The Central Flaw in Krugman’s Argument Against Keen

The key failing in Krugman’s response to Steve Keen’s response to Krugman’s paper (PDF) is here:

If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.

Krugman assumes here that people have to save (spend less) in order for other people to borrow. It’s actually the fundamental assumption, the sine qua non, of his paper (and of Krugman’s beloved IS-LM — the linch-pin of “New” Keynesianism — created by Hicks to subsume Keynes into neoclassicism, and later disclaimed and discredited by Hicks as a “classroom gadget”; see my post, and Philip Pilkington here).

But that’s not how things work (and it’s the very assumption that Keen is disputing). I tried to explain this in clear and simple terms here:

Think about it:

You get $100,000 in wages. Your employers’ bank account is debited, and yours is credited. Your bank can lend against your higher balance; your employer’s bank can’t. Net zero.*

You spend $75,000. It’s transferred from your account to other people’s/businesses’ bank accounts. Their banks can lend more, yours can lend less.

Is the total stock of loanable funds affected by whether the money is on deposit at your bank, your employer’s bank, or the banks of people you bought stuff from? No.

Meantime, you don’t spend $25,000. You “save” it. The money sits there in your checking account. If the action of spending — transferring money from one account to another — doesn’t change the total stock, how could not transferring money do so? Your bank still has the money, which it can lend out. Other banks still don’t, and can’t.

So here’s how the argument plays out:

Krugman assumes that people need to save in order for others to borrow.

Keen points out that they don’t.

Krugman explains that Keen is wrong by … assuming that people need to save in order for others to borrow.

And so the world goes round.

Cross-posted at Asymptosis.

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