You Need to Know Your Tobin – Ex Post Nonsense

If you are from Champaign Illinois or study economics at the University of Illinois, then you know who James Tobin is.


Fig. 1: Tobin!

Tobin was from Champaign Illinois. I, too, was born in Champaign-Urbana. Now, some of you might be wondering what all this “Tobin business” is that I’m up to. Well, frankly, it’s about this paper from Paul Krugman.


Fig. 2: Paul Krugman

In case you haven’t noticed, Paul has this penchant for being wrong and refusing to admit it, preferring instead to find creative ways out of the messes he gets himself into and then claiming he was right all along. What I’m referring to is called “ex post rationale”. It’s the mainstream thing to do post-financial crisis. That’s because mainstream economics is not science; it’s mysticism. There’s never responsibility nor consequences for being wrong, ever, in mainstream economics. Science is altogether different.

In a recent blog post Romer explains the concept of science,

“I name names because this is how science works. The standard practice calls for an individual to put his or her reputation behind a claim; to listen to the claims that others make; and to admit that the claim is false when this is what the evidence shows.”

And with that quote begins the purpose of my article. Admitting that his claims are false is entirely impossible for Krugman. Perish the thought. For example, consider endogenous money. In the real world, banks operate on the credit creation model where a bank lends regardless of its reserve position. When a bank lends, it creates its own IOU which it then denominates in the unit of account. Doing so makes the IOU acceptable to satisfy any tax liabilities to the state. At the same time the loan is made a deposit is made which consists of these IOUs. When the borrower spends the deposit, reserves shift from the lending bank’s reserve account to the seller’s bank’s reserve account and so, the IOUs behave as money in the private sector. Once the loan is paid off, the IOUs are destroyed. What all this means is that the central bank doesn’t control the money supply. The money supply is determined by demand for bank credit, which means it is “endogenous”. So, when loans are made, the money supply expands and when loans are paid off, the money supply shrinks.

Krugman, on the other hand, insists that banks are intermediaries and lend out customer deposits:

“First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand.”

Krugman also claims that the central bank controls the money supply:

“That’s the bottom line: the Fed controls credit conditions, except when we’re in a liquidity trap and it’s pushing on a string. Everything else — all the talk about banks creating money, and yes, all the gotchas my critics think they’ve found in what I’m saying — is irrelevant to the actual economic discussion.”

The above statements from Paul in 2012 were his responses to Steve Keen’s challenge of Krugman’s claim concerning banking operations. Most of us outside of the mainstream (along with the Bank of England) know that Krugman’s claim of banks being intermediaries is entirely false as well as his claim that the central bank controls the money supply, which it doesn’t since it sets the target interest rate.

Furthermore, as to the money supply issue, Krugman’s conditional liquidity trap: “the Fed controls credit conditions, except when we’re in a liquidity trap”, highlights that he possesses a deep, fundamental confusion as Scott Fullwiler demonstrates quite effectively:

“What he [Krugman] fails to understand is that it is only when the Fed sets its target rate equal to the rate paid on reserve balances (which will mean t-bills earn roughly the same as reserve balances—Krugman’s liquidity trap) that the Fed can actually target the quantity of reserve balances and by extension the monetary base. And even then, it must be sure to provide at least as many reserve balances as banks desire at the target rate to achieve its target rate in the first place. The key point here is that “under normal circumstances” the monetary base’s size would be determined endogenously based on the public’s demand for currency and banks’ demand for reserve balances at the Fed’s target rate; the Fed or any other central bank can only control the size of the monetary base directly by creating “liquidity trap” conditions that set interest on reserve balances equal to interest on t-bills.”

In the face of damning evidence to the contrary, Krugman refused to admit that his claims were false, ending the conversation before the public as a whole could discover that he had no idea what he was talking about. And so, that’s how science works, right?

A few years down the road when his errant views on banking and central bank operations actually began falling out of favor, or in Krugmanese, his views became rather “wonkish”, and a decent opportunity arose, Krugman reached into his bag of tricks, pulled a fast one and unwonked himself claiming that he’s always been an endogenous money sort of guy and that he’s always said the central bank doesn’t control the money supply:

“Basically, it was an application to asset markets, including the role of intermediates, of an approach similar to IS-LM: general equilibrium, yes, but with an ad hoc if plausible treatment of aggregate behavior. This approach told you right away that the volume of bank deposits, which are the non-cash component of broader money aggregates, was determined not by some mechanical multiplier but by incentives –and that in a liquidity trap just swapping monetary base for zero-interest securities would have no effect on these incentives, and hence no effect on deposits.

Oh, and this wasn’t an ex post rationale: it’s what those of us who knew the golden oldies were saying in advance. Me in 2009: ‘Central banks don’t control the money supply, they only control the monetary base.’”

Unfortunately, it is an ex post rationale and I do not care if he quotes himself from 2009. What about 1998?

“And that is why monetary policy is ineffective! Japan has been unable to get its economy moving precisely because the market regards the central bank as being responsible, and expects it to rein in the money supply if the price level starts to rise.”

Sounds like an ex ante “central banks control the money supply” to me.

And again, in 2012: “That’s the bottom line: the Fed controls credit conditions, except when we’re in a liquidity trap and it’s pushing on a string. Everything else — all the talk about banks creating money, and yes, all the gotchas my critics think they’ve found in what I’m saying — is irrelevant to the actual economic discussion.” – Krugman 2012. So, “Oh, and this wasn’t an ex post rationale: it’s what those of us who knew the golden oldies were saying in advance.” isn’t ex post rationale?

Really. That’s what I call junk science.

