Krugman Admits Keynesians Failed to See the Financial Crisis Coming

By Robert Wenzel

Paul Krugman recently commented on Martin Wolf's new book, The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis, at The New York Review of Books (October 23,2014).

The review itself, overall, is rather uninteresting. What I found interesting is Krugman's admission that the economic mainstream had no clue the financial crisis was developing.
He writes:

On the eve of crisis in 2007 the officials, analysts, and pundits who shape economic policy were deeply, wrongly complacent. They didn’t see 2008 coming; but what is more important is the fact that they even didn’t believe in the possibility of such a catastrophe...

Did supposed experts really think that nothing like what did happen could happen? Yes. In his 2003 presidential speech to the American Economic Association, Robert Lucas of the University of Chicago, the most influential macroeconomist of the late twentieth century, asserted that “the central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”... In 2004 Ben Bernanke gave an influential speech lauding the economy’s “great moderation,” which he argued was likely to be a lasting phenomenon, in part because it reflected the excellence of modern macroeconomic policy. “This now seems quaint,” remarks Wolf; I would have used a stronger word.

Krugman does admit that a few did see the crisis coming, but chalked those warnings to be those of the exclusive domain of perma-bears:

Almost nobody predicted the immense economic crisis that overtook the United States and Europe in 2008. If someone claims that he did, ask how many other crises he predicted that didn’t end up happening. Stopped clocks are right twice a day, and chronic doomsayers sometimes find themselves living through doomsday.

I hope Krugman isn't classifying me as a chronic doomsayer. As I have detailed in The Fed Flunks: My Speech at the New York Federal Reserve Bank. I warned about the financial crisis in real time. But I am far from a permanent bear. When I meet subscribers to the EPJ Daily Alert, they often say to me that they appreciate that I point out that it is a BOOM-bust CYCLE that is created by the Federal Reserve and thank me for not being a  permanent bear.

That said, the permanent doomsayers, may not track the economy as close as I do and spot every up and down tick, but at least they recognize that crisis can occur and is likely, given Fed money manipulations. This, as Krugman correctly points out, mainstream economists failed to recognize as a possibility.

Yet, in his essay, Krugman makes no attempt to understand or discuss the Austrian School Business Cycle Theory that is at the heart of  most of those who made correct forecasts about the developing crisis. Instead, Krugman ignores the theory developed by Ludwig von Mises and limits his discussion to taking a nasty distorted swipe at his fellow Nobel prize winning comrade the Austrian school economist Freidrich Hayek:

One of the great temptations one faces in writing about financial crises is the urge to turn it all into a morality play—to emphasize the lurid excesses of the boom, and accept the painful slump that follows as the necessary wages of sin. Liquidationism, the doctrine that policymakers should let a depression run its course, had powerful advocates in the 1930s. Friedrich Hayek, for example, warned against the use of “artificial stimulants” to boost a depressed economy, arguing that policymakers should “leave it to time to effect a permanent cure.”

If one were to attempt to so distort Krugman's all out money printing and over-the-top fiscal spending advocacy and frame it in the same manner that he frames (and distorts) Hayek's position, one could say that Krugman's theory is a dark morality play that sees the necessity of keeping the economy boozed up and high for as long as possible- before the system totally collapses and the patient ends up on a death bed.

One more point with regard to Krugman's essay. He has introduced a bizarre new distortion in his essay. He distorts the meaning of Jean Baptiste Says's observation that supply creates its own demand. And he has done so in a manner I have never seen before. He writes:

 Say’s Law—the false claim that income is automatically spent...

This is Krugman getting Say ass backwards. Say never said "income is automatically spent." In fact. it appears that Krugman here is referring to money income. Say wasn't talking about this at all. His observation was not about money income but about new products created. Say was merely stating that if one recognizes the validity of the theory that supply equals demand, then there can never be a general overproduction of goods, since prices will simply fall until the supplies clear.

Does Krugman deny supply and demand theory? Is he that confused? It appears so.

Robert Wenzel is Editor & Publisher at EconomicPolicyJournal.com and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics