Anti-Keynesians and market monetarists

Paul Krugman recently linked to this post in The Economist:

We had a debate about whether governments should respond to recessions with deficit spending or austerity.

That was the debate we had. And what’s interesting about this particular moment is that while Mr Grabell is writing about what did and didn’t work in the stimulus, and Mr Obama is staying away from the topic for political reasons, out there on the barricades what’s happening is that the entire argument that governments should engage in austerity appears to be collapsing.

Item 1: Over the past month, Paul Krugman, Brad DeLong, and Simon Wren-Lewis engaged in an interminable duel with Tyler Cowen, Scott Sumner, sort-of Karl Smith (occupying as usual an esoteric position not easily placed on the ideological grid), and probably some other people I’m forgetting—over an old argument by John Cochrane claiming that the multiplier effect of government stimulus spending probably ought to be zero.

Where does one even begin?  The writer (initials M.S.) clearly implies that I took John Cochrane’s side in a debate over the multiplier effect of government spending, and that I am some sort of proponent of “austerity.”  That must seem comical to readers of this blog, as I have spent three years relentlessly advocating stimulus.  If you actually read the article M.S. links to, you’ll see that I am quite critical of Cochrane’s argument.  Indeed the entire post has nothing to do with the question of whether the multiplier is positive, rather I simply pointed out that both sides of the debate were using bad arguments.

But what most bothers me isn’t the inaccuracy, but rather the re-writing of history.  The entire post seems devoted to the proposition that the Keynesians have been right and the anti-Keynesians have been wrong.  And yet as far as I can tell us market monetarists have been right about everything the Keynesians were right about, and plenty they missed.  Here are some examples:

1.  We consistently argued that the US was unlikely to face significantly higher interest rates or inflation.

2.  We consistently argued that the stimulus was inadequate.

In fairness, Keynesians like Paul Krugman were also completely right on these points, and many anti-Keynesians were wrong.  But the anti-Keynesian universe is large.  If I looked at the entire anti-monetarist universe I could also find plenty of ignorance.

I’d also argue that we were ahead of the curve on some very important points:

3.  In late 2008 and early 2009 market monetarists were loudly calling for more monetary stimulus.  Later others came around to that view.

4.  In late 2008 and early 2009 we pointed out that interest on reserves was contractionary.  Later others came around to that view.

5.  In 2009 we complained that Obama was waiting too long to fill empty Fed seats.  Later others came around to that view.

6.  We argued that expansionary monetary policy initiatives would tend to boost asset prices.  Others initially denied that, then later came around to that view.

7.  We insisted that inflation was the wrong target and that NGDP, level targeting, was needed.  Several prominent Keynesians later endorsed that policy.

Overall, we were right on the things the Keynesians were right about, and ahead of the curve on other points.  And let’s not forget that President Obama staffed his administration with Keynesians, and told us that unemployment would rise to 9% if we didn’t pass his stimulus program.  In fairness, smart Keynesians like Krugman knew their plan had flaws, but just imagine what Keynesians would say if we’d had a monetarist president for the last 3 years, and the same path of unemployment.  Do you think they’d make nuanced arguments separating out “good monetarists” and “bad monetarists?”

Later the article quotes John Cochrane making some eminently sensible classical arguments for countercyclical deficits, such as tax and consumption smoothing, or investment projects being judged on their (cost-benefit) merits, and we’re told that he has somehow thrown in the towel, and accepted that fiscal stimulus is a good way to boost GDP.  Sometimes I think Keynesians are so in love with fiscal stimulus that they assume any argument for a budget deficit is ipso facto an argument for fiscal stimulus.

The Economist article is also highly selective in its use of data:

Americans are starting to recognise that our recovery is further along than other advanced countries’ in part because the way we handled the financial crisis wasn’t really so awful. And that includes the stimulus.

I’m not quite sure what this means.  We are certainly further along than the periphery of Europe, but I don’t see what that shows.  We are less far along than northern European members of the eurozone like German, Austria and Netherlands.  But the US has its own currency, so we really ought to be compared to other developed countries with their own currency.  How about Japan, Australia, Canada, Britain, Sweden, Poland, etc?  Japan’s a special case that looks really good with unemployment and really bad in terms of growth.  We aren’t doing as well as Canada, Australia, Poland and Sweden.  We are doing better than Britain, but then Britain is one of the few countries that actually did even more fiscal stimulus than the US.  Indeed more than just about anyone.  So I don’t see how Britain’s poor performance strengthens the Keynesian case.

I haven’t seen Keynesians write down any objective formula for measuring the degree of fiscal stimulus.  Admittedly it’s not easy, as the deficit is distorted by the business cycle.  But when I read the pro-Keynesian pundits I constantly come across arguments that are supposed to simply be accepted on faith.  I’ve seen Keynesians argue that fiscal stimulus in Japan worked, and I’ve seen Keynesians argue that fiscal stimulus in Japan failed, and I’ve seen Keynesians argue that it only appears that fiscal stimulus failed in Japan, because they really didn’t do much stimulus.  If even the Keynesians can’t seem to get their story straight on Japan; how am I supposed to judge how effective the policy has been?  All I know is that their national debt as a percentage of GDP has soared much higher during recent decades, and all that stimulus produced precisely 0% nominal GDP growth in 19 years.  And yet we’re being told that fiscal stimulus is “obviously” effective?

It’s really annoying when Keynesian writers keep implying that only fools think fiscal stimulus is a bad idea.  The entire concept of fiscal stimulus fell out of favor in the best universities for several decades.  The only argument I’ve ever seen for reviving it is that monetary stimulus is ineffective at the zero bound.  But many of the most dogmatic proponents of Keynesian economics, the ones who in early 2009 were telling their readers that there was nothing the Fed could do at the zero bound, are now loudly and relentlessly bashing the Fed for not doing more.  That’s right, there’s only one good argument for fiscal stimulus, and even the proponents of fiscal stimulus don’t seem to believe it.


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57 Responses to “Anti-Keynesians and market monetarists”

  1. Gravatar of Morgan Warstler Morgan Warstler
    5. February 2012 at 07:15

    If a Keynesian can’t sow me a previous written position of theirs demanding we not raise public employee pay during good times…

    they are not Keynesian.

