11 Nov 2013

Krugman: Whether Potential GDP Is Up, Down, or Sideways, It’s More Evidence That I’m Right

DeLong, Federal Reserve, Inflation, Krugman 128 Comments

Krugman has made such a strategic error in his advocacy for monetary inflation that even his teammates had to rebuke him. But first some context: “Potential GDP” is a mainstream economics concept referring to the maximum sustainable level of (real) GDP. In the standard New Keynesian paradigm, if actual (real) GDP is above potential, you get accelerating price and wage inflation. Printing more money doesn’t do anything, except cause prices to rise more quickly. On the other hand, if actual GDP is below potential, then there is “slack” in the economy; boosting aggregate demand (through monetary and/or fiscal stimulus) will put people back to work and increase real output, without causing a significant rise in prices.

(#1)==> Now, over the last several years, various opponents of further Fed stimulus have been arguing that there is “structural” unemployment in the economy; further rounds of QE won’t lower the unemployment rate, since (say) there is a growing mismatch between idle workers’ skills and the type of job openings in the new global economy. Not surprisingly, Krugman has dismissed such pontifications as “humbug”–as recently as this August. Since there was no structural change to speak of, it proved that Krugman has been right all along in recommending more aggressive stimulus.

(#2)==> More generally, Brad DeLong and Paul Krugman have both argued that potential GDP today, is not significantly lower than what it would have been, had the Great Recession never struck. Readers may remember that in late August I had the temerity to question DeLong’s reasoning at the time. In response, Krugman sided with DeLong–agreeing that potential GDP today was not much lower than it would have been on the 2007 trajectory–and pointed out that the CBO took into account the lower pace of investment since 2008 (the specific issue I had raised). In the comments at Daniel Kuehn’s blog, DeLong called me a “clown” and said I needed to quit my job as an economist, since even rudimentary calculations showed that potential GDP right now was about 1% lower than its 2007 trajectory. DeLong further explained that if potential GDP today were, say, 5% lower, then that would indeed be something. (I tried to defend my honor by saying that the CBO showed potential GDP was about 3.6% below trend, but that’s just the sort of stupid thing a clown would say, isn’t it?)

Since potential GDP was not materially lower than the pre-recession trajectory, Krugman and DeLong were once again vindicated: We should heed their advice for more aggressive monetary and fiscal stimulus.

(#3)==> Last week, while attending an IMF research conference, Krugman wrote an op ed in which he discussed the “blockbuster paper of the conference” (his actual description of it). Here’s some of what Krugman had to say about that blockbuster paper:

[T]he authors — one of whom is the Federal Reserve Board’s director of research and statistics, so we’re not talking about obscure academics — put a number to these effects, and it’s terrifying. They suggest that economic weakness has already reduced America’s economic potential by around 7 percent, which means that it makes us poorer to the tune of more than $1 trillion a year. And we’re not talking about just one year’s losses, we’re talking about long-term damage: $1 trillion a year for multiple years.

That estimate is the end product of some complex data-crunching, and you can quibble with the details. Hey, maybe we’re only losing $800 billion a year. [Bold added.]

The part I put in bold was to emphasize (a) their estimate is for the drop in potential GDP that has already occurred, and (b) Krugman quibbled with their estimate and thought hey, maybe it’s only a 5.6% drop in potential GDP. (If a 7% drop is $1 trillion in output, then a 5.6% drop is $800 billion in output.)

Naturally, Krugman concluded that since the economic slump has already eroded potential GDP by anywhere from 5.6% to 7%, it’s evidence that we need to increase public (government) spending.

(Also, for those purists keeping score, I note that 5.6%, let alone 7%, are greater than DeLong’s threshold of 5%. But again, this is a clownish point, so I’ll move on.)

(#4)==> At that same IMF conference, Christina Romer and others apparently pointed out to Krugman that he had stepped in it, and just conceded the whole case to the austerians. Krugman realized the potential problem, and so clarified: We don’t know if that blockbuster paper is right in claiming that the drop in potential GDP is here already; for all we know, the damage has yet to be done. So by all means, put the pedal to the medal: We need more aggressive monetary and fiscal stimulus.

(#5)==> And so we see that whether potential GDP is relatively on trajectory, materially below, or on the verge of falling, the conclusion is always the same: It is evidence that we need aggressive monetary and fiscal stimulus. Also, be sure to watch out for ideologues like me, who invent rationales for my preferred policy prescription, no matter what the data say. You need to stick with objective scientists like DeLong and Krugman, who follow the evidence no matter where it may lead.

128 Responses to “Krugman: Whether Potential GDP Is Up, Down, or Sideways, It’s More Evidence That I’m Right”

  1. Gamble says:

    You know Bob, your blog and relentless Krugman focus has actually helped me not dislike Krugman as an individual.

    Krugman is ” The conscience of a liberal”.

    Krugman is simply giving us insight into their collective brain. This is how they all think. Maybe fluoride is bad.

    • Major_Freedom says:

      I always chuckle at how Krugman likes to accuse his ideological opponents of “moralizing.”

      Yet he doesn’t even seem to realize he is “moralizing” when he advocates that the government ought to do this or that, and that his ideological opponents ought to do this or that, both politically and methodogically.

      • Gamble says:

        I have analyzed the ” conscience of a liberal.” They say whatever they want whenever they want with their only goal being state expansion. They don’t care if it makes sense. They probably cant even tell the difference. ” Resistance is futile, you must assimilate.” The Borg

        What follows is a good book to give to the statist. The author theorizes the statist simply never got enough momma and desires the state take over where momma fell short. I gave this to a leftist lawyer during a deposition in which he was trying to punish/criminalize my anti-state political actions.. He blew a fuse, lol.

        The Liberal Mind: The Psychological Causes of Political Madness
        http://www.amazon.com/The-Liberal-Mind-Psychological-Political/dp/0977956318

        • Major_Freedom says:

          Thanks for that reference.

          One of the commenters summarizes the gist of the book:

          “Liberals [...] are projecting their childhood trauma upon the world of politics.”

          I’ve been saying that for a long time. Mommy and Daddy issues brought into adulthood and into politics. It’s almost certain that the “progressive” posters here have serious Mommy and Daddy issues.

          • Omar Benmegdoul says:

            This chain of comments makes me embarrassed to be a libertarian.

