Paul Krugman

A foundational principle of modern economics is that the creation of credit leads to economic growth. That precept underlies need for quantitative easing, and it is central to the question of what role monetary policy can and should play in stimulating a faster recovery from the Great Recession. It is also the subject of a debate between one of the world’s most prominent economic scholars, Paul Krugman, and a feisty Australian economist, Steve Keen.

Krugman is an unusually public figure for an academic. The Nobel Prize-winner and Princeton professor is also a widely-read New York Times columnist and prolific blogger, with the gift – unusual for someone in so wonky a profession – of clear and persuasive prose. He has earned a large and passionate audience, among them both ardent acolytes and rabid detractors. Krugman represents the mainstream of neoclassical economics, which believes that a combination of central bank monetary policy and government fiscal policy can moderate the business cycle.
Among the dissidents is Keen, the author of a provocative book, Debunking Economics. By his own admission, Keen is proudly out of the mainstream, but also able (“because of impediments like academic tenure,” he says in his book) to challenge it without fatal retribution. Keen thinks central bank controls are not as effective as Krugman believes, because private banks can create money in the form of debt through a process that is beyond the central bank’s control. Because of that, the economy will regularly experience “financial instability,” as advocated by Keynes’s disciple Hyman Minsky.

The debate in the blogosphere between those in the Krugman camp and those in the Keen camp has generated more heat than light; but the core of the debate is whether or not private banks can create money “out of thin air” to their heart’s content, by extending credit – leaving the central bank with no choice but to sanction this money creation.

Keen has taken aim at Krugman, and about a month ago Krugman, welcoming the challenge (at least initially), responded to Keen several times on his blog, setting off a furor in the economics blogosphere that has reverberated well beyond it.

I reviewed the exchange between Keen and Krugman, as well as much of the voluminous blog traffic of commenters weighing in, often to support one side or the other. I also conducted a personal phone interview with Keen. (I contacted Krugman through The New York Times to ask for an interview but did not receive a response.) These efforts shed new light for me on this debate, which I share below.