Krugman on Inflation
By David Henderson
Paul Krugman writes:
I’ve been writing about how macroeconomic reality under Ronald Reagan didn’t actually match the myth, and many people are inevitably upset. And one of the things they tend to bring up is the hoary old myth that the 80s success in taming inflation was somehow a terrible shock and surprise to Keynesians, who had no explanation.
This is, as it happens, completely wrong: what actually happened in the 80s was, quite literally, a confirmation of the validity of textbook Keynesian economics.
He then goes on to make his case. But back in 1982, Paul didn’t see it that way. In his famous memo to Marty Feldstein, co-authored with Larry Summers and written on his, Larry’s, and my third day on the job at the Council of Economic Advisers under Marty, he wrote:
As real intrest [sic] rates decline and the economy recovers, we can expect the real exchange rate and real commodity prices to return to approximately their historical levels. Our very rough guess is that correction of these distorted relative prices will add five percentage points to future increases in consumer prices and about two percent to the GNP deflator. This estimate is conservative in that it assumes stable oil prices.
The section of the memo from which this quote is pulled is titled, “The Inflation Time Bomb?” In other words, Paul thought at the time that inflation would increase. It didn’t, as his own graph shows. At the time they wrote, the annualized inflation rate (measured by the Consumer Price Index) for January through August, was over 6 percent.
Back then, we all got to read each other’s memos in a bound volume called “The Weekly Reader.” At the time I found Paul’s and Larry’s memo implausible. I remember talking to two other colleagues, Lincoln Anderson, the CEA’s macro forecaster, and Ben Zycher, the energy economist, and, if memory serves, we all thought that Krugman and Summers were too pessimistic on inflation.
So if he’s saying that what happened in the 1980s was “quite literally, a confirmation of the validity of textbook Keynesian economics,” is he saying that he didn’t buy into “textbook Keynesian economics” back then? Or is it just possible that what happened in the early to mid-1980s doesn’t confirm Keynesian economics?