This will be lots of fun for me. And just so people don’t scold me in the comment section, first read the following disclaimer:
Disclaimer: As you know, DeLong and Waldmann like to ridicule me in their posts. Here’s what you don’t know:
1. They’re just kidding.
2. I enjoy receiving their attacks just as much as they like making them.
3. They’re going to enjoy my ridicule just as much as I enjoy theirs.
For them, it’s all fun and games–intellectual jousting. I’m sure Brad and John Yoo have a beer after work every Friday night. Well, perhaps I should say it’s usually joking around. But I figure anything that doesn’t kill me makes me stronger. Last time Krugman responded to my criticism Ryan Avent pointed out that Krugman’s response actually supported my point. And after reading the recent posts by DeLong and Waldmann, I feel like Hercules.
Let’s start with Robert Waldmann, who responded to my argument that both Keynes and Krugman unfairly characterized their opponents:
So to Keynes unemployment due to nominal wage rigidity and unemployment due to collective bargaining were ‘voluntary’ unemployment. The quotes are not scare quotes. He is quoting other economists (principally Pigou) and he uses the word with that sense throughout The General Theory of Employment, Interest, and Money.
This means that self declared “New Keynesians” would be called “classicals” by Keynes.
For the moment, let’s put aside Keynes’s patently absurd assertion that unemployment caused by sticky wages is “voluntary,” and instead focus on Waldmann’s argument that new Keynesian economists would be considered classicals by Keynes. I agree. Waldmann continues:
However, it shows reckless disregard for the truth to claim that what Keynes wrote about the classicals was dishonest, because those classicals were essentially New Keynesians. It is equally reckless to say that what Krugman wrote “the other side in this debate generally adheres, more or less, to something like what Keynes called the “classical theory“ of employment, in which employment and output are basically determined by the supply side. ” is dishonest.
He specified that he meant what Keynes called “the classical theory” making it clear to anyone with normal linguistic skills (including Gricean maxims) that other people use the phrase with another meaning. And that and gave a link which no one could be expected to actually click since Krugmanhas only occasionally stressed that the links are not decorative (indeed maybe only once).
Now everyone is sloppy sometimes. But Sumner was reckless and sloppy when accusing others of intellectual integrity and has earned some quiet time.
Gricean maxims–I’ll have to remember that one. OK, let’s say that when Krugman uses the term “classicals” as a pejorative, he actually has a category in mind broad enough to include new Keynesians. This morning Krugman showed his gratitude for Waldmann’s valiant defense by describing his own economic philosophy as follows:
For the record, I tend to think things through in terms of New Keynesian models, as in my old Japan paper, but often translate the results into IS-LM for simplicity. If that’s a crude, primitive approach, somebody should tell Mike Woodford.
Ouch! Maybe next time Krugman, DeLong, and Waldmann should coordinate their talking points before going after me.
OK, enough sarcasm. Why did I say Keynes’s attack on Pigou was indefensible? Oddly enough, Waldmann provides the smoking gun, when he quotes Keynes as follows:
The classical school reconcile this phenomenon with their second postulate by arguing that, while the demand for labour at the existing money-wage may be satisfied before everyone willing to work at this wage is employed, this situation is due to an open or tacit agreement amongst workers not to work for less, and that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. If this is the case, such unemployment, though apparently involuntary, is not strictly so, and ought to be included under the above category of ‘voluntary’ unemployment due to the effects of collective bargaining, etc.
Keynes’s language may be a bit opaque for the modern reader, so it might take a moment for the utter absurdity of this statement to sink in. Ironically, I didn’t even have to emphasize the nutty part; it’s already bolded in the quotation Waldmann provides. Here’s what Keynes is saying: Assume a nominal shock has reduced the price level by 10%. In if a concerted agreement by all workers to cut their wages by 10% could produce full employment, then any unemployment associated with the lack of such agreement is “voluntary.” You might think; “Well, that’s a weird definition of voluntary; obviously the individual worker in a giant auto factory can’t single handedly do anything about this problem, but maybe Keynes used the term “voluntary” in an idiosyncratic fashion.” No such luck, as we see from a quotation just a bit further on in the chapter cited by Krugman and Waldmann:
Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment “” if there be such a thing (and who will deny it?). The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight “” as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.
Now Keynes is essentially saying “look around you; isn’t it obvious there is involuntary unemployment?” Um, no. Not unless you define “involuntary” in the way 99.9% of humanity would define it, i.e. as unemployed workers who are miserable and who would much rather be back at work. But of course that sort of involuntary unemployment is very possible when wages are rigid in the aggregate. It seems even the great John Maynard Keynes suffers from an occasional failure to adhere to Gricean maxims. So Keynes uses extremely deceptive language in one section, understanding that no sane person can follow the impenetrable logic of the General Theory, and then uses a few choice bon mots to make Pigou look like a fool. For those of you who don’t know, Pigou spent much of his career studying unemployment, so I imagine he wasn’t enthused by Keynes’s deeply disingenous remarks. BTW, someone in the comment section said Keynes later acknowledged that he’d been unfair to Pigou in the GT, can anyone provide the citation? I hope Waldmann will accept that apology if it is true, and I’m hoping he doesn’t maintain Krugman was temporarily insane when he referred to his own macro model as “New Keynesian.”