          • valueprax says:

            Almost everybody does. Including many libertarians. I think it’s something we should work together to overcome rather than trying to ignore it. You know, the whole “building the trust that’s necessary for a civilized society enjoying the benefits of the division of labor” kind of thing.

            But, it’s pretty hard to do and I doubt anyone will seriously take up the torch anytime soon. I tried a few times and found coping with my own issues by poking fun at everyone else trying to do the same to be much more satisfying. Mommy and Daddy made a mess of me!

  2. Gamble is an ass says:

    Thanks Bob for pointing out the inconsistences and contradictions into Krugman’s “logic” and positions. He doesn’t care if he’s being dishonest, inconsistent or logically wrong. And you’ve proved it time and again.

    Hopefully your posts will have educated some supports of the keynesian fallacies, and made those supporters at least question the integrity of krugman and his commentary.

    Keep up the excellent work :)

    And fingers crossed you’ll get a debate

    • Gamble is an ass is an ass says:

      Nice screen name.

      Lay off the fluoride and Mountain Dew.

      If we were physically sitting in the same room, at what point would you initiate violence towards me?

      • Gamble is an ass is an ass is an ass says:

        Nice screen name.

        Lay off the fluoride and Mountain Dew.

        If we were physically sitting in the same room, at what point would you initiate violence towards me?

      • Omar Benmegdoul says:

        If you’re going to engage with statists, don’t start by telling them that they’re not capable of reasoning like you are. Are you going to call them knaves and clowns next?

  3. Yancey Ward says:

    Well, in the Infinite Krugmans Hypothesis, all Krugmans are right.

  4. Major_Freedom says:

    Why is it that Krugman didn’t say that Reifschneider, Wascher and Wilcox are “clowns” who don’t understand how to do “rudimentary calculations” of potential real GDP? They are even more pessimistic than you were Murphy.

  5. Major_Freedom says:

    Are any of us surprised that the largest, most complex, most expensive government intervention in history has been accompanied by a massive decline in potential output?

    We have been saying for years that the increased “stimulus” and regulations would hamper economic recovery. We have been proven right (if this study is accurate) yet again.

  6. Innocent says:

    So, and forgive me if I am being foolish as again I am not as well versed in the basics of Economics as perhaps I ought to be, but I do think about things lol. Would not ‘Potential’ GDP be the difference be tween 100% efficiency + Full employment compared to where we are? But would not potential GDP then fluctuate based on what you were producing as well ( flowers versus hand guns ) and their relative values as marketable goods? So if everyone in the United States began farming potatoes ( I know not possible this is a thought experiment to understand ) would this not

    1 ) drive down the cost of potatoes lowering GDP
    2 ) Realize full ‘Potential GDP – assuming 100% efficiency
    3 ) not matter in the least as to actual wealth?

    This is why Economics bothers me so much… Especially when espoused by Krugman… Yes there is an employment gap, yes the economy is driven by consumer spending ( since everyone is a consumer why would it be otherwise ) but honestly the issue is one of structural micro-economic wealth creation in proper fundamental areas that are both short term and long term sustainable.

    I see what Krugman MEANS, heck what all Keynesian’s mean when they talk the way they do and dear goodness I would LOVE to believe that all the Government has to do is pump money into the economy and viola all the horrible woes to the system are gone. Everyone is at full employment and tax revenues hold steady and no one ever has to worry again. But I simply cannot see that not causing long term fundamental problems that would escalate due to ‘shoring up’ the economy built on eroding fundamentals… Again I am probably simply not seeing things correctly. Please if you wish to point me to education material or correct me yourself I would be the better for it.

    • Major_Freedom says:

      “Especially when espoused by Krugman… Yes there is an employment gap, yes the economy is driven by consumer spending ( since everyone is a consumer why would it be otherwise )”

      That’s incorrect. The fact that everyone is a consumer is not grounds for concluding consumer spending drives the economy.

      For imagine that everyone stopped investing entirely, and consumed 100% of their incomes. According to the “consumer spending drives the economy” maxim, this should generate maximum economic growth. But in reality economic output would collapse of course, since without investment, all the machines and factories and everything else that requires investment spending to sustain, would wear out. Everyone who is employed with wages would be laid off, since wage payments are financed out of saving, not consumption.

      So we’d be living in a world where everyone lost their job, and machines are wearing out. What kind of output do you think can be had here?

      What actually drives the economy is saving and investment. Maximum economic growth would be had if consumer spending were at the smallest possible minimum to sustain life, and investment spending (capital and labor) took the rest of all spending. The economy would explode in productivity.

      Consumption shrinks the economy. Production (which requires saving and investment) grows the economy.

      This is indisputible.

      • valueprax says:

        It is indisputable but the ultimate point of all saving and investment is consumption.

        So “consumption drives the productive process”, but not in the way the Keynesians mean.

        • Major_Freedom says:

          Consumption does not even drive the productive process in that interpretation either. For even then, one still cannot consume what is not first produced. In order to consume more, there has to be more produced.

          Yes, the ultimate goal of saving and investment is consumption, but that doesn’t mean consumption is a driver. A “driver” is antecedent to the goal. One drives towards the goal. The goal is not the driver. It is the finish line.

          • valueprax says:

            Okay MF I think we’re talking past each other here because I didn’t say or try to imply that one can consume without first producing.

            But rather, my point is that what people want to consume determines what people produce.

            If I want to consume an apple and I can’t trade for it, then my desire to consume an apple drives my production of an apple.

            If I want to consume an apple and I can trade for it, then my desire to consume an apple drives the production of an apple by someone else, and in return what hey want to consume drives my decision to produce that.

            But if you don’t like the word drive here that’s okay. I think the two points were making can stand independent of that particular word.

            • Major_Freedom says:

              “But rather, my point is that what people want to consume determines what people produce.”

              Oh, well, if you put it that way, then we agree. Consumption determines the direction of existing resources devoted to production.

              My argument though is about consumption as such and production as such. Sorry for not being more clear.

              The way I think about it is that at the individual producer and consumer level, production is very much dependent on consumption. If it weren’t for McDonald customers, McDonald’s would not exist. McDonald’s competes with other producers for the money of food buying customers. This is what most people have in mind when they think of the economy in general. It is what most Keynesians have in mind.

              But when the context is the economy as a whole, then the individual producer vis a vis individual producer competition offsets, and consumption as such depends on production as such.