    Their DESIRE for stimulus today for correct reasons is proven only by their desire for cutting fiscal spending when we were booming.

  2. Gravatar of William William
    5. February 2012 at 08:28

    The main reason I stopped reading the Democracy in America blog was M.S.’s (Matt Steinglass’s) weak grasp of economics.

    Firms can save money by producing everything they use in-house: http://www.economist.com/node/21529141

    Cheap Chinese junk products are designed to break after a couple of years so that firms can make more money: http://www.economist.com/node/21012498

  3. Gravatar of Greg Ransom Greg Ransom
    5. February 2012 at 08:49

    Could you please equipibrium money what it is — equilibrium money. And please stop calling it what it it not — “stimulus”.

  4. Gravatar of david david
    5. February 2012 at 09:36

    @William – the notion that firms can save money by producing (some) things in-house is exactly the Coasean theory of the firm, isn’t it? Otherwise all firms would be one individual large.

    And if consumers don’t want to pay for durability, then making expensive durable consumer goods is exactly what M.S. says it is: insane.

  5. Gravatar of ssumner ssumner
    5. February 2012 at 09:57

    Morgan, Yes, I don’t hear much about cutting government in good times.

    William, Yeah, those aren’t very impressive.

    Greg, Fine, equilibrium money.

    David, Yes, I think William agrees with you, and was criticizing M.S.

  6. Gravatar of Kevin Donoghue Kevin Donoghue
    5. February 2012 at 10:12

    “The entire concept of fiscal stimulus fell out of favor in the best universities for several decades.”

    The argument from snobbery is never very persuasive. If there is a compelling reason for rejecting the concept then we should reject it even if the argument comes from a patient in a mental hospital. If the arguments presented are no good then the fact that they became fashionable in the best universities is just a sad reflection on human frailty.

  7. Gravatar of John Thacker John Thacker
    5. February 2012 at 10:13

    Morgan:

    In addition, when unemployment is high, I have to wonder why Keynesians insist upon raising pay for government workers (who are generally above the median in pay) rather than concentrating on hiring more government employees. Wouldn’t the latter have higher propensity to spend and thus be a better idea if the problem is AD from their perspective?

    Fight for higher overall spending, sure, under their framework, but shouldn’t Keynesians at least be amenable to tradeoffs that maintain the level of spending? (That seems to be what we’ve seen in Wisconsin, where school districts have hired additional teachers or canceled layoffs after being able to reduce their benefits costs.)

  8. Gravatar of Major_Freedom Major_Freedom
    5. February 2012 at 10:27

    “That must seem comical to readers of this blog, as I have spent three years relentlessly advocating stimulus.”

    When an economist reads that, he sees “I have spent three years relentlessly advocating that some privileged people receive unearned money to benefit themselves at the expense of everyone else, outbidding them for consumer goods, capital goods, and financial securities. The net result is that everyone else has less real wealth and more depreciated currency, and they’re supposed to think they’re wealthier.”

  9. Gravatar of Major_Freedom Major_Freedom
    5. February 2012 at 10:49

    If the Fed adopts NGDP targeting, then that will still generate the business cycle because the Fed will be increasing bank reserves which then affect the loan market and thus interest rates. The Fed will bring about interest rates that deviate from the unadulterated unhampered price system rates.

    Since the Fed is heavily influenced if not controlled by the major banks, then what’s to stop the major banks from accumulating huge quantities of cash over time by refusing to spend it every time they are given it by the Fed, thus necessitating the Fed in giving the banks even more money?

    In principle, the major banks can accumulate any quantity of new money they want by simply stockpiling any cash the Fed gives them expecting them to spend. They can keep accepting new money and refuse to spend it, thus requiring the Fed to give them even more new money until they do.

    In a recession, they can do pretty much what they have been doing since 2008, which is stockpile new cash, and then consume out of it if they want.

  10. Gravatar of Tommy Dorsett Tommy Dorsett
    5. February 2012 at 10:50

    Scott – A chart you may like: http://research.stlouisfed.org/fredgraph.png?g=4Oj

  11. Gravatar of Benjamin Cole Benjamin Cole
    5. February 2012 at 12:55

    If the Patriots some some real steel and better relief pitching they will win in the Super Bowl today.

    And less or more fiscal stimulus will end the recession.

    For Market Monetarists, is it difficult not to feel exasperated. The Keynesian vs. Anti-Keynesian “debate” is about how a strong goal-line stand turned the middle innings of the Super Bowl.

    This “debate” is the battle of the Econo-Shamans, tussling for supremacy amid their numerated chants, medicine bags, verses and partisan rituals. The Theo-Monetarists vs. the Fiscal Witch Doctors.

    Please, my fellow residents in econo-land, embrace Market Monetarism!

  12. Gravatar of Ben Wolf Ben Wolf
    5. February 2012 at 13:41

    @Major-Freedom

    “In principle, the major banks can accumulate any quantity of new money they want by simply stockpiling any cash the Fed gives them expecting them to spend. They can keep accepting new money and refuse to spend it, thus requiring the Fed to give them even more new money until they do.”

    It doesn’t work this way. When the Fed makes transfers to banks, it is either in the form of loans or asset swaps, none of which involve net creation of money. Furthermore the liquid assets transferred to the bank are reserves, which can only be used for four things:

    1) clearing inter-bank payments

    2) buying U.S. bonds

    3) eschanging for cash, which banks prefer not to do because the cash has storage and transporation costs, while the reserves pay some small level of interest.

    4) loaning to other banks, which earns them slightly more than zero percent interest.

  13. Gravatar of Major_Freedom Major_Freedom
    5. February 2012 at 14:27

    Tommy Dorsett:

    “Scott – A chart you may like: http://research.stlouisfed.org/fredgraph.png?g=4Oj

    That chart is consistent with these theories:

    A. A change in RGDP causes a change in NGDP; and

    B. A change in NGDP causes a change in RGDP.

    C. A change in RGDP is caused by the same thing that causes a change in NGDP.

    None of these theories can be rejected or confirmed by only referring to the data.

  14. Gravatar of Tommy Dorsett Tommy Dorsett
    5. February 2012 at 14:58

    The chart is consistent with the idea that nominal shocks have real effects.