Brad DeLong probably had the good sense to understand that my attacks on Krugman were accurate, and so he mostly tries to change the subject, or point out which parts of Krugman’s criticism of the right were accurate. (And BTW, some of Krugman’s attack was accurate, as I acknowledged.)
I think Sumner oversteps here: Hawtrey and Hayek were definitely in the Eugene Fama camp. (Hawtrey changed his mind.) I don’t believe Keynes classified Fisher and Wicksell as “classical” economists. But I do agree with Scott that Pigou and Cassel have a legitimate beef.
Unfortunately, I haven’t had the good fortune to study Fama’s theories of macro, so I don’t quite know what this means. But based on the criticism he got, I believe his faux pas was denying that fiscal stimulus could boost aggregate demand. If so, that has no relevance for my accusation that Keynes falsely accused his contemporaries of ignoring the problem of unemployment. It’s one thing to argue that fiscal stimulus fails to boost AD, and quite another to argue that higher AD fails to boost employment. As I recall, both Hawtrey and Hayek understood that fluctuations in AD (or nominal spending, or whatever it was called in the 1920s) did in fact affect employment. Hawtrey’s (1946) book on the Great Depression is still the most accurate explanation of what went wrong, and yet is a very non-Keynesian book. Hayek warned that “secondary deflation” could cause unemployment. Their views on fiscal stimulus may have been primitive, but that has no bearing on my argument.
DeLong continues by quoting me:
What I find more worrisome is Sumner’s assessment of the current debate:
“In his recent post Krugman has misrepresented the views of those he disagrees with in much the same way that Keynes did. I’ve read most of the economists that he ridicules (except Fama), and they do not believe that nominal shocks have no short run real effects. There are debates about whether it is most useful to think about nominal shocks as being essentially monetary, or due to Keynesian expenditure shocks, and there are also disputes about how much of the unemployment in the current recession is due to insufficient AD and how much is due to structural problems. For instance, Cochrane holds NGDP constant when evaluating fiscal stimulus, as he assumes changes in NGDP are a monetary policy issue…”
To “hold nominal GDP constant when evaluating fiscal stimulus” is to go the full Treasury View. That’s one.
Sumner gives up on Fama. That’s two.
Actually, I said I never read Fama, not that I gave up on him, so I don’t see how Fama’s views are relevant to the accuracy of my criticism of Krugman. I don’t know precisely what the “full Treasury view” is, but here’s what Cochrane said in the paper that was ridiculed by Krugman and DeLong:
My first fallacy was “where does the money come from?” Well, suppose the Government could borrow money from people or banks who are pathologically sitting on cash, but are willing to take Treasury debt instead. Suppose the government could direct that money to people who are willing to keep spending it on consumption or lend it to companies who will spend it on investment goods. Then overall demand for goods and services could increase, as overall demand for money decreases. This is the argument for fiscal stimulus because “the banks are sitting on reserves and won’t lend them out” or “liquidity trap.”
In this analysis, fiscal stimulus is a roundabout way of avoiding monetary policy. If money demand increases dramatically but money supply does not, we get a recession and deflation. If we want to hold two months of purchases as money rather than one months’s worth, and if the government does not increase the money supply, then the price of goods and services must fall until the money we do have covers two months of expenditure. People try to get more money by spending less on goods and services, so until prices fall, we get a recession. This is a common and sensible analysis of the early stages of the great depression. Demand for money skyrocketed, but the Fed was unwilling or, under the Gold standard, unable, to increase supply.
This is not a convincing analysis of the present situation however. We may have the high money demand, but we do not face any constraints on supply. Yes, money holdings havejumped spectacularly. Bank excess reserves in particular (essentially checking accounts that banks hold at the Federal Reserve) haveincreased from $2 billion in August to $847 billion in January. However, our Federal Reserve can create as much more money as anyone might desire and more. There is about $10 trillion of Treasury debt still outstanding. The Fed can buy it. There are trillions more of high quality agency, private debt, and foreign debt outstanding. The Fed can buy that too. We do not need to send a blank check to, say, Illinois’ beloved Governor Blagojevich to spend on “shovel-ready” projects, in an attempt to reduce overall money demand. If money demand-induced deflation is the problem, money supply is the answer.
Some people say “you can’t run monetary policy with interest rates near zero.” This is false. The fact of low interest rates does not stop the Fed from simply buying trillions of debt and thereby introducing trillions of cash dollars into the economy. Our Federal Reserve understands this fact with crystal clarity. It calls this step “quantitative easing.” If Fed ignorance of this possibility was the problem in 1932, that problem does not face us now.