              I understand now the point you were making. But when I see the word “consumption” without qualification, out of habit I understand that to be universal consumption, the economy as a whole conception of consumption.

              “If I want to consume an apple and I can’t trade for it, then my desire to consume an apple drives my production of an apple.”

              Agreed. But did your desire for apples serve as the driver for whether or not you consumed anything? You will have to produce something if you want to consume something. But if you want to consume apples specifically, then that will determine you producing apples specifically.

              We agree.

              “If I want to consume an apple and I can trade for it, then my desire to consume an apple drives the production of an apple by someone else, and in return what hey want to consume drives my decision to produce that.
              But if you don’t like the word drive here that’s okay. I think the two points were making can stand independent of that particular word.”

              Agreed. I will even venture to say that yes, your desire for apples can be understood as “driving” your production of apples.

              But when the context is the economy as a whole, where people must consume something to stay alive and be happy, then it’s not what people want to specifically consume that drives production, but rather, it is production as such that drives consumption as such.

              It can be difficult to explain…depending on how alert I am.

              • lwaaks says:

                I think George Reisman does a good job of explaining the difference between “consumptionism” and “productionism” in the most lucid, logical way in his book Capitalism, pp. 694ff. (free online).

          • valueprax says:

            MF,

            Yeah, got ya.

            FYI, this is fresh in my mind because I am leading a discussion group on the book, so I think I had this passage in mind specifically when I said what I said… now I wouldn’t want to pull an LK and argue from authority, Mises could be wrong, but I offer it as evidence that it wasn’t a totally zany way of thinking I came up with all on my own:

            The farmer who lives self-sufficiently outside exchange society can call his fields, his plough, his draught animals his own, in the sense that they serve only him. But the farmer whose enterprise is concerned with trade, who produces for and buys in the market, is owner of the means of production in quite a different sense. He does not control production as the self-supporting peasant does. He does not decide the purpose of his production; those for whom he works decide it—the consumers. They, not the producer, determine the goal of economic activity. The producer only directs production towards the goal set by the consumers.
            From here: http://mises.org/books/socialism/part1_ch.1.aspx

            So, I had said “drives” which was contentious language, Mises talks more about “goals” as you mentioned. Anyway, not trying to further the debate because there isn’t one at this point, just sharing what made me think of it in the event it interests others.

          • Tel says:

            For even then, one still cannot consume what is not first produced.

            That’s true only for the physical world, not true for the accounting world.

            For example, I can pay you to cut my hair next week. From an accounting perspective I’ve paid now so the transaction happens now. You might take that money and go and buy a pair of scissors or something. Next week when you “deliver” the haircut, that’s merely a delivery docket, not a real transaction.

            This may sound like a stupidly contrived example, but some of the “crowd funding” and other business bootstrap concepts are very similar to this.

            • valueprax says:

              Tel,

              Can you purchase (consume) a pair of scissors, like in your example, if they haven’t been produced first?

              Let me answer that for you: no, you can not.

              I got into this horse-excrement with Cullen Roche on his blog when he went off on the idea that investment can precede savings (which is the same argument in principle as consumption preceding production). If you’re interested in what that looks like, see here: http://pragcap.com/qe-and-the-epic-credit-bubble/comment-page-1#comment-155795

              But the salient point is this: even with your accounting principle you only make a point by pushing the exchange of real resources out of the picture into a separate transaction or time period.

              There has to be pre-existing real goods the haircutter can exchange your dollars for or else he wouldn’t accept them in exchange.

              To see why your point fails, just imagine everyone trading IOUs and only IOUs. So, you give an IOU to the haircutter, he trades your IOU to a scissorIOUer who issues you one of those, then he takes the IOU he received and gives it to the IOUbaker, etc. What is the value of this exchange if there isn’t any actual haircuts, scissors, bread, etc, ever?

              To actually consume the goods being exchanged via IOU, eventually someone has to produce them or else all the people in question grow fros/can’t cut things/have no bread/etc.

    • skylien says:

      “I see what Krugman MEANS, heck what all Keynesian’s mean when they talk the way they do and dear goodness I would LOVE to believe that all the Government has to do is pump money into the economy and viola all the horrible woes to the system are gone. Everyone is at full employment and tax revenues hold steady and no one ever has to worry again. But I simply cannot see that not causing long term fundamental problems that would escalate due to ‘shoring up’ the economy built on eroding fundamentals… Again I am probably simply not seeing things correctly. Please if you wish to point me to education material or correct me yourself I would be the better for it.”

      I asked the same question X times as well. It amazes me that they obviously do believe in the market to allocate resources, do believe in the subjective value theory (So far I have not one of them seen to dare deny those things) and at the same time think their policies don’t significantly disturb this market processes. They don’t try to answer it, or even mention this point. As if those things have absolutely nothing to do with each other. I only got ignored. And so will you… The only thing you can do is read Keynes, Hicks, Samuelsson maybe someone else. But if you are finished with it and your questions still aren’t answered…well then obviously how do you expect to get an answer on internet blogs which isn’t even in any of those books? Of course theoretically you can switch the argument around and say: If no one can answer me this on internet blogs or even can point me to a book and chapter that explains this or at least deals with this, then there probably is no such book and chapter answering this. So it is probably a waste of time to read them. However if you want to be sure you need to read them.

      I’ll start with Hicks soon.

  7. Daniel Kuehn says:

    My recollection was that Bob’s post way back when struck a lot of us as weird because (1.) he seemed to think it was an Austrian idea that potential GDP could go down, and (2.) they were citing statistics that took the decline of potential GDP into account when Bob was criticizing them! So it was a classic case of Bob overreach.

    On this one, I’m sure a lot of people would have their preconceptions dashed by this. I suppose Krugman, perhaps. I’m not sure what to think of the numbers.

    But here’s another thing to consider – if an AD slump could cause a fall in potential GDP, couldn’t and AD boost restore that potential? I mean, we think potential GDP is down (whether it’s down a little bit or a lot) because of the problems with investment over the last several years. So you restore potential GDP by… investing, right? Am I missing something?

    This is not meant to be a “heads I’m right/tails you’re wrong” comment.

    I just don’t see this as a major deciding issue.

    • skylien says:

      As far as I see it, the most important thing for you guys are the unemployment numbers. As long as unemployment is high and inflation isn’t through the roof you will argue for pushing AD, wouldn’t you? I mean high unemployment by definition means you could produce more of whatever..