At the moment, evidence against the intermediaries viewpoint has reached critical mass and because there’s a lot of pressure on the utter failure that is “mainstream economics”, Krugman saves face by informing us that there is no problem – He’s always been an endogenous money sort of guy. At least he was back when the world began in 2009. Today, for sure – maybe. It depends: what’s popular at the moment?

Right, right. Sure, sure. What all of this means, in no uncertain terms, is that Paul Krugman is not a scientist; he’s a mystic trying to maintain his position of influence while avoiding, on the one hand, losing all of his credibility with the general public, and on the other hand, being labeled a traitor by New Keynesians. In other words, he’s trying to play both sides of the fence. Am I being harsh? Yep, but not any harsher than Romer was to RBC apologists. So what’s all this to do with Tobin? Glad you asked.

In his new paper, Krugman again uses knowledge after the fact (ex post rationale) to claim that he always “knew” something (ex ante) by appealing to Tobin:

“One aspect of the post-2008 story that apparently surprised many people, even smart economists like Martin Feldstein, was that huge increases in the monetary base didn’t seem to produce much rise in broader monetary aggregates, leading to claims that something strange was going on – that maybe it was all because the Fed was paying interest on excess reserves. But the same thing happened in Japan in the early 2000s, without any special interest payments. And it was, in fact, completely predictable if you were aware of Tobin’s 1960s work with William Brainard on his “general equilibrium” approach to monetary theory.”

Beforehand, Hicks was all that Krugman needed. Now, we discover that he adds Tobin as a necessity in order to see things clearly. Given the fact that MMT is making huge strides, how long before we hear Krugman opine “those of us who knew our Minsky were saying all of this in advance”? Or how long before we hear him say, “It is what those of us who knew our Lerner were saying in advance”? I swear, if socialism were to become popular in the US, Krugman would say, “Those of us who knew our Cherneschevski were saying all of this in advance.”

So, by gosh, if you were aware of Tobin like Paul, then everything was completely predictable, you see. First, he tells us that many people, even “smart economists” were “apparently” surprised, but no mention of whether or not Krugman himself was surprised. Frankly, I’d like to know, but oh well, right?

Second, Krugman’s mentioning of Japan is a big red flag. Krugman fancies himself a Japan success story even though he was wrong, since it was fiscal policy and not monetary policy that lifted Japan out of the doldrums. Krugman believed that QE would get Japan going again:

“But this argument against the effectiveness of quantitative easing is simply irrelevant to arguments that focus on the expectational effects of monetary policy. And quantitative easing could play an important role in changing expectations; a central bank that tries to promise future inflation will be more credible if it puts its (freshly printed) money where its mouth is.” – Krugman, December 1999

Were Krugman an endogenous money guy pre-financial crisis, he never would have written the above unless he had a high fever. But since everyone believes that Krugman understands Japan, then he must also have some deep insight in this case as far back as the early 2000’s that even “smart economists” like Martin Feldstein were not privy to. His use of the phrase “smart economists” would seem to imply that Krugman is much smarter and therefore, above the confused majority. Which naturally leads Krugman to his ex post appeal to Tobin as some sort of clue as to how he did, in fact, possess ex ante knowledge. “My deep insight is now revealed, pathetic mortals! I knew my Tobin and you didn’t. Behold: Science! Another triumph for New Keynesians.”

Of course, there’s no proof that he was referring to himself– and that’s the point! If you criticize him, he can claim that he didn’t say that and wasn’t referring to himself, which is why he used the word “you” – “if YOU were aware of Tobin”. Vague. All scientists are vague, aren’t they? It’s a good thing Nostradamus wasn’t vague or we’d never have any hope of knowing the year when the anti-Christ arrives.

Nevertheless, that’s all fine and dandy if Krugman uses the word “you”. All I want to know then is why Krugman felt the need to write that paragraph and why he phrased the Tobin sentence the way he did. For instance, he could have said: “With the benefit of hindsight, things would have been completely predicable were we to have taken into consideration Tobin’s 1960’s work.” But Krugman didn’t say that, did he? In the end, should we believe that a guy at Princeton constructed the sentence in such a way as to leave the reader with a false impression totally by accident or perhaps because he didn’t know any better? I think not. In my view it’s a case of ex post rationale to intentionally claim ex ante knowledge. Besides, you don’t need a PhD to know how to be honest.

Look folks, here’s the stone skinny of it: Krugman merely wants to impress upon his disciples that he knew everything all along; that he was a lone voice crying in the wilderness, but those neoclassicists were meddling pre-crisis; that he’s never wrong; that New Keynesian economics is a fortress of wisdom; that he’s potentially the greatest economist who ever lived and he knows that his loyal, devoted flock will swallow it hook, line and sinker. “I’m bigger than Keynes, damn it: I’m Krugman!” Hey, it keeps his NY Times column and his position of influence in good health. Am I being harsh again? Um… Yeah.

And that’s Kruggles for you.

So, I bought a Tobin meter. Each time he uses ex post rationale to prove his prior knowledge, the meter will go off and I will record the data. Factually, I don’t need to go through all of this. I know for certain that Krugman doesn’t know what he’s talking about and he doesn’t know his Tobin either.

Paul used one of Tobin’s papers to argue against endogenous money in 2012, missing the fact that Tobin wrote another paper, “Commercial Banks as Creators of ‘Money’

Don’t you find that odd for a man who claims to know his Tobin? I know I do.

An appeal to Tobin is not the science way to do things. It is ex post rationale to distance yourself from your own ex ante nonsense. Paul should give up on all of this silliness and get with reality.