Krugman's education evidently lacked a theory of capital and time, therefore all recessions must be due to shocks of one kind or another.
Nice response to Krugman's original article by Roger Garrison:
Krugman's view of recessions is best put in perspective by comparing it with the contrasting views of Keynes and Hayek. These arch rivals of the thirties were in agreement that the increase in money demand, the "scramble for liquidity," was a secondary aspect of the downturn but in disagreement about what the primary aspect was. Keynes thought it was investment demand, which, in a decentralized economy, is prone to collapse. Hayek thought it was malinvestment induced by short-sighted or politically motivated actions of the central bank. Krugman elevates what both Keynes and Hayek saw as a secondary aspect to the status of the primary aspect. And then, creating difficulties for the historian of thought, he attributes the high-money-demand theory of recessions to Keynes himself.
Presumably rejecting all hangover theories, Krugman pronounces the Austrian variety "intellectually incoherent"—largely on the basis of a telling question: "[How can] bad investments in the past require the unemployment of good workers in the present?" Krugman's implicit answer: They can't—and therefore we need not pay any attention to Hayek. (The question itself is a good one and is likely to find its way onto a macro exam at Auburn University.)
A Hayekian would answer in terms of the intertemporal complementarity that characterizes the economy's capital structure. During the downturn, good workers are out of work because the capital they need to work with is in short supply, having been committed to long-term projects now in need of liquidation. Krugman's response ("Well, fine. Junk the bad investments and write off the bad loans.") is all too facile. His advice is well taken, but the market process that implements it is time-consuming. During the junking and capital restructuring, the demand for much of the labor force (labor whose capital complement has not yet been recreated) is low. And low demand translates into unemployment—except under the decidedly unAustrian assumptions of instantaneous wage-rate adjustment and near-infinite labor mobility.
Recognizing that in Austrian theory the unemployment is somehow related to capital restructuring, Krugman poses another question: "Why doesn't the investment boom—which presumably requires a transfer of workers in the opposite direction [from short term projects to long-term projects]—also generate mass unemployment?" Gottfried Haberler asked the same question in his 1937 book, Prosperity and Depression. The answer is that during the cheap-credit boom, there is a net increase in labor demand. And because of the effects of a low interest rate, many workers are bid away from jobs in the late stages of production and into jobs in the early stages. During the downturn there is a net reduction in labor demand. As liquidation gets underway, workers are released in the higher stages and (eventually) reabsorbed elsewhere in the economy.
Both of these future exam questions have been answered by drawing on Hayek's contributions. Significantly, both answers involve heavy doses of capital theory, which serves as the underpinning of the Austrian theory of the business cycle. One of the most profound effects of the Keynesian Revolution was to tear macroeconomics loose from these underpinnings. Today, capital theory simply has no standing in mainstream macroeconomics. Accordingly, Hayek has no standing in the eyes of Krugman and other modern mainstream macroeconomists. It is a pity. |