      • Lord Keynes says:

        ” if an AD slump could cause a fall in potential GDP, couldn’t and AD boost restore that potential? I mean, we think potential GDP is down (whether it’s down a little bit or a lot) because of the problems with investment over the last several years. So you restore potential GDP by… investing, right?”

        Right. In fact, it is an obvious answer here.

        The unwillingness to drive aggregate demand to the level necessary to restore full employment is likely to damage the real capital structure as

        (1) failing business go bankrupt and their capital goods are sold, scraped or whatever and

        (2) pessimistic ones simply do not invest in new plant or invest in current plant.

        To increase AD will do the opposite, not only to increase real GDP but medium/long term potential GDP too.

        • valueprax says:

          “pessimistic ones simply do not invest in new plant or invest in current plant.”

          Yes, but which ones?

        • Bob Roddis says:

          Never forget that “increasing AD” is nothing more than a temporary theft of purchasing power allegedly directed to “the masses” which, because it is nothing but a temporary subsidy, will be unsustainable. Further, such policy will increase the price distortions that need to be undone in order to have intelligent and sustainable economic activity.

          • Lord Keynes says:

            Oh yes, those mythical price distortions in an economy where most prices are administered fixprices that do NOT normally change when demand changes. Tell us another fable.

            Even the inflation happening in flexprice markets would also happen if a private boom (without government fiscal or monetary policy) increased AD.

            So is “increasing AD” in a purely private sector boom “nothing more than a temporary theft of purchasing power allegedly directed to “the masses” which, because it is nothing but a temporary subsidy, will be unsustainable”??

            Apart from the fact that roddis is now back to logically needing to ban all forms of credit money (suggesting he’s an “evil” hater of capitalism and freedom), his observation that booms end is just a real herring.

            Real output goes upwards in the long term, so the whole idea that somehow booms never increase real per capita output growth in the long run is rubbish.

            • Lord Keynes says:

              correction:
              red herring”

              • Bob Roddis says:

                If these prices are so “administered”, how come nobody is buying?

              • Bob Roddis says:

                Big firm says: We are Gods. We “administer” our prices however we damn well please!

                Customer says: Screw you. I’m not buying any of your crap.

                Big Firm says: OMG. No one will buy our stuff!

                Lord Keynes says: We need the government to increase “aggregate demand” to facilitate more buying.

                I GET IT. I FINALLY GET IT!

              • Bob Roddis says:

                Oh yes, those mythical price distortions

                You know. Those unsustainable prices that induced the manufacture of all the junk that suddenly wouldn’t sell at the prior “administered” prices.

              • Lord Keynes says:

                Another worthless straw man.

                The argument is not that nobody is buying administered price consumer goods. (!!)

                It is that there is insufficient investment and demand for final output. Demand for final output drives investment in administered price businesses. Increase demand and you increase investment. The US government can also engage in public investments to increase demand.

              • Bob Roddis says:

                Why would anyone make stuff with the intent to make a profit to sell at “administered” prices at which there are no buyers?

                If there are no buyers, how can the prices have been “administered” or “set”.

              • Major_Freedom says:

                LK:

                “It is that there is insufficient investment and demand for final output. Demand for final output drives investment in administered price businesses. Increase demand and you increase investment.”

                False. Final goods spending is always in competition with saving and investment. A dollar can only be spent one way. If it is spent on final output, it is not being spent on input. Investment cannot rise unless that dollar is NOT spent on final output, but on investment and labor instead.

                Your error is that you conflate final goods spending as automatically bringing about investment spending. That is not true. If total final goods spending rises, then investment spending must fall, ceteris paribus.

                Aggregate demand is never “insufficient.” Ever. When there is a decline in aggregate investment, it is not because there is a decline in aggregate demand. The fall in aggregate demand is a consequence of a fall in investment. Wage payments and capital goods spending declines, and that reduces the funds available to purchase final product thereafter.

                As usual you have reality backwards.

              • Bob Roddis says:

                And don’t forget the law:of the universe: Your supply of stuff is what you can use to “demand” other stuff from other people.

                Exchange, exchange, exchange.

              • Lord Keynes says:

                “That is not true. If total final goods spending rises, then investment spending must fall, ceteris paribus.”

                Only in a completely worthless model unrelated to the real world.

                Meanwhile in the real world, consumption and investment increase simultaneously all the time.

              • Major_Freedom says:

                LK:

                “Only in a completely worthless model unrelated to the real world.”

                No, that’s a necessity. It’s not a hypothetical model. It is true by nature of how money is spent.

                It’s clear you don’t know what you’re talking about.

                “Meanwhile in the real world, consumption and investment increase simultaneously all the time.”

                Most consumption spending in a modern economy arises from saving and investment.

                Capital goods sellers and labor sellers who spend money on consumer goods, depend on money that is saved an invested which goes to their incomes.

                In an ongoing context, that is, in a context where saving and investment occur, and then consumption, and then saving and investment once again, yes, it appears that consumption spending and investment spending occur simultaneously. But you’re confused if you believe this means there is no order.

                According to your logic, if we turn on a water faucet into a bathtub, then after a few moments it will appear as though water is falling from the faucet and rising in the bathtub simultaneously. While that is true, it does not tell the whole story, which is that water must first come from the faucet before the water level in the bathtub can rise. There is still an order there that your garbage worldview would fail to discern.

              • Major_Freedom says:

                In other words, if there is consumption spending and investment spending taking place simultaneously, then it is still true that the consumption spending is being made on goods already produced, which implies saving and investment prior.

              • Lord Keynes says:

                Virtually all this garbage falls apart simply when one looks at empirical studies of why businesses increased investment: they say it was because demand for the product increased:

                Firms told the Bank’s officers that they await strengthening of demand before they improve capacity. Almost the same proportion as in the summer survey (35% vs 34%) said they expected to increase their investments in machinery and equipment, while 67% said they would invest at the same or lower paces.

                https://mninews.marketnews.com/index.php/boc-canada-biz-confidence-recedes-more-re-domesticus-demand-0?q=content/boc-canada-biz-confidence-recedes-more-re-domesticus-demand-0

              • Bob Roddis says:

                Rich western executives announced today that they would not be selling (as had been previously announced) advanced billion dollar computer systems to a newfound colony of aborigines who have no clothes, tools or housing and dig grubs out of the ground to eat.

