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The Krugman tension

Ben Chu
paul krugman 190 150x150 The Krugman tension

Efficient market hypothesis?

Paul Krugman’s latest New York Times column got me thinking about a tension in the great economist’s arguments which I’ve half noticed before.

Krugman argues that because the bond markets are showing no signs of running away from US debt, contrary to the warnings of fiscal hawks, there is plenty of scope for further stimulus. He also argues that because the bond markets are still clearly worried about Irish government debt, this is evidence that  austerity is a bad idea in the teeth of a slump.

But what if the bond markets were alarmed by US government debt? Would Krugman regard that as an indication that the time had come for fiscal and monetary tightening? Of course not. As a good Keynesian, he would argue that such tightening would merely make the economy weaker.

One of Krugman’s thoughtful Chicago-school rivals, Scott Sumner, puts his finger brilliantly on the tension:

“Krugman is an anti-EMH [efficient market  hypothesis] guy who forecasts as if he believes in the EMH.”

In other words, he thinks that markets are often wrong, or capable of acting irrationally. But he uses market sentiment to justify his macroeconomic prescriptions, implying that those markets are omniscient and inherently rational.

I’m sure Sumner over-eggs it when he suggests that Krugman relies more on market sentiment than his own Keynesian economic model. But there is a potential problem here.  If the markets do start demanding fiscal and monetary self-harm from countries (which one can plausibly argue has already happened with the PIIGS) Krugman will have to explain why, having told us to pay attention to market sentiment in the past, we must now ignore it.

UPDATE: oserdavid argues below that Krugman is merely exposing the inconsistency of the arguments of the fiscal hawks, rather than buying into those arguments. It’s a very fair point. But I still think it might be wise for him to point out more often that even if the markets were panicking about US debt they would be wrong and should be ignored by policymakers.

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  • oserdavid

    No Ben, it’s not a ‘tension’. Just that the deficit hawks are using adverse market sentiment as an argument, and Krugman is simply pointing out that there is no evidence of this adverse market sentiment, except in the case of Ireland, which has done exactly what the hawks say it should have done. This has nothing at all to do with any belief or otherwise in the efficient market hypothesis on Krugman’s part

  • Dave514

    Krugman is a far left Socialist and a writer for a Socialist paper the NYT. His opinions are perforce suspect.

  • BenChu

    I accept all that. But I think it might be sensible for Krugman to point out more often that even if the markets were indeed panicking about US debt (or UK debt for that matter) they would be wrong and should be ignored by policymakers.

  • jockmoron

    Krugman is not a far left socialist, he’s a classic European style liberal; only a in a pathologically unbalanced, neo-fascist society, like the US, would such a liberal be considered a far-left socialist. But I agree with some of the thesis here, the markets aren’t working, but it’s the markets that Krugman would like to put things back together; there is a logical inconsistency here, but this has been the problem now for Krugman and other economists who think like him for a long time. Krugman’s solutions to our financial and economic woes turn out to be as naive, simplistic and wrong as the the naive and simplistic neo-liberal, monetarist dogma that got us into this mess in the first place.

  • jockmoron

    Krugman is not a far left socialist, he's a classic European style liberal; only a in a pathologically unbalanced, neo-fascist society, like the US, would such a liberal be considered a far-left socialist. But I agree with some of the thesis here, the markets aren't working, but it's the markets that Krugman would like to put things back together; there is a logical inconsistency here, but this has been the problem now for Krugman and other economists who think like him for a long time. Krugman's solutions to our financial and economic woes turn out to be as naive, simplistic and wrong as the the naive and simplistic neo-liberal, monetarist dogma that got us into this mess in the first place.


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