[T]here has, indeed, been a huge expansion of the monetary base. After Lehman Brothers fell, the Fed began lending large sums to banks as well as buying a wide range of other assets, in a (successful) attempt to stabilize financial markets, in the process adding large amounts to bank reserves. In the fall of 2010, the Fed began another round of purchases, in a less successful attempt to boost economic growth. The combined effect of these actions was that the monetary base more than tripled in size. Austrians, and for that matter many right-leaning economists, were sure about what would happen as a result: There would be devastating inflation…. So here we are, three years later. How’s it going? Inflation has fluctuated, but, at the end of the day, consumer prices have risen just 4.5 percent, meaning an average annual inflation rate of only 1.5 percent. Who could have predicted that printing so much money would cause so little inflation? Well, I could. And did. And so did others who understood…Keynesian economics.…
—Paul Krugman
Both: We’ve been going back and forth for a century.
Keynes: I want to steer markets!
Hayek: I want them set free!
— “Fear the Boom and Bust,” a Hayek vs. Keynes Rap Anthem
Keynesian economist Paul Krugman is big on predictions. He loves to make them, and he most particularly loves to crow about how accurate his predictions are…and how wrong the predictions of anyone who disagrees with him invariably (or so it seems) turn out to be.
In point of fact, it is not news that Dr. Krugman’s economic analysis tends to be colored by his political leanings. When he retired as ombudsman for the NY Times—the host of Dr. Krugman’s “Conscience of a Liberal” weblog—Daniel Okrent noted in his farewell column that “Op-Ed columnist Paul Krugman has the disturbing habit of shaping, slicing and selectively citing numbers in a fashion that pleases his acolytes but leaves him open to substantive assaults.” Basically the same point has been made by The Economist and Richard A. Posner writing in The Atlantic (as well as legions of conservative pundits and bloggers, of course).
But in criticizing Austrian School economists for bad short-term predictions, Dr. Krugman has ratcheted the chutzpah level up a notch or two.
Arguably, the single most significant point of contention between Keynesians and the Austrian School concerns the feasibility and utility of managing markets. The Keynesians claim not only that it is eminently doable but that to eschew their advice is both dumb and potentially immoral…because left to their own devices, markets will gyrate madly causing economic turmoil and human suffering. Austrian School economists profess that it is dangerously presumptive to believe that we are smart enough to “manage” markets and that attempts to do so are both dumb and potentially immoral…because misguided controls inevitably distort markets and engender malinvestment—mispriced goods and services—that leads to bubbles and boom-and-bust cycles that in turn cause economic turmoil and human suffering.
Manifestly, if it is possible to reliably predict the effect of control “x” or “y” on economic activity, then the Keynesians are right. But the Austrians’ contention is that this is not possible, in the short run, to reliably make such predictions. For Dr. Krugman to criticize them for failing to accomplish what they say is impossible is pure sophistry.
Austrian School economists would indeed argue that debasing a fiat currency eventually leads to its collapse, but there are too many independent variables in the equation to specifically predict when that will happen or, in the interim, what the particular effect of any given attempt to steer things might be. Dr. Krugman cites the average rate of inflation since 2008 as being “only” 1.5%. But we are discussing macroeconomics here, and looking at just three years does not tell you much. In fact, one of those three years was 2009, when the inflation rate was -0.4%…the first year with deflation since 1955 (when it was also -0.4%). During the first decade of the 21st Century, the inflation rate averaged 2.4%—and at the end of 2010, the dollar was worth 79 cents in 2000-dollars. If we go back to 1955—the other deflationary year—the inflation rate has averaged 3.8%.
Let’s take the middle number—2.4% average inflation, as we have experienced over the last decade—and project forward. By 2020, the dollar would be worth 63 cents in year-2000 dollars. By 2030, it would be worth 49 cents. Taking a longer and more data-rich perspective, with the average 3.8% inflation since 1955, at the end of 2010, the dollar was worth 11 year-1955 cents. Presuming 3.8% average inflation going forward, by the end of 2030 the dollar would be worth a 1955 nickel. (If annual inflation between now and then averages “only” 2.4%, make that seven cents.)
Hmm…now the Austrian School fiat-money-collapse scenario is not looking so far-fetched.
The whole Keynesian-inspired notion that “low” inflation is a normal and acceptable condition is bizarre. If I borrowed $100 dollars from you and then wanted to pay you back just $50, you would likely—and justifiably—be pretty upset and may well consider me a thief. When Keynesian-inspired central bankers do it to us, however, it’s like the weather: everyone complains about it but it’s no one’s fault.
Any inflation has the undesirable effects of distorting market values, encouraging malinvestments—which lead to potentially dangerous bubbles—and destroying the value of savings, thus discouraging people from taking a long-term view. Deliberately stoking inflation, therefore, is a dubious and problematic policy.
Which is not to say there is a lack of good reasons to be critical of Austrian School economics and their potential application to policy: for example just looking at the financial markets, if we eschew regulation, would we be better off going forward with an unregulated market for credit default swaps and other derivatives (as we had in 2008…and is still the case)? What would prevent unscrupulous naked short sellers from ganging up on vulnerable early-stage startup companies and making it hard for them to raise capital via the public markets? Would rolling back Regulation FD—as some Tea Partiers have advocated—be a good thing for investors?
But setting up straw men and incinerating them, as Dr. Krugman does here, is not advancing the ball.