  15. Gravatar of Bonnie Bonnie
    5. February 2012 at 15:11

    Major_Freedom,

    You just described the current state which is incentivized by IoR. Dr. Sumner has argued to end IOR or make the interest negative so they stop hoarding the money.

  16. Gravatar of Luis H Arroyo Luis H Arroyo
    5. February 2012 at 15:27

    I think the BASIC point is that Keynes never Was for a fiscal expansion without a paralel monetary expansion. This is the sense of liquidity trap. The FIscal policy is to push monetary effectivity, not to substitute it.

  17. Gravatar of libfree libfree
    5. February 2012 at 18:56

    Scott,

    This is the same economist that argued that “A HUNDRED years from now, looking back, the only question that will appear important about the historical moment in which we now live is the question of whether or not we did anything to arrest climate change” I love predictions and all but it seems to take a good amount of arrogance to think you really know what the world will look like/care about a hundred years from now.

    http://www.economist.com/blogs/democracyinamerica/2011/12/climate-change

  18. Gravatar of cthorm cthorm
    5. February 2012 at 19:04

    @William

    Hilarious, I did the same thing. I used to read and comment on all the Economist blogs daily, but M.S. killed it for me around 2009. Not just poor economics, but a blatant leftistism and affinity for ad homonym. Such a shame.

  19. Gravatar of StatsGuy StatsGuy
    5. February 2012 at 19:26

    Morgan:

    “If a Keynesian can’t sow me a previous written position of theirs demanding we not raise public employee pay during good times…”

    Actually, most keynesians were arguing against the Bush II tax cuts around 2004/2005, which is consistent. However, if you mean cutting SPENDING, that’s different.

  20. Gravatar of PrometheeFeu PrometheeFeu
    5. February 2012 at 19:53

    “The only argument I’ve ever seen for reviving it is that monetary stimulus is ineffective at the zero bound. But many of the most dogmatic proponents of Keynesian economics, the ones who in early 2009 were telling their readers that there was nothing the Fed could do at the zero bound, are now loudly and relentlessly bashing the Fed for not doing more.”

    Playing devil’s advocate here. But let’s say the Fed is doing something like a Taylor rule or NGDP targetting or something along these lines. (aka vaguely following the dual mandate) Now assume that you think they are doing it wrong. You think that their forcasts are inaccurate and that they are undershooting the target, not in a systematic way, but rather in a random way which just happens to be low right now. In that case, you could say: “Alright. The Fed is a poor shot and right now they are shooting low. Let’s lightly push the barrel of their gun up using fiscal policy and hope they won’t push back down.”

    I don’t think they have a very strong argument in favor of that world being the case, but it is a not-stupid reason to favor some fiscal stimulus right now.

  21. Gravatar of Bob Murphy Bob Murphy
    5. February 2012 at 20:15

    Very interesting post, Scott. I get a thrill up my leg when you criticize Keynesians. But please tell me if the following is your argument (or one of them):

    1) Several countries–including Canada, Australia, Poland, and Sweden–clearly had smaller fiscal stimulus packages than the US in response to the Great Recession, and yet they are clearly doing better than the US in terms of the recovery. These countries also have their own currencies, so this is a fair apples-to-apples comparison.

    2) Therefore, this is objective evidence that fiscal stimulus isn’t effective at promoting recovery. Perhaps there are other offsetting factors, etc. etc., but if we are going to be empirical at all, then surely we must realize that this evidence is pretty strong *against* the efficacy of fiscal stimulus.

    Is that a decent summary of your view?

  22. Gravatar of Charlie Charlie
    5. February 2012 at 20:18

    “The entire concept of fiscal stimulus fell out of favor in the best universities for several decades. The only argument I’ve ever seen for reviving it is that monetary stimulus is ineffective at the zero bound. But many of the most dogmatic proponents of Keynesian economics, the ones who in early 2009 were telling their readers that there was nothing the Fed could do at the zero bound, are now loudly and relentlessly bashing the Fed for not doing more.”

    Maybe you are ruling this argument out, because you don’t consider it a “good” argument, but my interpretation is a bit different. The mainstream still often teaches that monetary policy works through “long and variable lags.” Stimulus went out of style because even New Keynesians argued that the gov’t was too slow. Feldstein once quipped that congress passing a fiscal stimulus was an early predictor of already being in a recovery. Even when stimulus packages fell out of favor, economists at top schools advocated automatic stabilizer forms of stimulus. One argument for why this time was different is that the recession was expected to be long and deep, so that even if it took a while for a stimulus package to pass it would still hit the economy when it was needed.

    Granted, I think there is a lot of confused statements in that narrative. I think both fiscal and monetary stimulus work immediately through expectations, but I’m not so sure top schools agree with me, and I’m pretty confident these avarying timeline arguments were a popular reason for fiscal stimulus losing favor during the great moderation.

  23. Gravatar of Morgan Warstler Morgan Warstler
    5. February 2012 at 21:17

    Stats, I gave you the proof point, they have to want to see public employee salaries stay down at or below trend.

    That’s the only way a Keynesian can best ensure we don’t get tempted to slash gvt. staff with austerity.

    Rational expectations and all that.

    Keynes himself would agree.

    Since there is no one on the left who made such suggestions, no one on the left is actually a Keynesian.

    You admit it yourself, without exploring what it means about you.

    Shame. shame.

  24. Gravatar of Hugh Hugh
    5. February 2012 at 21:29

    I cannot for the life of me understand why commentators such as MS are trying to write the history of the Great Recession in 2012.

    Think for a moment about what still needs to be achieved:

    - growth at, say, 3% must resume and be maintained
    - unemployment must fall to ~5%
    - the various QEs must be unwound

    All the while keeping debt/GDP within reasonable bounds so that we have some chance of survival in the next recession.

    In summary it won’t be possible to see who adopted the winning strategy before 2020 (I’m an optimist), and people like MS are likely to seem foolish for having tried to do so preemptively.

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. February 2012 at 21:36

    Scott wrote:
    “The only argument I’ve ever seen for reviving it is that monetary stimulus is ineffective at the zero bound. But many of the most dogmatic proponents of Keynesian economics, the ones who in early 2009 were telling their readers that there was nothing the Fed could do at the zero bound, are now loudly and relentlessly bashing the Fed for not doing more.”