                I guess that shows dumb old MF all about the primacy of “demand”, doesn’t it?

              • Major_Freedom says:

                LK:

                “Virtually all this garbage falls apart simply when one looks at empirical studies of why businesses increased investment: they say it was because demand for the product increased:

                “Firms told the Bank’s officers that they await strengthening of demand before they improve capacity”

                When the context is individual firms, yes, this is what individual firms do. They invest based on expected demand.

                But this does NOT imply that aggregate investment can rise on the basis of an increase in aggregate demand.

                You’re committing the fallacy of composition you numbskull.

                In the economy as a whole, it is NOT true that aggregate investment is boosted by aggregate demand. In the economy as a whole, if aggregate demand increases, then ceteris paribus aggregate demand must fall, since you can only do one thing with a dollar.

                Your silly response prior about investment and consumption taking place “simultaneously” was already addressed, and you did not respond to it, so I’ll take it as a concession.

        • Bob Roddis says:

          And as we have discussed so many many times before (to no avail), why is a set of sales and price data regarding a prior episode that was unsustainable be the source of a “trend line” in any event?

          • Lord Keynes says:

            It’s the real output that real GDP measures since it is inflation adjusted. And potential GDP is what the real capital stock of an economy could produce if demand was high enough.

            Alas, these basic economic concepts are beyond you — just like the concept of a market clearing price.

            • Matt Tanous says:

              “potential GDP is what the real capital stock of an economy could produce if demand was high enough.”

              AD = GDP. Potential GDP is what could be produced if GDP was high enough? And then people wonder why Keynesian theory makes no sense. GDP is deemed a function OF ITSELF!

              • Gamble says:

                Oh my Matt,

                I think you have solved Rubik’s Cube.

                These people are always trying to artificially stimulate humanity to a theoretical max GDP.

                These sheep dogs really need to stop nipping at my ankles. I have had enough. It appears to me, most people, have had enough.

                Where did these busy bodies come from, another universe. Are they aliens? Maybe The Krugman Borg (“liberal conscience”), is on a first name basis with little green space aliens? Oh that’s right, Borg do not have names nor individual identity.

                http://www.youtube.com/watch?feature=player_embedded&v=PHpa2Fu1mrQ

            • Gamble is an ass is an ass is an ass says:

              LK, you don’t understand the Austrian conception of market clearing prices. How can you possibly lecture anyone on it? You’re clueless.

        • marris says:

          My understanding is that there is a distinction between changes in equilibrium AS quantity and shifts in the AS curve.

          The things you describe (plant closings, etc) can be classified as “finding a new equilibrium point, due to an AD shift.”

          Potential GDP changes would be shifts in the AS curve itself (due to tech changes, skills atrophy, etc).

          Sorry New-Keynesians, but you can’t have it ALL ways.

    • Bob Murphy says:

      Daniel do you agree with the following two propositions?

      (1) As late as late August, Krugman and DeLong argued that potential GDP was only about 1% below trend. In contrast, actual GDP was much lower than that (closer to 5.5% below trend, according to DeLong). Since actual GDP was down 5.5%, and potential GDP was down only about 1%, it showed that there was plenty of scope for more stimulus.

      (2) Last week Krugman said that a blockbuster paper showed that potential GDP was down by 7%. He cited that as further evidence that we need more stimulus.

      You don’t see any problem here? Can you at least get inside my “gotcha” head and see why there appears to be a contradiction?

      • Ken B says:

        My blood pressure was high (I was reading Bob call critics trolls that day perhaps) so the doctor put me on one pill. Then a few weeks later it was still high so he put me on two pills. Crazy huh?

        Now of course the second pill could be wrong, and there could be something else going on unaddressed by conventional BP meds. Which is why we tracked by BP for a while. But it’s hardly fair to suggest my doctor is an inconsistent quack for upping the dose on a commonly accepted remedy as a first step.

        • valueprax says:

          I see what you did here, Ken B.

          In your example, blood pressure meds not only are commonly accepted as a valid remedy, they are (in this example) an actually viable antidote to the problem at hand.

          But with the economy, not only is the validity of the remedy in dispute, it also isn’t (in this example) actually viable as an antidote.

          So yeah, it’d be quackish to call for it no matter what.

          • Ken B says:

            I am not arguing Krugman is right, as I don’t sport stimulus. I am pointing out that “more of the same! More! More!” May be wrong but it’s not inherently contradictory or crazy. The two facts Bob cites to Daniel seem to fit that analogy.

        • valueprax says:

          (Please note, I said “In this example” in reference to the viability of BP meds because I don’t actually think that’s an appropriate recourse for the symptoms mentioned… but then that would put me on the fringe of medicine in so saying. Anyway, the point was not to focus on my crank medical views and instead focus on the crank analogizing you were attempting.)

        • Bob Murphy says:

          No no no Ken B. Here you are totally mixed up.

          Back in August, DeLong and Krugman weren’t saying that we needed stimulus because potential GDP was down by 1%, and so the stimulus would help get it back up. No no no, the exact opposite: If potential GDP had been down 0%, their case would be stronger. DeLong was saying it wasn’t down that much–only a mere 1%–and so that’s why there was room for stimulus.

          Often you get the big picture, and focus on what I think is some minor quibble, but here you are totally mixed up. You don’t even understand the original argument.

          They are trying to boost ACTUAL gdp up to the ceiling provided by POTENTIAL gdp. So if the ceiling itself has fallen 7%, then their whole case collapses. DeLong back in August said ACTUAL gdp was about 5.5% below trend. So if the ceiling is down 7%, then their whole case collapses–at least their case as they’ve presented it from 2008 through August 2013.

          If they want to switch cases and now argue that we need to boost POTENTIAL gdp by increasing government spending–as Daniel and Lord Keynes are saying in this post–OK fine, but that is 180 degrees opposite what they were doing rhetorically as of late August.

          • Ken B says:

            Yes, I misread it as actual in each clause. So in my analogy that would be like him saying I was high for my age and then after learning the recommended level rose prescribing more. So my analogy is indeed backwards.

          • Lord Keynes says:

            “They are trying to boost ACTUAL gdp up to the ceiling provided by POTENTIAL gdp. So if the ceiling itself has fallen 7%, then their whole case collapses.”

