Having been an onlooker of the recent tiff between Paul Krugman and Steve Keen, I was very eager to see what Mr. Keen had to say in tonight's LSE public lecture on "Banks Versus the Economy." Observing how Keen had quarreled with Krugman and effectively ate his lunch, I thought he would bring a lot to the table. I was wrong.
Keen had raised the (very interesting) issue about how neoclassical economists and their models fail to recognize the role of banks in the economy. When attempting to defend against this allegation, Krugman acknowledged that banks do play a role in the economy, and that in fact the Fed is fully able to contain the supply of money via monetary policy tools (i.e., manipulating the amount of reserves banks hold and therefore restricting or encouraging lending). In a word, neoclassical models still assume no banks in the economy, so point to Keen here. Moreover, Keen closely adheres to Hyman Minsky, whom I find very inspiring and am glad to hear Keen reiterate Minsky's theory of debt and banks in the economy. Keen uses Minsky to prove that the Fed does not in fact have control over credit in an economy, since it is solely borrowers and lenders who influence credit, and that reserves have nothing to do with the amount of credit in an economy. For instance, the Fed only has a 10% RRR for household deposits, and does not have a RRR for corporate deposits. The amount of credit in an economy consists of the demand for loans by borrowers, and supply of loans that lenders are willing to lend, irrespective of reserves, end of story.
But while Keen is quick to chastise neoclassical economists (namely Krugman) for inadvertently proclaiming that their models reign supreme whereas they fail to incorporate substantive variables and therefore fail to reflect reality in the least, Keen offers no alternatives. My main issues with Keen and his (horrific) showing tonight, are as follows:
If he goal is to denounce macroeconomic models and their failure to account for real world phenomena, he should not be bringing microeconomic models and their assumptions into the equation. These are two separate issues. Since his attack is on economic models' failure to predict crises such as the one we have just/still are experiencing, his condemnation of microeconomic models is superfluous
If he wants to attack micro and/or macroeconomics and their models, then he cannot only point at neoclassical economics since he is raising an entirely different discussion, namely the discussion role of models in economics
To (1), Keen denounces the assumptions of perfect competition and utility maximization in the economics courses taught in universities today. This, I understand, is why he targets neoclassical economics, given its prevalence in economics programs globally. However, Mr. Keen acknowledged himself importance of the role of abstraction in his own "sect" of economics (whatever that is), but has decided that it is bad if the "neoclassical" tag slapped on it. If he is going to debase unrealistic models in economics, he has to address models across economics, not just within one realm (2).
Moreover, microeconomic models should not have been mentioned at all if he is discussing Dynamic Stochastic General Equilibrium (DSGE) models and their role in the macro economy. DSGE's do not account for many endogenous factors in the real world, such as regime shifts, and they make drastic assumptions such as intertemporal optimization, perfect information, a single representative agent, zero transaction costs, and no banking sector. These are the models that professionals relied on leading up to the crisis, so it is good that Keen is raising awareness of this fact and calling for newer and better models to guide policy. But this issue does not relate to an individual ideology or any individual such as Krugman; it relates to the question "what role should models play in economics?"
There are two answers to this question, none of which Keen addressed (or even seemed to think about addressing). One is that they should emulate the real world, and should be considered worthless if they do not contain information from the real world and do not describe what occurs in the real world. Ironically these proponents are called realists. The other side tends to believe that models do not need to contain real world information at all, but as long as they either a.) tell us about some factor that occurs in the real world or b.) lead to correct predictions, then the model will do just fine. Proponents of this camp are instrumentalists. Clearly Keen is just another realist, and he could have simply conceded to this and we could have moved onto bigger and better things.
In essence, the role of models in economics should have been the topic of discussion tonight and should be what Keen is out campaigning for. Instead of useful insights regarding how to fix the banking system, we got a campaign against neoclassical economics (yawn). He proposed no alternative models (except that he is building a model which emulates the real world in its entirety, named, you guessed it! Minsky), but he did offer some groundbreaking fiscal policy solutions!
His solution to global debt overhang is for governments to implement a "debt jubilee" whereby governments pay consumers (rather than banks) to either a.) pay their debts off or b.) if they don't have debts, use that cash to SPEND. Wait a minute, this guy who I thought was a neo-Hayekian superhero who finally toppled Krugman from his high-horse is proposing that government cut out a check to a.) people with high debt (i.e., less well-off individuals) so that they can pay down their debt, and b.) to individuals who DON'T have debt because they are wealthy enough that they don't need it. Excellent, now the poor are "less poor" and the rich have more cash to inflate our economy back to (wait for it) equilibrium. What an absurd "solution."
Finally, Keen has not even read into Austrian economics. He admitted not having done so because he is too focused on toppling neoclassical economics. How does he expect to do this with no viable replacement?
All said, Krugman is a boob. This is a quintessential example of how an "expert" in one facet of a profession is assumed to be infallible. Krugman won the prize for his trade theory and his theory of "new economic geography." I would assume the concept of banks are not mentioned once in his research. So he is not an expert in monetary policy, or the banking sector as a whole, and should not step into this foreign territory. Keen has demonstrated that this nobel-laureate, NYT-writing rockstar is as fallible Lindsay Lohan. But Keen should keep to what HE specializes in (i.e., Minsky), and focus his arguments in the right areas, before the whole profession of economics turns on him next.