    Pretty much all there needs to be said. If monetary stimulus were ineffective at the zero bound, then why are they asking for more?

  26. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. February 2012 at 23:07

    Scott wrote:
    “We aren’t doing as well as Canada, Australia, Poland and Sweden.”

    Poland finally made the short list. I guess all the nagging by me (with a little help from Marcus Nunes) finally paid off.

  27. Gravatar of Weaving a narrative through the facts | Historinhas Weaving a narrative through the facts | Historinhas
    6. February 2012 at 02:22

    [...] Noah Millman and Scott Sumner, present a discussion of the “foundations” of the crisis. Scott Sumner also takes on “allegations” by Keynesians on fiscal [...]

  28. Gravatar of Anti-Keynesians and market monetarists « Economics Info Anti-Keynesians and market monetarists « Economics Info
    6. February 2012 at 03:00

    [...] Source [...]

  29. Gravatar of Ben Wolf Ben Wolf
    6. February 2012 at 04:17

    “Pretty much all there needs to be said. If monetary stimulus were ineffective at the zero bound, then why are they asking for more?”

    It’s what they know so they keep pushing it, not accepting that the Fed can quantitatively ease until the cows come home and it still won’t do much of anything. We long ago reached the limits of interest rate manipulation.

  30. Gravatar of ssumner ssumner
    6. February 2012 at 06:15

    Kevin, You said;

    “The argument from snobbery is never very persuasive.”

    You took my quote completely out of context. I wasn’t using it to defend the anti-fiscal stimulus view. I was saying people like Cochrane should not be singled out as holding foolish policy views without the accuser telling us why the mainstream view for two decades was also silly. This comment referred to the tone of the debate, not whether he was right or wrong.

    I’m still waiting for a good explanation for why we should abandon 20 years of New Keynesianism. Do you have one?

    Major Freedom, You still don’t seem to understand anything I’m saying.

    Thanks Tommy.

    Ben, Alas, they didn’t win.

    Luis, Perhaps, but with Keynes, never say never.

    libfree, I agree.

    Statsguy, It has to be spending cuts. Krugman was saying in 2009 we need spending increases, that tax cuts wouldn’t do much.

    Prometheefeu, I agree with your comment, but I see that as supporting me and undercutting M.S. He’s saying the case for fiscal stimulus is obvious, you are saying it’s a bank shot in billiards.

    Bob, Not quite. I was just saying that I don’t see the US as having done particularly well. I’m not even sure how much stimulus those other countries did–although I do know Sweden has a balance budget, and I think the others also have much smaller deficits. Britain has run bigger deficits than us in recent years, and is doing worse. But my main point is that the US isn’t doing very well, contrary to M.S.

    Charlie, I had thought it fell out of favor because if the central bank is targeting inflation then the fiscal multiplier is zero.

    Hugh, I agree.

    Mark, Yes, I was thinking of you.

    Ben, I agree that we reached the end of interest rate manipulation, but interest rates aren’t monetary policy. Indeed low rates are usually a sign that money has been tight.

  31. Gravatar of StatsGuy StatsGuy
    6. February 2012 at 06:36

    ssumner:

    “Statsguy, It has to be spending cuts. Krugman was saying in 2009 we need spending increases, that tax cuts wouldn’t do much.”

    But don’t you think that Krugman would argue that during a boom/bubble, tax increases OUGHT to be effective at restraining AD? The fact that he thinks tax cuts in a liquidity trap aren’t that effective (e.g. have a lower multiplier) doesn’t mean that outside of a liquidity trap a tax increase is not effective.

    So an internally consistent Keynesian strategy is:

    During booms, increase taxes
    During busts, increase govt spend

    :)

  32. Gravatar of Brendan Brendan
    6. February 2012 at 07:13

    Imagine the Keynesian response if President John McCain said “It’s clear monetary policy has already shot its wad” and waited a few years to fill empty fed seats. Krugman would’ve found a way to get an hour long ABC special explaining how monetary policy works at the ZLB and how McCain’s IQ is about 32.

  33. Gravatar of Mike Sax Mike Sax
    6. February 2012 at 09:38

    “The writer (initials M.S.) clearly implies that I took John Cochrane’s side in a debate over the multiplier effect of government spending, and that I am some sort of proponent of “austerity.” That must seem comical to readers of this blog, as I have spent three years relentlessly advocating stimulus.”

    Yes and no. You relentless advocate monetary stimulus. During that debate reference above you did relentlessly attack fiscal stimulus and largely agree with austerity-on the fiscal side. Your position amounts to the idea that if we hafe the proper monetary policy-NGDP targeting-we can practice fiscal side austerity.

  34. Gravatar of Mike Sax Mike Sax
    6. February 2012 at 09:44

    “We are less far along than northern European members of the eurozone like German, Austria and Netherlands.”

    Not really. The problem with Germany is that as part of the Eurozone the problems of the periphery at some point become their problems. That’s why some level of bailout as been agreed to even by them.

    Right now I’d much rather be the United States than any country stuck in the Euro strait jacket.

  35. Gravatar of Mike Sax Mike Sax
    6. February 2012 at 09:47

    “Britain is one of the few countries that actually did even more fiscal stimulus than the US.”

    That is some license you take there even for you. David Cameron is the Dr. of fiscal stimulus. He never in a million years cut anything. Got to see where you get your news from.

  36. Gravatar of Mike Sax Mike Sax
    6. February 2012 at 09:51

    “I’ve seen Keynesians argue that fiscal stimulus in Japan worked, and I’ve seen Keynesians argue that fiscal stimulus in Japan failed, and I’ve seen Keynesians argue that it only appears that fiscal stimulus failed in Japan, because they really didn’t do much stimulus. If even the Keynesians can’t seem to get their story straight on Japan; how am I supposed to judge how effective the policy has been?”

    Keynesians don’t need to “keep their story straight” as there is not one story that every Keynesian believes.

    As far as Japan is concerened there is some diagreement on how Japan has being doing lately. A central question has been whether or not Japan suffered one lost decade or two. This disagreement is not necessarily totally on Keynesian vs anti-Keynesian lines either.

    Do you as a Monetarist agree with every other Monetarist about every econmic and monetary event of history? Only a cult does that.

