excess savings in the non-goverment sector - these 'savings net of investment' - and it allows them to build up first in the causal chain. That means that the non-government sector can be seen as 'pushing' money onto the government sector. This is the view that MMT takes and bases its economic model upon - the non-government sector is the one doing the 'net saving' which the government sector then has to react to.

With a Neo-Keynesian model it cannot - the government has to be 'pulling' money from the non-government sector - the government sector is over spending and the private sector is reacting to that. The current Neo-Keynesian viewpoint is why all governments are talking about cutting spending, trying to avoid 'pulling' money from the private sector because they believe that is what is stopping the private sector spending.

Secondly it allows the build up of an excess of private sector debt. Banks can push debt and are not constrained by having to fund the debt because the debt funds itself by its very creation. This leads to dynamic instability in the system and a collapse due to the funding of ponzi schemes. This is the area where Steve Keen and the Modern Circuit Theorists operate and drives their view that the level of private debt must be controlled to prevent any more 'Minsky Moments' like we saw in the GFC.

In the Neo-Keynesian model the level of private debt is a distributional issue and has limited or no effect on the macroeconomy. Banks cannot lend in excess of savings and will be brought under control 'in the long term'. And this is why government isn't panicking about the 450% private debt levels in the UK, and its economic strategy involves pushing more debt onto the non-government sector in an attempt to kick-start the economy.

Thirdly it allows these excesses to persist 'into the long term' (that favourite cop-out phrase of all economists). The Post Keynesian view doesn't see an automatic return to equilibrium - savings can stay in excess of investment for a very long time indeed. Certainly long enough to affect pension planning and the like. So you get persistent trade deficits and you get persistent government deficits due to the dynamics of the money system. Therefore policy must deal with these conditions. MMT's choice to accommodate those savings defers the issue of dealing with them to the future. You deal with them if and when they become spending in excess of your economy's ability to cope in the future. Chances are they won't and the impact will be smaller in the future because you're building a stronger economy today.

In the Neo-Keynesian view that must all resolve itself 'in the long term'. So you get the line that the central bank 'must' put up its interest rates if government runs a persistent deficit and that the trade deficit 'must' be repaid in the future at some point. In their view you have to get rid of excess government spending/trade deficit now because you will have to deal with the results of that excess in the future and it'll be a bigger problem then. Hence the lines about enslaving our grandchildren, etc.

Make no mistake this debate over the nature of money is the capital debates of our time. The result of this will have a profound effect on all our futures.

Keen vs. Krugman represents the start of the Kambridge Kontroversy.