Sunday, November 9, 2014

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 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


  1. "It is worth while to remark, that a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value"

    -Jean Baptiste Say, A Treatise on Political Economy

    RW states:

    "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..."

    I think Say is stronger here than you realize. You are letting Krugman off the hook and the Proof of this in the realization that it is the INDIVIDUAL who meets in the Marketplace to exchange Goods and Services. This is the problem with the Demand Economist who wishes to replace a Market decision with an "Ought To" Statement: "Commodities "Ought To" be priced higher in Money terms, THEREFORE I will replace a Market Agreement with a Political One."

    One may buy only from what one has produced. This formulation eliminates the discussion of "Money" in the Krugmanite sense and returns the focus to the individual who produces and purchases from the value he derives. Friedman mentioned that one could "take your profit in pleasure" and that is just so.


  2. The whole "Minsky" meme is journalistic and academic fraud. It's a crypto-Austrian analysis that meticulously avoids thinking about or mentioning distorted and unsustainable pricing induced by funny money and government intervention. Instead, problems are the fault of the"free market" where people simply act irrationally. Just cuz.

  3. The Financial Instability Hypothesis* by Hyman P. Minsky

    The financial instability hypothesis has both empirical and theoretical aspects. The readily observed empirical aspect is that, from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes the economic system's reactions to a movement of the economy amplify the movement--inflation feeds upon inflation and debt-deflation feeds upon debt-deflation. Government interventions aimed to contain the deterioration seem to have been inept in some of the historical crises. These historical episodes are evidence supporting the view that the economy does not always conform to the classic precepts of Smith and Walras: they implied that the economy can best be understood by assuming that it is constantly an equilibrium seeking and sustaining system.


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    “The conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government which is the true ruling power of our country. …We are governed, our minds are molded, our tastes formed, our ideas suggested, largely by men we have never heard of. This is a logical result of the way in which our democratic society is organized. Vast numbers of human beings must cooperate in this manner if they are to live together as a smoothly functioning society. …In almost every act of our daily lives, whether in the sphere of politics or business, in our social conduct or our ethical thinking, we are dominated by the relatively small number of persons…who understand the mental processes and social patterns of the masses. It is they who pull the wires which control the public mind.” – Edward Bernays – Propaganda

    Bernays and his disciples believed the American citizenry nothing more than a herd of irrational animals that needed to be led by enlightened despots like him and other highly educated wealthy men who knew what was best in a democratic society. The term propaganda developed negative connotations after some Germans used it so effectively during the 1930s, so modern American despots changed the term to public relations. It’s all about the message. As media tools have become more technologically advanced and the study of human psychology perfected, the members of the invisible government have achieved their goal of governing, molding, and pulling the wires that control the public mind in a way that enriches them and their benefactors while satisfying the base needs of the masses and keeping them distracted with trivialities, technological wonders, and a myriad of bogeyman threats. These men have contempt for the common man. They have contempt for the U.S. Constitution. They have contempt for free markets. And they have control of our country.
    Needs, Wants & Desires

    they're all fos...