Krugman's world -- or Alice in Wonderland

[Paul Davidson <pdavidson@xxxxxxx>]

At 10:39 PM 9/7/01 -0700, you wrote:
Professor Paul Davidson suggested that Paul Krugman's macro economic
recommendations for the the Japanese problems with deflation rested on the
quantity theory of money and the thesis of the neutrality of money. I would
greatly appreciate it if this criticism could be elaborated.


Krugman's argument is that as long as prices in Japan are falling, the
Japanese have an incentive tp save and hold onto their money rather than
psend. Thus even when the government deficit spends on public works
projects there is little or no multiplier affect, according to Krugman,
because of the decreasing price level 's effect  on the propensity to save.

If you have followed Krugman's tortured stream of thought so far, then it
is obvious that the solution is to "cause" the price level to rise and
therefore discourage savings ---.

Well how do you cause inflation in the Krugman world?
Simple.  The Bank of Japan should just print money and if the quantity of
money rises then their will be inflation -- at least if you believe tin the
neutrality of money!!  But then Krugman's "Keynesianism" kicks in.  If the
price level rises this will reverse the hypothesized increase in the
propensity to save because of price declining!.

Now you might ask-- If the Bank of Japan prints money -- how does it get it
out in the hands of the public?? And why will this increase prices -- if
people are already saving "money" because prices are falling??  And why
didn't the Japanese government deficit spending create money (and jobs)
sufficiently to start the price level of its Krugman upward march?

well perhaps it is too much to expect a inflated star like Krugman (who is
so celebrated he even gets an oped column in the NY times) to explain the
mechanism he has in mind to us poor mortals who insist on a logical
analysis instead of rely (as Krugman does) on subliminal 8 second sound
bites-- e.g., printing money causes inflation; in inflation money becomes a
hot potato; etc.

As Skidelsky explains, it follows from the quantity theory of money that a
change in the quantity of the value of money can disturb a previous
equilibrium
only if produces non proportionate changes in agents' money stocks. That is,
rising prices benefit investors and entrepreneurs at the expense of savers and
wage earners. Is Professor Davidson saying that this is the kind of effect
which Krugman is hoping for?


No that would be asking Krugman to be logically consistent.


It does not seem to me that Krugman clearly relies
on this kind of mechanism in the Return of depression economics.



Looking at Keynes' General Theory, I find that he does not say the general
price level is determined by the quantity of media but rather by money wages (
a rise in the money wage having the effect of raising prices) and by "the
scale
of output as a whole (taking equipment and technique as given", p. 294. (that
is as employment increases, diminishing returns sets in)


Correct -- but that is merely the flip side of the non-neutrality of money.

So if these are the determinants of the price level, then it does not seem
that
the quantity of media has anything to do directly with the level of prices.
What  then is the relationship, if any, between the quantity of money and
changes in the price level?

In Krugman's world, or in the real world??
.
Paul
Paul Davidson
Editor, JOURNAL OF POST KEYNESIAN ECONOMICS
Economics Department - University of Tennessee
523 SMC
Knoxville, Tennessee 37996-0550
work phone: (865) 974-4221
fax: (865) 974-4601/  (865) 974-1686
home phone and fax (865) 692-0802