            No, it doesn’t. Krugman would also think that potential GDP can be lifted as the private sector engages in more investment and expansion of plant and production facilities. Also, you ignore how productivity growth can boost potenial GDP.

            The increasing use of automation is a factor that will also boost potential GDP.

            • Major_Freedom says:

              “Krugman would also think that potential GDP can be lifted as the private sector engages in more investment and expansion of plant and production facilities.”

              That isn’t what Krugman is calling for when he calls for more government spending. He is calling for more spending on final goods, brought about by government inflation. Government spending is not private investment.

              If potential GDP has fallen 7%, it cannot be raised in the way you describe. In fact, it is precisely because of government inflation, spending, and regulation since 2009 that the potential output collapsed the way it did.

              If there was instead a scorched Earth laissez-faire policy, where individuals constrained to market activity were free to fix any and all problems, then we would not be at such a lower potential output right now. We would have recovered and brought about a healthy, sustainable economy.

              We are lagging because of the high levels of stimulus.

      • Steve J says:

        The 7% decrease in potential GDP cannot be correct. If it were true we would already be running above potential and QE3 would result in inflation. Krugman needs to explain the discrepancy in these numbers and how the “blockbuster” paper got it so wrong.

        • Major_Freedom says:

          We do have inflation.

          • Steve J says:

            Where?

            • peter says:

              DJIA, for one, assuming you mean price inflation.
              You’re asking the same question that people were asking in the late 1920′s. Why, we have no inflation, look, prices of butter and eggs are all down! Meanwhile, back on Wall Street, the bubble got bigger and bigger ….

              • Steve J says:

                I think you are right. But I also think my point still stands. If the economy was running at potential the combination of very low interest rates and QE would show up in CPI.

              • Bob Murphy says:

                I definitely agree that KRUGMAN has no business saying potential GDP is down from 5% – 7%. As I pointed out in the OP, that’s precisely why he and DeLong bit my head off back in late August; they both were arguing that it was down just a pittance (DeLong specifically said about 1%).

                So it’s hilarious that Krugman now flips and says matter-of-factly it’s down 5% – 7%, when he thinks that argument helps his cause, not realizing he just slit his own throat. (Which he quickly revised, once Romer et al. pointed out the problem.)

              • Mike T says:

                Steve J -

                “If the economy was running at potential the combination of very low interest rates and QE would show up in CPI.”

                >> Did it show up in the CPI at any point during the 2000′s?

              • Peter says:

                Steve –
                Only if CPI was an honest measure of (price) inflation. Remember that certain commodity prices are not included because they are “volatile”. Of course a more cynical person (not me, Lord no…) would say that it’s because commodities are more sensitive to money printing.
                Me, I prefer the Big Mac index.
                http://shadesofthomaspaine.blogexec.com/images/easyblog_images/368/Big-Mac-2.2.png

              • Steve J says:

                Mike – I see your point but keep in mind things are a little different now than they were in the 2000s.

                http://research.stlouisfed.org/fred2/series/BASE/

            • Major_Freedom says:

              Virtually everywhere.

              CPI:

              http://research.stlouisfed.org/fredgraph.png?g=oo5

              S&P500:

              http://research.stlouisfed.org/fredgraph.png?g=oo6

              Price inflation is positive.

    • Matt Tanous says:

      AD is just nominal GDP. So, no, this is nonsense – unless GDP and potential GDP are basically the same thing.

      And since AD is defined by Keynesian theory as simply GDP, with GDP the (absurd) measure of an economy’s growth and size, the whole theory almost resolves to a tautology. The solution to unemployment is to grow GDP. Doesn’t matter what for – just grow it. Really, the fastest way to do that is start a war – war equipment and weaponry is expensive, after all.

      Those of us that don’t view GDP as a useful metric of anything will look on in wonder as Keynesians actually follow their theory for once and start WWIII.

    • Jonathan Finegold says:

      Isn’t potential GDP determined mostly by supply-side factors?

    • Ken P says:

      Daniel, I don’t think an AD slump caused the job losses. It was a bunch of particular demand drops that caused it. Increasing AD is not going to open up jobs for unemployed HELOC specialists. Many workers are looking at 50% pay cuts or more because they acquired skills for jobs to support artificial demand. For those companies that were collateral damage, restructuring was a common approach. Most of the jobs they cut are not coming back at any level of demand.

    • Yancey Ward says:

      Daniel,

      Now it sounds like you are creating a new metric- Potential Potential GDP.

  8. Tel says:

    Maybe Austrians should start publishing a chart of “Potential Employment” that is the difference between our current system and a free market system.

    I mean, no one else is taking this seriously.

  9. Bob Roddis says:

    But but but…..

    If potential GDP is so much lower now than in 2007, more “stimulus” now will only cause horrific inflation because “the gap” between actual GDP and the now much lower GDP is small or non-existent.

    What a horrible mess and paradox these Austerians have inflicted upon us!

  10. marris says:

    well played sir

  11. Bala says:

    While I do understand and appreciate Bob’s efforts at trying to engage the whatever-Keynesians on their own terms and proving them wrong, I don’t see it helping. This is just one more example. Krugman will slither out unscathed by just ignoring the incident and pretending that the criticism was never hurled at him. To him, Murphy is non-existent for now. The fundamental problem is with the construct that they have gotten the masses to accept as legitimate. I for one don’t see how significant success against the dominant Keynesian paradigm can be achieved until the masses realise that the concept of GDP is nothing more than wool pulled over their eyes to prevent them from seeing the truth.

    The masses need to understand that GDP is an anti-concept designed to destroy all real economic concepts. They need to learn that it is a completely nonsensical number that tells us nothing meaningful about an economy. They need to realise that its sole purpose is to provide intellectual fig-leaf cover for intervention, intervention and more intervention. They need to see that it’s as slippery as it gets. The more the adjectives you add to it, i.e., potential, real, nominal, etc., the more slippery it gets and the more wiggle room its proponents and acceptors get to slime out of every corner they pain themselves into.

    • Bob Roddis says:

      The public does not even understand that inflation is not a mysterious, inexplicable force of nature but a purposeful government program to steal purchasing power. People are not going to be able to understand more advance concepts unless and until they grasp the basics.

      • Major_Freedom says:

        Kind of difficult to do when most of the people grew up educated in government schools.