  37. Gravatar of Mike Sax Mike Sax
    6. February 2012 at 09:53

    “I haven’t seen Keynesians write down any objective formula for measuring the degree of fiscal stimulus.”

    Haven’t seen you “write down” and objective formula about this either and if you think that Britain in any way-since David Cameron has been in office-has any degree of fiscal stimulus then your own understanding of the question is so flawed there’s no way to even make sense of the question.

  38. Gravatar of Mike Sax Mike Sax
    6. February 2012 at 09:56

    “The entire concept of fiscal stimulus fell out of favor in the best universities for several decades”

    That hardly means that there were good reasons for it falling out of favor. Now it is less out of favor, so what? Reminsiicing about the good old days when you and your freshwater pals would giggle about Keynesian arguments in class proves nothing.

  39. Gravatar of Major_Freedom Major_Freedom
    6. February 2012 at 10:11

    Ben Wolf:

    “In principle, the major banks can accumulate any quantity of new money they want by simply stockpiling any cash the Fed gives them expecting them to spend. They can keep accepting new money and refuse to spend it, thus requiring the Fed to give them even more new money until they do.”

    “It doesn’t work this way. When the Fed makes transfers to banks, it is either in the form of loans or asset swaps, none of which involve net creation of money.”

    Wrong. What you call “asset swap” is in fact the creation of new money. Whenever the Fed buys up anything, and “swaps” dollars for assets, it is doing so using dollars that did not already exist in the market prior, and is hence inflationary by definition.

    For you to say that the Fed doesn’t create new money is the intellectual equivalent of saying the government doesn’t use force.

    “Furthermore the liquid assets transferred to the bank are reserves, which can only be used for four things:”

    “1) clearing inter-bank payments”

    “2) buying U.S. bonds”

    “3) eschanging for cash, which banks prefer not to do because the cash has storage and transporation costs, while the reserves pay some small level of interest.”

    “4) loaning to other banks, which earns them slightly more than zero percent interest.”

    It is the act of creating the reserves itself that is inflationary. It increases the TOTAL supply of money and volume of spending in the economic system. Whether a new supply of money is held by the banks or loaned out is irrelevant. Whatever happens after the inflation, spending in dollars is higher than it would have otherwise been.

    Bonnie:

    “You just described the current state which is incentivized by IoR. Dr. Sumner has argued to end IOR or make the interest negative so they stop hoarding the money.”

    Actually I just described the reality that the major banks have control over aggregate spending in a monetarist NGDP world, and so I explained how banks can hoard cash while continuously creating new cash, without increasing NGDP. When the economy goes through a correction, which is inevitable if the banks are flooded with cash for lending that isn’t a product of real savings, such that NGDP would have otherwise fallen, they can use their accumulated cash reserves to buy up assets at firesale prices without increasing NGDP, while communicating to the world that they are just maintaining NGDP.

  40. Gravatar of Ben Wolf Ben Wolf
    6. February 2012 at 12:25

    @Major_Freedom

    Assets held by the Fed effectively do not exist because they are removed from circulation. The reserves swapped for the assets do not and cannot increase the money supply or generate inflation. I should think this would be obvious from a 2000% increase in reserves since 2007 without corresponding monetary inflation. Bank reserves and their uses are entirely endogenous to the banking system and have no channel to the real economy because they do not affect lending, which the Fed has already acknowledged.
    http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

    All quantitative easing does is swap highly liquid financial assets (reserves) for somewhat more illiquid (bonds).

  41. Gravatar of Kevin Donoghue Kevin Donoghue
    6. February 2012 at 12:28

    Scott, are you really saying that mainstream New Keynesians rejected the “entire concept of fiscal stimulus” for 20 years? That’s a strong claim. It goes far beyond merely saying that monetary policy can usually do the job. I’d say the consensus among NK economists is that they simply neglected fiscal policy for a long time and it was a mistake to do that.

    As for your question, why should we abandon NK, it’s news to me that you ever embraced it. I’m not saying that you should have, either. It’s just a model, it’s not a flag to rally around.

  42. Gravatar of 123 123
    6. February 2012 at 15:01

    Scott:”In late 2008 and early 2009 we pointed out that interest on reserves was contractionary.”

    Here is a case study below. Did the absence of IOR made 2001 version of QE in Japan much more powerful than 2008 version of QE in Japan? Is the effect of IOR visible if you compare 2001 QE in Japan vs. Bernanke’s 2008-09 QE?

    “Because the Bank of Japan had not begun to pay interest on excess reserves until November 2008, the successful winding down in 2006 of its quantitative easing policy was achieved without raising the interest rate paid on excess reserves.
    Accordingly, the policy tightening that occurred in 2006 was preceded by a large decline in aggregate balances held at the Bank of Japan.”

  43. Gravatar of RN RN
    6. February 2012 at 21:27

    “It’s really annoying when Keynesian writers keep implying that only fools think fiscal stimulus is a bad idea.”

    They don’t think ALL who oppose fiscal stimulus are fools. Just some of you.

    “The entire concept of fiscal stimulus fell out of favor in the best universities for several decades.”

    - Garbage. Universities don’t have opinions, people do.

    “The only argument I’ve ever seen for reviving it is that monetary stimulus is ineffective at the zero bound. ”

    - Um…yeah, and that seems pretty important right about now, wouldn’t you say?

  44. Gravatar of ssumner ssumner
    7. February 2012 at 06:41

    Statsguy, It’s not a sustainable strategy to raise spending during recessions and not cut it in booms. That leads up a staircase to a steadily higher share of GDP in the public sector.

    Brendan, Yup.

    Mike Sax, There are two questions: Austerity vs. stimulus, and monetary vs fiscal policy. If we mix them up we’ll end up talking gibberish. I am not a fan of austerity. Period. End of story. I do not agree with Cochrane’s claim that fiscal stimulus cannot boost output. I do not agree with Cochrane’s opposition to stimulus.

    Your point about the eurozone is reasonable. Obviously I took M.S. as referring to macro performance.

    Mike Sax, I meant that the UK has run bigger budget deficits. I recall Krugman praising Gordon Brown’s fiscal stimulus. I did a post on Britain a few days ago, check it out.

    You said;

    “That hardly means that there were good reasons for it falling out of favor. Now it is less out of favor, so what? Reminsiicing about the good old days when you and your freshwater pals would giggle about Keynesian arguments in class proves nothing.”

    Just like Kevin (above) you didn’t read my comment carefully. See my reply to Kevin.

    And you are behaving like a 4th grader again. BTW, I’m not a “freshwater economist” that you think I am tells me you are way over your head trying to read my blog.

    Kevin, Yes, I’m not a new Keynesian. I meant to ask if there is any reason why Keynesians should go back to old Keynesianism, and abandon inflation targeting or the Taylor Rule. Fiscal stimulus plays no role under those monetary regimes.

    123. I don’t recall the data on the monetary base. Is it higher today than before IOR?

    In any case, just because other policies are a mistake (like making currency injections temporary) doesn’t mean that IOR isn’t also contractionary.

    But I agree with your general point that in the absence of IOR the Fed might have found some other way to fail.

    RN, You said;

    “They don’t think ALL who oppose fiscal stimulus are fools. Just some of you.”

    M.S. includes me in that group, are you surprised I’d criticize him? Which opponents of fiscal stimulus does he praise?

    I never said universities have opinions, so that comment is rather idiotic, in my view.

    The zero bound does not prevent expansionary monetary policy. Read Krugman’s papers on the Japanese zero bound problem.

  45. Gravatar of Potpourri Potpourri
    7. February 2012 at 07:42

    [...] A nice post from Scott Sumner blasting Keynesians. (I love Scott like a customer service representative, by the [...]

  46. Gravatar of 123 123
    7. February 2012 at 09:26

    Scott: “I don’t recall the data on the monetary base. Is it higher today than before IOR?”

    Yes. There is a 5 year chart available at the bottom of this link:
    http://www.bloomberg.com/apps/quote?ticker=JNMBMOB:IND
    The base is now higher than in 2005.

  47. Gravatar of Major_Freedom Major_Freedom
    7. February 2012 at 09:39

    Ben Wolf:

    “Assets held by the Fed effectively do not exist because they are removed from circulation.”

    The money they created does exist, even it is not in circulation.

    “The reserves swapped for the assets do not and cannot increase the money supply or generate inflation.”

    They do in fact increase the money supply, since reserves can be used to purchase assets, goods and services, they do generate inflation, which is the whole reason for the Fed existing the first place.

    “I should think this would be obvious from a 2000% increase in reserves since 2007 without corresponding monetary inflation.”

    You’re talking about price inflation. I was talking about increase in the money supply inflation.

    The price inflation that has taken place is higher than what it otherwise would have been absent the 2000% increase in reserves. At all times, these reserves have the potential of generating credit expansion, and for the last 3.5 years, they have been. Producer prices are way up, consumer prices are way up, and we’re supposed to believe the increase in reserves had nothing to do with this?

    “Bank reserves and their uses are entirely endogenous to the banking system and have no channel to the real economy because they do not affect lending, which the Fed has already acknowledged.”

    The Fed can’t “acknowledge” a fallacy as if it’s true.

    Bank reserves are the fuel that allows the banks to generate credit expansion. The “channel” is by way of ensuring that overnight lending is available at low rates through expanding bank reserves, despite an increase in rates that would otherwise take place if the Fed stopped increasing bank reserves and banks kept expanding loans ex nihilo. Banks that expand loans ex nihilo will at some point reach a limit to further expansion, because any more and they won’t have enough money on hand to fulfil their liabilities that are created by expanding loans.

    This is why the major banks in the early 20th century wanted a central bank. They wanted a central bank to enable all bank branches to inflate together while continually being backstopped by central bank inflation.

    Your knowledge of how central banking works is based on a lie.

    “All quantitative easing does is swap highly liquid financial assets (reserves) for somewhat more illiquid (bonds).”

    That is inflation. The Fed creates new money that did not exist before to purchase bonds. It’s misleading to call this a “swap” only. The additional reserves are what enable the banks to continually expand their loans.

  48. Gravatar of Kevin Donoghue Kevin Donoghue
    7. February 2012 at 12:49

    “I meant to ask if there is any reason why Keynesians should go back to old Keynesianism, and abandon inflation targeting or the Taylor Rule. Fiscal stimulus plays no role under those monetary regimes.”

    I’m no NK expert but I gather that models using a Taylor Rule get a bit tricky when the ZLB is binding; there is more than one steady state, hence the rational-expectations solution isn’t unique. It’s not true to say that people like Simon Wren-Lewis have gone back to Old Keynesianism. With very few exceptions, they didn’t come from there in the first place. Granted, some ideas they have are very reminiscent of Old Keynesians. But so what? When people face similar problems they tend to find similar solutions.

  49. Gravatar of Ben Wolf Ben Wolf
    7. February 2012 at 12:52

    @Major_Freedom

    Firstly we must understand that banks do not loan money. All they do is clear a large payment in exchange for a series of smaller payments from the “borrower”. This creates an asset (the loan) and a liability (the deposit). The two net to zero and as the loan is repaid the dollars literally cease to exist. In addition the borrower pays interest to the bank, which in turn pays some interest to the Federal Reserve on the reserves it used to clear the original transaction. The end result is that bank loans are a net DRAIN on the money supply. If government did not intervene to replace the financial assets the real economy would be starved for financial wealth as the private sector repaid its debts.

    “The price inflation that has taken place is higher than what it otherwise would have been absent the 2000% increase in reserves. At all times, these reserves have the potential of generating credit expansion, and for the last 3.5 years, they have been. Producer prices are way up, consumer prices are way up, and we’re supposed to believe the increase in reserves had nothing to do with this?”

    The inflation rate (in line with the post-WWII average) we’ve been experiencing is almost entirely due to the cost-push from oil prices which have continued to drive price increases throughout the economy. There was also a small speculative boom in response to QE: traders mistakenly believed this meant the Fed was printing money, and when a trader hears this he starts buying. The inflation of couse did not materialize and those who acted on that belief ended up taking losses. To my knowledge no ne has been able to demonstrate a link between our reserve levels and inflation.

    The Fed study I linked cannot simply be dismissed. There is no demonstrable correlation between reserve levels, loans and the money supply. In fact the only way the Fed CAN add financial assets to the real economy is by making loans and deliberately taking losses.

