Tuesday, February 5, 2013

A Diagnosis: Does Paul Krugman Suffer From Apoplithorismosphobia?

In a 2003 piece for The Quarterly Journal of Austrian of Economics, Mark Thornton wrote (my highlights):
Apoplithorismosphobia (ay-pope-lit-horris-mos-foe-be-ah) is the fear of deflation. Or, more correctly, the fear that an economy would “suffer” from falling prices, or a general decline in the prices of goods and services. It is a fear that has gripped some economists, journalists, and policymakers with a blinding strength as powerful as faith. Evidence seems to suggest that the phobia develops from the inability to understand the causes of the Great Depression and a more general failure to distinguish between what Bastiat called “the seen” (e.g., deflation) from “the unseen” (e.g., the causes of contraction and unemployment). Under the influence of this phobia, victims develop an unfounded faith in the ability of monetary and fiscal policy. In extreme cases it leads to the support of powerful policy “weapons” to combat deflation—the equivalent of using economic weapons of mass destruction[...]

Nowhere is the fear of deflation stronger than in the person of Paul Krugman, editorial writer for the New York Times and an economist at Princeton University. The evidence suggests that his fear of deflation is based on the association of deflation and depression, especially the Great Depression causes either phenomenon or the causal link between the two. He is clearly afraid of their combination, although he claims that “the only thing we have to fear is fear itself.” His fear of deflation and depression leads him to advocate policies that are known to cause recessions and depressions.

Krugman firmly supports the demand-side approach of Keynesian economics where demand can falter because of psychology and Keynes’s “animal spirits.” There is no real cause of depressions or recessions, they just start, and “for whatever reason, the economy becomes depressed” (Krugman 2002d). He notes with Lucas (1987) that “the Great Depression had no obvious cause at all” (Krugman 2001).[...]

Paul Krugman uses a “model” economy based on the experience of a babysitting coop in Georgetown to describe and diagnose macroeconomic maladies (Sweeny and Sweeny 1977). Members of the co-op pay and receive one unit of script for one unit of babysitting, but Krugman claims that the co-op experienced an increase demand to hold babysitting tickets, the same thing as a deficiency of aggregate demand, and that the co-op went into recession. His solution to this “recession” is to print up more script and hand it out to members, i.e., inflation. In the real world “recession is normally a matter of the public as a whole trying to accumulate cash” and likewise Krugman declares inflation the solution (Krugman 1999). For Krugman, financial breakdowns in Latin America and Asia were simply a matter of insufficient aggregate demand.

The model is too simplistic to explain or illustrate recession, and it is near fraud to base real-world analysis on such a flimsy foundation. In the economy of the co-op there is a single, homogeneous good, babysitting, while the real world is characterized by an ever-increasing heterogeneity of goods. In the co-op economy the only input is labor, but in business cycle economics and history, things like credit, capital, investment, technology, debt, and bankruptcy are the primary issues, and even in laborbased business cycle theories, the main story is always that labor is attached or
detached to capital goods. The most basic economic point is that the co-op has only
one fixed price and prices are not allowed to adjust due to the bylaws of the co-op. As
the authors of the original paper state, “The script-price of babysitting couldn’t adjust,
and the shortage worsened” (Sweeny and Sweeny 1977, p. 87). But Krugman does not
even bring up the issue of prices, nor does he discuss the price adjustment that eliminates shortages and surpluses in the market economy. [...]

The babysitter model appears in a four-page comment where the co-authors place their tongues firmly in their cheeks. There have been no citations to the four-page paper since it was published in 1977, as indexed by the Institute for Scientific Information, the most comprehensive source of citations, which reviews over 7,000 sources for citations.

You could say that the article was largely written and read “just for fun,” and at the end of the article the authors are careful to issue a clear message of caution for the reader to not read too much into the paper, and an explicit cautionary statement to guard against the type of recommendations that Paul Krugman is so famous for making:

Now, if goodhearted people in an area that offers little scope for chicanery can so bungle economic management (the babysitter co-op), can we really be surprised at the results of turning our economy over to the tender mercies of political experts? Indeed, unlike the co-op, the national economyseems virtually indestructible, not having died yet. (Sweeny and Sweeny1977, p. 89)

In other words, resist the fairy tales of consultants and pundits, like Paul Krugman, who offer “economic management” of the economy as a panacea when in fact
national economies are best left to their own devices.
Is there any hope for Krugman? Possibly. Mark Thornton in his column also suggests a  12- step program for Apoplithorismosphobes:
In order to recover from apoplithorismosphobia it is recommended that patients follow this 12-step program:
1. Revisit and relearn the basic principles of economic analysis, such as
supply and demand.
2. Remember that the cause of misallocations and unemployment is government interventions, such as price controls, inflation, and regulations.
3. Re-examine the effects of monetary policy, other than on the price level.
4. Stop thinking about the price level.
5. Pay less attention to statistics in general.
6. Forget modern macro altogether.
7. Note that macroeconomic problems are usually preceeded by large
increases of the money supply (i.e., inflation).
8. Remember that the Great Depression occurred after central banks were
established, not before.
9. Remember the Fed’s “mistakes” took place well after the Great Depression began.
10. Recall that Herbert Hoover and FDR (and modern Japan) pursued
activist policy regimes to keep wages and prices high.
11. Remember that monetary and fiscal policy do not cure recessions or prevent deflation; they only exacerbate the problems and delay recovery.
12. Remember that some of the best periods of economic improvement in
human history have occurred during deflations.

RW note: Paul Krugman's reference to the  babysitting coop is no casual aside. He devotes a chapter to it in his most recent book, End This Depression Now!

In 1998, Krugman wrote in Slate of an "earth shattering" experience, the reading of the co-op story:
Twenty years ago I read a story that changed my life. I think about that story often; it helps me to stay calm in the face of crisis, to remain hopeful in times of depression, and to resist the pull of fatalism and pessimism.
For more problems with the Babysitting Co-op Model see here.

1 comment:

  1. Has anyone ever asked Krugman, "You have been a sharp critic of many macro economic/monetary policies, i.e. Japan, U.S., Europe, in effect blaming the implementers for the failure of these modern economies, usually for not spending enough. If the implementation is so often wrong, what good is the theory?" It would be like understanding the principal of lift, but every attempt to fly ending in disaster. Shouldn't we stop trying to fly in that scenario?