        • Bala says:

          Difficult – Yes.

          Impossible – No.

          Most of us grew up educated in government schools or schools whose curriculum is controlled by government, didn’t we?

          • Major_Freedom says:

            I don’t want to sound elitist, but the probability of what you describe is rare.

            • Bala says:

              I don’t see your response as elitist. I also agree with you that the chances of that happening, at least in my lifetime, are remote.

              However, I also believe that the chances of success in the attempt at beating the interventionists on their own terms are even slimmer. Your target will keep moving and reinventing itself. I also believe that education is possible and will work, though in the long-term over a couple of generations.

      • Steve J says:

        Bob so would you prefer deflation to inflation? Deflation is generally considered a very bad thing. Yet here you seem to imply you would prefer it.

        • Major_Freedom says:

          Prices falling on the basis of productivity does not reduce profitability or make debts harder to pay back.

          Think of selling twice the number of goods for half the prices. Revenues are unchanged.

          When you say deflation is “generally considered a bad thing”, you’re really only talking about either people who don’t understand deflation, or you’re talking about a decline in the supply of money and volume of spending, which does reduce profitability.

          • Steve J says:

            Due to productivity increases I agree. Due to a recession not so much.

            • Bala says:

              You should first ask yourself what caused the recession. If it was the prior inflation, would that convince you?

        • Bala says:

          Actually, your question is incorrect. You should be asking whether Bob prefers he prefers a free market in money even if it means steadily falling prices or an interventionist monetary system given that it implies inflation and a consequent steady rise in prices. As MF said, falling prices is not necessarily a bad outcome. I would be glad to see my money get me more.

          • Steve J says:

            Ah change the subject, a good way to avoid the real issue. You are not going to convince me that we should favor deflation over inflation. We have inflation targeting to avoid deflation. There is no government desire to “steal purchasing power”.

            • Bala says:

              It’s not changing the topic. The simple point is deflation that happens on a free market is a good thing while inflation that happens in an interventionist economy is a bad thing. I am not interested in convincing someone who does not want to be convinced and wants to continue believing what he wants to believe.

              • Steve J says:

                Well when you come back to the reality of central banking you can let us know.

              • Bala says:

                Oh! Someone who talks of an interventionist economy is not talking in the context of modern central banking, is he?

              • Steve J says:

                Major Freedom – just wanted to let you know I read your comment and appreciate you trying to explain that to me. My belief is that if prices in general decreased rather than increased this would require a huge change in economic thinking. For example wouldn’t the idea of loans either go away or be massively different (maybe negative interest rates)? Would anyone even consider buying assets that don’t appreciate? It is somewhat hard to imagine a deflationary world. That doesn’t prove deflation is bad but more just says remember how big a change living in a deflationary world would be.

            • Rick Hull says:

              > *There is no government desire to “steal purchasing power”.*

              I’ve got a bridge to sell you. Would you agree that at least half of Congress would love to raise taxes on the population? Would that not steal purchasing powers from the tax base?

              • Steve J says:

                Wow you guys like to change the subject. Remember it is whether we should prefer inflation or deflation. Was just looking back at some of Mr. Murphy’s posts on inflation predictions back when this all started. Pretty funny reading.

              • Rick Hull says:

                I’m not the one who denied that the government desires to steal purchasing power. I literally quoted your statement, challenged it, and I guess you don’t have a response.

                And *I’m* the one changing the subject?

                If you can acknowledge that the government would like nothing more than to steal purchasing power, we can continue this convo.

              • Steve J says:

                I will agree the government is trying to steal from us in a variety of ways. My opinion is inflation is not one of them. My preference for inflation is due to my dislike of sloth. Money at rest should not increase in value.

              • Major_Freedom says:

                Steve J:

                The whole point for why the government would want to coerce everyone else into taking control of the monetary system, is precisely because they cannot acquire as much ill-gotten purchasing through taxation alone, as compared to if they can print their own money.

                Surely you do not dent the human tendency of greed, which when combined with anti-rational, anti-market ideology results in power of some over others?

                “My preference for inflation is due to my dislike of sloth. Money at rest should not increase in value.”

                So that’s why you believe the government cannot be taking from us in the form of inflation. It is because you want inflation yourself. After all, what you want can’t possibly be the same exact thing that the government wants to take from us, right? Obviously what you want cannot be deceitful or coercive.

                News flash: There is no exploitation in a free market. If prices are falling, and people holding their money enables them to buy more in the future than today, simply by waiting, does not come at the expense of anyone else, for EVERYONE in the division of labor would be earning the same real purchasing power return on their cash. This is not exploitative even if you tried to define it in terms of “inequality”.

                And what’s more, sloth will not pay off. For in order for anyone to earn a real return on cash, guess what? They’re going to have to EARN money. You can’t earn a real return if you don’t earn money.

                Finally, you should clue into the fact that if you believe inflation reverses “gains from sloth”, then inflation won’t eliminate productivity gains. Inflation would simply TRANSFER the gains from those who receive the new money last, to those who receive the new money first, and it would have nothing to do with earning money versus not earning money.

                Sloth will not be paid in a free market. The real gains you are imagining from falling prices and cash holding is an argument stripped away from the full story. You’re only focusing on the after effects of earning money, and you’re ignoring the prior earning of money.

                Actually, this is the final point:

                Someone who earns money, and just sits on their cash, for years on end, are actually BENEFITTING others. For think of the real production and exchanges. What happens in real terms when someone earns money but doesn’t spend it? They produce for other people’s benefit without consuming anything themselves! It’s the height of selfless action. Producing for others and not consuming for yourself. That is the equivalent of working for money but not spending it.

                And no, you can’t argue that the above is fine, but that the “actual” problem is when they finally do consume, for then they would consume more than they otherwise would if they had spent the money immediately. There is no sloth derived gains here either. The trade-off is producing for others without consuming for a period of time. That means more goods for others for that period of time. That means the cash hoarder is enabling others to consume more NOW than they otherwise would have consumed NOW, had the cash hoarder spent the money right away. So the “payoff” to the cash hoarder is LESS consumption NOW, and MORE consumption LATER.

              • Steve J says:

                Major Freedom – looks like I hit the wrong reply button. Please see response above.

            • skylien says:

              Right, only Kings did that. Today politicians have of course no desire to buy any votes by promising candy for all voters…

              • skylien says:

                That is directed at Steve’s

                “There is no government desire to “steal purchasing power”.”

            • Peter says:

              The common argument against deflation is that it causes people to postpone purchases, as they try to anticipate lower prices. This according to the AD types is “bad” and causes a death spiral. This has been thoroughly debunked by the fact that the public is still buying computers, cell phones, TV’s and all sort of other stuff. Plus, it never computed with me that people would stop eating, heating their homes, etc. because these activities may get cheaper in the future. Even if it were true, it would mean more savings and thus more investment, and thus more prosperity down the road.

              So no, give me deflation, especially the kind that results from productivity increases. Let’s stop the banks from skimming our hard earned productivity increases.

        • Bob Roddis says:

          There’s “inflation” in the stock market. There’s “inflation” in all of those financial assets that have been pumped up since their collapse in 2008-09.

          I prefer non-distorted prices. If you don’t know what that means, I no longer have the energy to start explaining Austrian concepts at the very beginning.

          • Steve J says:

            I worry I agree with you on where the inflation went. And I understand a preference for non-distorted prices. Let’s just say I think Mr. Murphy has a genuine gotcha here and got sidetracked by the remark about inflation.

            • Tel says:

              Try a chart of electricity prices.

              Have a look at healthcare costs.

              Or most transport costs, public transport tickets, etc.

              http://inflationdata.com/inflation/inflation_articles/Education_Inflation.asp

              Yeah, also education expenses.

              I might also point out that the USA has leveraged it’s international position to be able to export inflation into Asia. Something the Chinese brought onto themselves in a way by buying all those bonds, but gradually the Chinese are getting their act together to change this situation.

    • pater tenebrarum says:

      In this context, one must never forget to stress that A) economic theory cannot be proved or disproved with the help of ‘statistics’, which only describe specific historical situations, and that B) the aggregates used in much of today’s macro-economic theorizing don’t make much sense in the first place (GDP is a prime example actually), as they obscure more than they reveal.
      I can understand why Bob Murphy often does cite empirical data and disagreements involving empirical studies, since presumably more and more economists and laymen alike are these days peering over the fence into the Austrian camp so to speak, and they are used to these lines of argument. Still, in this debate over ‘output gaps’ it couldn’t hurt to briefly discuss what the problems with the notion as such are and why the ‘data’ actually do not constitute ‘incontrovertible evidence’ for anything.

      • Bala says:

        My point is that the proper response to any claim of output gap is to point out that it is nonsense upon stilts since the concept on which it is based, i.e., the concept of GDP as a measure of output, is nonsense. Why waste any more time than what it takes to do that?

        • Gamble says:

          Bala,

          With your shortest sentence possible, explain why GDP is not a measurement.

          • Major_Freedom says:

            I think he said it was nonsense, not that it isn’t a measurement.

          • Bala says:

            MF put it correctly. It is a measurement but nonsense.

            It is nonsense because it ignores the heart of a capitalist economy – Gross savings of capitalists.

            • Major_Freedom says:

              It is also nonsense because it measures total spending, which of course isn’t a measure of real output. Not even inflation indexes can turn it into something representative.

              It also includes government spending. If the government spent $1 trillion on weapons of war, GDP would go up. It’s sickening.

              • Bala says:

                I agree. I put myself under the constraint of the shortest sentence possible.

            • Gamble says:

              So GDP measures the amount of nonsense ?

    • Gamble says:

      Why did American Federal government ever hire this boob in the first place? I think it was a small part of the 1913 revolution…

      http://en.wikipedia.org/wiki/Simon_Kuznets

      • Gamble says:

        I posted the above in response to Bala. Bala great post btw!

        Bala said:
        While I do understand and appreciate Bob’s efforts at trying to engage the whatever-Keynesians on their own terms and proving them wrong, I don’t see it helping. This is just one more example. Krugman will slither out unscathed by just ignoring the incident and pretending that the criticism was never hurled at him. To him, Murphy is non-existent for now. The fundamental problem is with the construct that they have gotten the masses to accept as legitimate. I for one don’t see how significant success against the dominant Keynesian paradigm can be achieved until the masses realise that the concept of GDP is nothing more than wool pulled over their eyes to prevent them from seeing the truth.

        The masses need to understand that GDP is an anti-concept designed to destroy all real economic concepts. They need to learn that it is a completely nonsensical number that tells us nothing meaningful about an economy. They need to realise that its sole purpose is to provide intellectual fig-leaf cover for intervention, intervention and more intervention. They need to see that it’s as slippery as it gets. The more the adjectives you add to it, i.e., potential, real, nominal, etc., the more slippery it gets and the more wiggle room its proponents and acceptors get to slime out of every corner they pain themselves into

  12. Bob Rooney says:

    I will try to reconcile Krugman:
    Boosting AD will boost GDP, will boost Potential GDP (-7% pre-crisis trajectory) that will boost Potential Potential GDP (still intact?). If Potential Potential GDP has also fallen, boost it until it meets Potential Potential Potential GDP etc etc etc ….

    • Yancey Ward says:

      Damn it, you beat me to it!

  13. Andrew Keen says:

    Does anyone have any theories about how Krugman let this happen? It looks like he is oblivious to his own opinion here. It is one thing to make a silly statement because you misread someone else’s argument, but Krugman actually appears to be unfamiliar with his own position in the matter on which he is writing. This is incredibly bizarre.

    When I take this a step further, it makes me wonder how anyone, even his allies, could take him seriously on this matter going forward. A man that that has two different opinions on the validity of a statement depending on who has presented it to him cannot be considered objective or scientific by an objective, scientific person.

    Dare I say that Krugman sits at the peak of a subjective, faith-based economic pyramid? His worshipers recite his words and defend his apparent contradictions from blasphemers: “You’ve intentionally misinterpreted his meaning!”

    • Gamble says:

      Andrew I think you summarized the entire situation nicely.

      I can give you Biblical teaching about men with foundation built on sand, a ship without rudder and no memory of what they see in the mirror but I don’t want to bore everybody to tears.

  14. So, Are Summers and Krugman Now Confirming That They Austrians Have Been Right About Bubbles? says:

    [...] concession, even though he doesn’t realize it. This is even more monumental than when he accidentally threw in the towel on the “potential GDP” discussion. I wonder if Christina Romer will pull him aside on this “secular [...]

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