  50. Gravatar of Major_Freedom Major_Freedom
    8. February 2012 at 09:54

    Ben Wolf:

    “Firstly we must understand that banks do not loan money.”

    What universe are you living in? Of course banks loan money.

    “All they do is clear a large payment in exchange for a series of smaller payments from the “borrower”.”

    Putting “borrower” in quotes gives the impression that you deny that they exist.

    When you say “clear a large payment”, that is loaning money in the form of new fiduciary media. It’s legal tender. It’s universally accepted. Using different words to describe the process doesn’t change the nature of the process.

    “This creates an asset (the loan) and a liability (the deposit). The two net to zero and as the loan is repaid the dollars literally cease to exist.

    So now the loan exists?

    Yes, the nature of FR loans is that once the debt is paid, the fiduciary media ceases to exist, and thus the total supply of money is reduced by the size of that loan. The same thing occurs through bank failures, and debt defaults. It’s why fractional reserve money based systems like ours are so precarious and subject to sudden monetary deflation.

    “In addition the borrower pays interest to the bank, which in turn pays some interest to the Federal Reserve on the reserves it used to clear the original transaction.”

    Isn’t interest paid on….loans? Which you first said the banks don’t do, and then you said they did do?

    “The end result is that bank loans are a net DRAIN on the money supply.”

    Only after being a net INFLATION on the money supply by virtue of it being created before.

    “If government did not intervene to replace the financial assets the real economy would be starved for financial wealth as the private sector repaid its debts.”

    It would just put the economy’s money supply back to where it was prior to the loan. If the “economy would be starved” (nice analogy by the way, you make it seem like the economy is a hungry beast that needs to be satiated by mommy and daddy government) through a transition back to the previous money supply after the loan was extinguished, then why isn’t it “starving” prior to the loan and why didn’t the economy “require” mommy and daddy government then?

    The economy does not need credit expansion, Ben. The economy can grow to practically unlimited heights by being financed through real savings only. Without credit expansion, and with only real savings backed loans, all that will happen is that the prices of whatever is purchased with loan money will be lower. Lower prices than the status quo is not destructive. If prices gradually fall through productivity, then there is no negative pressure on profits or employment. The real economy can grow along side the growth in the money supply through means other than credit expansion. To believe that money has to grow as the real economy grows, is to not understand anything about the nature of money. If you aren’t partial to theory, then just look at the mid to late 19th century. The supply of gold was very stable, and yet the real economy grow by leaps and bounds as production lead to a healthy fall in prices.

    I said: “The price inflation that has taken place is higher than what it otherwise would have been absent the 2000% increase in reserves. At all times, these reserves have the potential of generating credit expansion, and for the last 3.5 years, they have been. Producer prices are way up, consumer prices are way up, and we’re supposed to believe the increase in reserves had nothing to do with this?”

    You said: “The inflation rate (in line with the post-WWII average) we’ve been experiencing is almost entirely due to the cost-push from oil prices which have continued to drive price increases throughout the economy.”

    Cost-push inflation is a chimera. The inflation rate we have been experiencing is due ENTIRELY to the increase in the supply of money and volume of spending.

    In the absence of an increase in the supply of money and volume of spending (let’s hold it constant for a moment to isolate the effects of a rise in the price of oil), then should the demand for oil rise, then it MUST accompany a fall in demand elsewhere in the economy. In an economy with unchanged money supply and volume of spending, people can’t increase their demand for one thing without reducing their demand for other things. People can only provide one set of demands with a given dollar. If then the demand for things other than oil falls, then there is nothing present to increase those prices. The prices of other things can’t remain constant unless there is a new demand to replace the lower demand that was formed on account of the higher demand for oil.

    If then the price of oil rises, and everything else rises as well, then it MUST be the case that either aggregate supply fell (which is definitely not the case since WW2), or there was an increase in aggregate money spending, i.e. inflation.

    “There was also a small speculative boom in response to QE: traders mistakenly believed this meant the Fed was printing money, and when a trader hears this he starts buying.”

    QE is in fact “printing” money. Traders who understood it to be printing money and correctly forecasted future demand for money holding, made a killing.

    “The inflation of couse did not materialize and those who acted on that belief ended up taking losses.”

    Of course the inflation materialized. Producer prices are higher than they otherwise would have been, stock prices are higher than they otherwise would have been, consumer prices are higher than they otherwise would have been. What are you talking about “inflation of course did not materialize”? Are you saying a 2000% price inflation did not materialize? Who ever said that an increase in the supply of money must immediately increase prices from one period of time to the next? The correct interpretation of the quantity theory of money isn’t about temporal prices changes, it’s about the logical relationship between quantity of money, demand for money, and aggregate prices. It’s not a prediction, because we cannot predict how much money Ben CTRL-P Bernanke will print in the future, and we cannot predict what the demand for money will be in the future.

    “To my knowledge no ne has been able to demonstrate a link between our reserve levels and inflation.”

    Well then your knowledge is sorely lacking.

    “The Fed study I linked cannot simply be dismissed. There is no demonstrable correlation between reserve levels, loans and the money supply.”

    You mean there is no constancy relation between money supply, demand for money holding, and prices. That I will agree with. Sometimes an increase in the supply of money is hoarded, sometimes it is spent. There is no constancy because it depends on knowledge and human choice. But what we can say that refutes what you said above, is that IF there is a sustained, general increase in prices, then provided there is no sustained decrease, general decrease in supply, then the ONLY explanation for the rise in prices is inflation of the money supply, which includes base money, reserve money, fiduciary media money, the sum total of all money that can be used for making exchanges.

    “In fact the only way the Fed CAN add financial assets to the real economy is by making loans and deliberately taking losses.”

    The Fed taking losses will never make it go bankrupt. It can print money for itself.

  51. Gravatar of ssumner ssumner
    8. February 2012 at 14:32

    123, My hunch is that the IOR was a net negative, but offset by other factors like larger asset purchases.

    Kevin, You may be right. I recall that prior to 2007 the BOJ was widely viewed as incompetent. It seems to me there’s a double standard, with great sympathy for Bernanke among many economists, who were the same ones who thought the BOJ was simply refusing to do what needed to be done. What makes this even more dismaying is that Bernanke still insists he has lots of ammo, so we aren’t even taking him at his word.

