Has Paul Krugman Become an Austrian Economist?

Well, not exactly, but he has toned down his viciousness and while he distorts the Austrian answer to why there is no unemployment during the boom period, he recognizes that there is an Austrian answer.

Krugman wrote today:

Martin Wolf asks for a discussion of Austrian economics.

My view is that the fatal flaw in Austrian economics is that it can’t explain unemployment — or, worse, that it thinks that it can explain unemployment, but is deluding itself. The Austrian view is that unemployment in a slump results from the difficulty of “adaptation of the structure of production” — workers are unemployed as resources are painfully transferred out of an overblown investment-goods sector back into production of consumption goods.

But this immediately raises the question, why isn’t there similar unemployment during the boom, as workers are transferred into investment goods production?

I’ve asked this question repeatedly over the years, and all I get is one of two things: gobbledygook, or “but during the phase of rising investment, the economy is booming!”, which is of course circular. In practice, Austrians seem to be Keynesians during booms without knowing it; they realize that high demand produces a boom, but don’t realize that this contradicts their own theory of slumps.

 And the key to all this, I believe, is that the Austrian abhorrence of explicit models, even for the purposes of clarifying thought, leaves them unaware of the holes in their account.

There are many things to note in his post. First, note the lack of viciousness in his tone toward Austrians. As long time EPJ readers know this is a new approach for Krugman. Out of a new apparent civility in the debate, I will refrain from pointing to the previous viciousness.

Second, all though he charges that the Austrians can't explain why there is no unemployment during the boom phase in the economy, for the first time (that I am aware of), he acknowledges that Austrians have attempted to answer this question. He completely distorts the answer, for reasons only he can fully explain, but I personally think we may be on to real debate here. Krugman is looking at the world in terms of demand but does not recognize changes in money supply as influencing demand. Thus his comment may be legitimate in the sense that he is seeking truth, though missing it. He writes:

I’ve asked this question repeatedly over the years, and all I get is one of two things: gobbledygook, or “but during the phase of rising investment, the economy is booming!”, which is of course circular. In practice, Austrians seem to be Keynesians during booms without knowing it; they realize that high demand produces a boom, but don’t realize that this contradicts their own theory of slumps.

In an earlier response to Krugman, I believe I clearly outlined what can be called the Austrian position on the difference in the employment situation between the boom phase and the bust phase:

As for as Krugman’s question as to why there isn’t a rise in unemployment during the boom part of the cycle... Before a boom starts, the economy can be said to be in equilibrium between the consumer goods production and capital goods production. When a central bank then pumps in new money, new demand is created for labor in the capital goods sector causing bidding for labor away from the consumer goods sector. Thus, there is no point where rising unemployment would be a factor in this part of the cycle. However, during the downturn part of the cycle, it is not a case that the central bank is pumping money into the consumer sector. What is occurring, instead, is that a transfer of money is taking place from the capital goods sector to the consumer goods sector. It is this money drain from the capital goods sector that causes the unemployment. During the central bank induced boom, money isn’t being drained from anywhere.

So it can be seen that if you take out the influence of money supply out, what you have is free floating demand which for a Keynsian needs to be fixed. Thus, it can be seen how Krugman is missing this crucial point, if doesn't get the money supply involvement . You need to leave in the very real influence that money supply has during the different phases of the business cycle, in the theory.

As for Krugman's comment that there is an:

Austrian abhorrence of explicit models

This is, again, a distortion of the case, but it may be a result of Krugman's view of the world. To an Austrian, a non-mathematical model can be explicit in explaining the real world, and it is, to an Austrian, economists who use mathematical tools to explain the economy who must cut corners to get their explanations to fit into mathematical equations.

Further, an Austrian would also argue that mathematical testing  is inappropriate for the science of economics. This is a another point Krugman may not understand about Austrian thinking.

Is Krugman an Autrian? Not by a long shot. But he is raising questions that Austrians consider important. And he is raising questions on topics most Austrians have thought about. In this sense, I am almost ready to declare,"We are all Austrians now."