No one can deny that Paul Krugman is a gifted expositor of economic ideas. His column today, “Death by Hawkery,” constitutes a fine example of this skill in action.
What I found most interesting in this column is something that would have almost surely escaped his average reader. In particular, I noticed that in telling his basic story, he appealed to a mathematically explicit model of credit cycles written by Nobu Kiyotaki and John Moore (JPE 1997).
Why do I find this interesting?
Well, first of all, I notice that at the time, Kiyotaki was affiliated with that great “freshwater macro” department at the University of Minnesota. You will also notice that the arch-devil Ed Prescott is thanked (among others) for his “thoughtful comments and help” on the paper.
I mention this because I think that Krugman has in the past overemphasized the disagreement that exists among the newer cohorts of macroeconomists (one could make the case that disagreement was much greater in the past); see, for example, here: Disagreement Among Economists. On this matter, I side with Steve Williamson, who I think has rightly taken Krugman to task on this issue; see here and here.
Secondly, I find it interesting that the mechanism highlighted by Kiyotaki and Moore in no way relies on nominal or real price rigidities. It is, in fact, a real business cycle model. Yes, you heard me correctly: Paul Krugman is appealing to an RBC model to help him account for recent events. (Granted, it is an RBC model that incorporates limited commitment, a friction that plays a prominent role in all modern macro theory; see my post here: Asset Shortages and Price Bubbles: A New Monetarist Perspective).
I think this constitutes evidence that the great macroeconomic divide is not as great as it is sometimes portrayed. Most of the disagreement I am aware of is of the gentlemanly “let us agree to disagree” type. But there is no fundamental disagreement in basic macroeconomic methodology among most academic macroeconomists. (There are, of course, healthy and welcome challenges from the fringes of the profession.)
Now for some comments on the economic ideas.
As you may have gathered from my previous post, I am generally sympathetic to the idea of expanding the supply of U.S. treasury debt at this time (with a commitment to unwind in the future, if and when economic conditions improve). Of course, a big question is what to do with the funds acquired in this manner. I’m with Krugman in that heck, we may as well use it to build physical capital (public infrastructure). Financing a corporate tax cut to stimulate domestic private capital spending might be a good idea too (not so politically popular though).
These provisional policy recommendations suggest themselves to me by way of a class of “new monetarist” models that I like to use to organize my thinking about things. But I should say, however, that I’m still not sure just how seriously to take these models (at least, their current incarnations). I’m still a little sketchy about how one might plausibly generate negative real rates of interest in these models; that is, models that take seriously the intertemporal production capabilities of actual economies (you will note that Krugman abstracts from physical capital in telling his little story).
I can’t help but note that this same class of models might be used instead to support “conservative” policies. In particular, one force that can potentially drive the expected marginal product of capital (real interest rate) lower is the rational (or irrational) expectation of a future regulatory/tax burden paid for by capital accumulators of all types (including human capital).
If (and I emphasize the if) this is the (or a significant part of the) fundamental problem (and how do we really know that it is not?), then it is hard to see how treasury debt expansion and/or inflationary policy is going to solve it. Fixing the problem in this case means providing an environment that rewards private investment. Death by Dovery is also a possibility.