What the Hell is Wrong With Princeton? Why New Keynesianism is BS

What do Ben Bernanke and Paul Krugman have in common, aside from the fact that they are both madmen?  They are both professors of economics at Princeton University.  Now I have a cousin who got his PhD in Physics from Princeton.  I hit Princeton on my college tour years ago.  It is a lovely place and I can see why you would like to live there.  Einstein made his home there and Edward Witten is there now, among others.  Unfortunately for them, their peers in the soft sciences are giving their University a black eye.

Bernanke has decided he is the King Slayer.  He has just attempted to slay King Dollar by monetizing the debt of the United States.  Strangely, the dollar now rallies.  But I already took my shots at him (see below).  Krugman writes almost daily missives in the New York Times arguing that if we the polity would just spend much much much more money that we do not have and that needs to be borrowed, we could restart an already debt saturated economy and bring down unemployment.  The key to any argument about such stimulus is whether such spending has a positive multiplier effect or not.  As even a schoolchild could tell you such spending obviously does have a positive multiplier.  As long as you have your blinders on and follow the money up from where it is spent.  Of course if you give teachers some money, they will spend it.  And those whom they paid will also spend some more, and so on.  Monetary velocity ensues and voila! you have takeoff.

Except that if you take the blinders off, you realize that the money given out as stimulus came from the private economy in the form of taxes (or debt which just represents a claim on future taxes).  In the aggregate then, the muliplier can not be greater than 1 unless you believe that the government will put resources to more productive uses, in the aggregate, than if they had left the resources in the private economy.  Now as any second grader could also tell you, that is not the case.  Any reading of history will suffice to demonstrate that money expropriated by the government results in less value or output than the same resources left in the private economy.  The multiplier has been demonstrated to be less than 1, as anyone should have been able to tell you a priori, unless you are a Princeton economist.

But it does not stop there, just in case we are wrong, we can buttress our case by constructing a contrary argument and then following its consequences through to a reductio ad absurdum to disprove it.  So if the multiplier in the aggregate really is greater than 1, it follows that to achieve any level of output growth and employment growth, all you need to do is create dollars out of thin air and spread it around in perpetual stimulus!  Why haven’t we been doing this for years!?  Well it is because this does not work of course.  There is a reason natural scientists, who have been trying for millennia to create the perpetual motion machine, have failed.  It is because it violates principles of natural physical law.  It cannot be done.  QED:  Krugman style stimulus is a net loser.  While you might argue in the blinders on way that a limited stimulus might be appropriate in limited cases to prime a pump here or there, Krugman’s shock and awe strategy is just ludicrous.  People give him the time of day presumably because he got a Nobel Prize.  But that he has one speaks more poorly of the Nobel than it speaks positively of Krugman.

Princeton will survive.  It really is a beautiful place.  The nation may not if it keeps getting subjected to the insane meddlings of Princeton’s economists however.

4 Responses to “What the Hell is Wrong With Princeton? Why New Keynesianism is BS”

  1. Bob Heeter Says:

    Hey, don’t go knockin’ my Alma Mater Piled Higher and Deeper! There doesn’t appear to be any school (academic institution, nor group of economic thinkers) that has a practical clue how to use monetary policy to fix the economy. Personally I think the solution lies with the Justice Department more than the Federal Reserve, but economists don’t know how to think holistically… We have to stop the fraud and imprison the con artists in fancy suits, if we want to restore economic confidence…

    As a monetary policy implement, Hussman did a very good takedown showing (with real data, plotted nicely) that QE2 will simply cause velocity to drop and have no significant effect on either prices or GDP, so in that sense it’s actually a benign move.

    However, there is an alternative explanation of the QE2 gambit, which doesn’t involve economists being dumb: I think the Fed doesn’t want to get caught with its pants down again, and everyone can see there’s another round of financial crisis on the horizon. QE2 buys the new Congress some breathing room by financing the $1,000,000,000,000-plus U.S. deficit just long enough for Congress to take action to fix the long-term issue while also threatening to implode the Treasury market when the program ends, if they don’t act. It also puts China on notice that if they don’t rebalance the exchange rate, we’ll push over inflation to do the job for them. And it keeps the U.S. system awash with cash at a time when Europe hits a critical point in their ongoing sovereign & financial liquidity crisis and the fraudulent Primary Dealers’ balance sheets are under long-overdue legal stress. So it’s possible that this particular move might not be a total disaster.

    Obama clearly wanted to take on the long-term solvency issue after the election, and the public is ready to engage … although we’ll have to graduate from the last 2 decades’ Boomers-wearing-blinders “debate team” BS and get back to serious policymaking. Sigh…

  2. Bob Heeter Says:

    Here’s a link to Hussman’s analysis of QE2 in liquidity-trap conditions: http://www.hussmanfunds.com/wmc/wmc101025.htm

  3. t0mmyBerg Says:

    Bob, well said. But that part about crashing the Treasury market when they have to back these dollars out of circulation is what worries me most. I read the Hussman pieces every Sunday night. Finally, as to serious policymaking coming from anyone who has run the election gamut, I will believe it when I see it – which is to say I will never believe it. And so that leaves them backing out with no credible plan to avoid default. The market moves are going to be epic. Good to hear from you.

  4. Bob Heeter Says:

    I don’t think they even have to back the dollars out of circulation to crash the Treasury market, I think they just have to stop buying! Where’s the bid going to come from?

    Glad to hear Hussman’s on the approved reading list.

    Seems like a market-neutral strategy is very appropriate here, hope all’s going well!