    Obviously your view is more widespread than mine, but the BOJ situation was widely understood prior to 2006. If the conventional wisdom circa 2012 is correct, then the profession was grossly incompentent for not taking the Japanese case more seriously, and developing a backup plan for how to operate at the zero bound. And by back up plan I mean alternative monetary regime, not fiscal stimulus. At a minimum, a higher inflation target.

  52. Gravatar of andrew andrew
    8. February 2012 at 23:43

    Mr. Sumner, I agree that the current “Keynesian vs. Neoclassical” breakdown is too simplistic, but I think your suggestion doesn’t go far enough:

    There are Keynesians, Neo-Monetarists, Neoclassicals, and the Austrians.

    I believe that the Keynesians and Neo-Monetarists are like the Men and Elves united against the Orcs and Uruk-Hai of Mordor.

  53. Gravatar of Curt Doolittle Curt Doolittle
    9. February 2012 at 06:35

    @andew is right

    There are four competing groups: Keynesians, Neo-Monetarists, Neoclassicals and Austrians. These four groups describe a spectrum of policy recommendations from the short term tactical to the long term and systemic.

    It is not impossible that ALL FOUR ARE RIGHT. It is actually likely that all four are right. It is simply unlikely that we can create a political system that can implement policy along that spectrum.

    It is possible to CONCEIVE of a political system that will make use of the entire spectrum of tools. It’s just not practically possible to implement it.

    Why? Because the short term tactical approach favors consumption and redistribution while the long term favors innovation and concentration. And without a systemic and procedural means of balancing those two political extremes, it is not possible for the different advocates to compromise on policy.

    A thought experiment: Let’s pretend we have four houses of government that roughly correspond to ‘The Fiscal House (Keynesians)’, ‘The Monetary House’ (Monetarists), ‘The Industrial Policy House’ (neoclassicals), and the ‘Human Capital House’ (Austrians). And we have an executive branch that can only execute bills that are approved by all four houses. These houses cannot create laws in the sense that they cannot create binding obligations over the long term. They can only ‘print’, borrow, and allocate fixed amounts of money over fixed time periods with defined dates of conclusion. In that model, all four houses would have to compromise with one another in order for policy to be enacted.

    The reason the different camps cannot agree on policy is that each side is actually trying to constrain the other and can only do so by advocating their methodology at the extremes.

  54. Gravatar of Curt Doolittle Curt Doolittle
    9. February 2012 at 07:03

    Scott,

    Well, I’m in the middle of the Monetarist-Neoclassical-Austrian spectrum and I agree with the Monetarists and objects to the Keynesians.

    The unstated argument here is that:

    1) The American people do not trust their government. All spending is suspect. And they would rather suffer in order to starve the beast than gain relief by feeding it. This isn’t going to change any time soon. Demographics guarantee it. Tilting at windmills is a waste of time.

    2) The monetarists failed to make their case with the public. If the monetarists DID make their case with the public by stating that they would in no way expand the government, the public would have endorsed it. I blame this failure entirely on the monetarist public intellectuals who allied with the Keynesians instead of the Neo-classicals (improve industry) and Austrians (improve human capital) with whom most Americans are more sentimentally aligned – puritan ethics prevail..

    3) The public is justifiably angry at the financial sector as well as the government. Galbraith, myself, and to some abstract degree Arnold Kling, recommended that bypassing the financial sector entirely and paying down consumer debts was a radical idea, but would have won the hearts and minds of the citizenry, as well as avoiding worldwide price recalculation within the Patterns of Sustainable Specialization and Trade, which is the result of the shock to people’s ability to forecast and plan. (I dont think anyone appreciates the value of Kling’s arguments as adding another tool to the neoclassical inventory.) This was a better solution than the Keynesian OR Monetarist solutions. And it would have astronomically cheaper.

    Keynesian spending only works if people trust the government and people only trust the government in small culturally and ethnically homogenous nation states. Monetarists SHOULD be politically neutral, but by allying with Keynesians they become untenable with the public. By allying with Neo-classicals and Austrians Monetarists can become politically neutral, and the public will accept their recommendations.

    The importance of this concept is significant – not only for monetarists, but for the country as a whole. Perhaps for the world.

  55. Gravatar of ssumner ssumner
    10. February 2012 at 08:52

    Andrew, Good analogy.

    Curt, Too much to fully address there, but I agree that there is some truth in each of the perspectives. Obviously I prefer the market monetarist approach. I have other posts that touch on those issues you raise.

  56. Gravatar of josh josh
    12. February 2012 at 14:51

    “But the US has its own currency, so we really ought to be compared to other developed countries with their own currency. How about Japan, Australia, Canada, Britain, Sweden, Poland, etc? Japan’s a special case that looks really good with unemployment and really bad in terms of growth.”

    I think the effectiveness of a stimulus would depend on the savings rate and trade account. A country with a higher savings rate would have much more room to stimulate consumption. In a country with a trade surplus a stimulus would be more impactful than a country with a trade deficit. All of the listed countries either had high savings rates or large trade surpluses. The United States and the United Kingdom were unusual in that they had both an exceptionally low household savings rate (close to zero during the peak of the bubble in the US) and a large trade deficit. Whereas in countries like Canada households reduced their savings rate, households in the United States increased their savings rate from around zero to around 5%, a decrease in consumption of about 750 billion a year.

    For a smaller economy, like Sweden, they can concentrate a higher percentage of their workforce in high growth areas, whereas the US is a much more diversified economy.

    Poland isn’t really a developed country. Its GDP per capita is only $13,000, which is well less than half of the GDP per capita of any of the other countries you listed. They are growing fast, but I don’t think they are comparable to those other countries.

  57. Gravatar of ssumner ssumner
    13. February 2012 at 11:58

    Josh, The Polish figures are higher in PPP terms, but I accept your point.

    Not sure about how the trade deficit relates to the Keynesian model. I wasn’t under the impression that it affects the multiplier, but I don’t follow all the recent developments in Keynesianism very much. When Obama was proposing stimulus in early 2009 I don’t recall lots of Keynesians saying it wouldn’t work well because of our trade deficit.

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