Of course Krugman and DeLong “forgot” to quote that passage, as it would have spoiled their perfect “gotcha” moment. As for the merits of the argument, all I can say is if that’s the “full Treasury view” then count me in. (I had thought that the Treasury view was a denial that fiscal policy could boost AD, but I admit that my knowledge of the history of economic thought is more superficial than DeLong’s, so I may be mistaken on that point.) As an aside, I do think Cochrane’s article was poorly organized, but that’s another issue.
The others whom Krugman mentions are Mulligan, Ferguson, Meltzer, and Laffer. Krugman is completely right about Mulligan and Ferguson. I don’t think Laffer has a coherent model of the economy at all. The only one of the six whom Krugman “ridicules” for whom Sumner has a case is Meltzer. And when I look back at Meltzer’s piece:
Notice what DeLong does, just because Mulligan and Ferguson might have been wrong about something, he assumes it somehow proves that my criticism of Krugman was unjustified. OK, someone produce the Ferguson and Mulligan quotations that say severe AD shocks have zero effect on employment. Laffer is a supply-sider who doesn’t place enough emphasis on demand shocks, in other words the exact opposite of DeLong and Krugman. But unless my memory is faulty, he never argued the SRAS curve is vertical. Meltzer’s views on money are similar to those of Milton Friedman, so I’d say that I have something more than “a case.” Notice how DeLong changes the subject, and quotes a Meltzer passage where he overreacted on the bulge in the money supply. Last year I also criticized Meltzer in my blog, and argued that Krugman would be proved right (as he was.) Of course none of this has anything to do with my claim that Krugman falsely accused the right of believing that demand shocks don’t have any effect. And that’s it, there’s no actual evidence that any of my assertions were wrong, just smoke and mirrors.
DeLong ends as follows:
So, Ezra, believe Paul.
Yes, if you want to stay in the cocoon of liberals who tolerate no criticism of Krugman but have fun calling right-wing intellectuals fools and knaves, then you should believe Paul. If’ you prefer to emulate people like Matt Yglesias, who actually do try to occasionally understand the alternative point of view, I’d suggest getting outside that warm and cozy cocoon.
It seems like every time I criticize Krugman, others leap to his defense—and that just drives more traffic to my blog. So let’s see what we can find in today’s Conscience of a Liberal. How about this:
In the 1930s, competitive devaluation mattered largely because a number of countries were still on the gold standard, and were keeping interest rates well above the zero lower bound in an attempt to preserve their gold reserves. Devaluation relaxed this constraint by making the gold worth more in domestic currency, and hence was expansionary.
Actually, that’s not why devaluation worked. The case I am most familiar with is the US, which devalued in 1933. The gradual depreciation of the dollar sharply raised prices, but not because of interest rates or the money supply (which didn’t change much.) Rather dollar depreciation led to expectations of a future expansion in the money supply once gold was fixed at a higher price. Commodity prices rose immediately, due to both PPP and expectations of higher future prices.
The most famous example of a liquidity trap (albeit not called that at the time) was the spring 1932 OMOs, which failed to boost AD. This was the only example cited by Keynes in the General Theory. Krugman once cited Keynes’s views on monetary policy ineffectiveness when criticizing Milton Friedman:
Now, a word about Japan. During the 1990s Japan experienced a sort of minor-key reprise of the Great Depression. The unemployment rate never reached Depression levels, thanks to massive public works spending that had Japan, with less than half America’s population, pouring more concrete each year than the United States. But the very low interest rate conditions of the Great Depression reemerged in full. By 1998 the call money rate, the rate on overnight loans between banks, was literally zero.
And under those conditions, monetary policy proved just as ineffective as Keynes had said it was in the 1930s. The Bank of Japan, Japan’s equivalent of the Fed, could and did increase the monetary base. But the extra yen were hoarded, not spent. The only consumer durable goods selling well, some Japanese economists told me at the time, were safes. In fact, the Bank of Japan found itself unable even to increase the money supply as much as it wanted. It pushed vast quantities of cash into circulation, but broader measures of the money supply grew very little. An economic recovery finally began a couple of years ago, driven by a revival of business investment to take advantage of new technological opportunities. But monetary policy never was able to get any traction.
In effect, Japan in the Nineties offered a fresh opportunity to test the views of Friedman and Keynes regarding the effectiveness of monetary policy in depression conditions. And the results clearly supported Keynes’s pessimism rather than Friedman’s optimism.
Actually, Keynes and Friedman were both wrong, the problem in the US during 1932 was the gold standard. The failure of the OMOs was due to an outflow of gold, due to devaluation fears. So Krugman’s right about that—the gold standard was the problem. But it’s wrong to look at this problem through the lens of interest rates, unless you want to argue that devaluation lowered real interest rates by raising inflation expectations. And of course Japan never had any inflation because the BOJ raised rates any time inflation rose to 0%, thus driving the economy right back into mild deflation. There’s no “trap” involved at all.
On the other hand Krugman’s right that competitive devaluations would be essentially like a coordinated policy of QE.
BTW, nice parrot Brad.
Tags: Brad DeLong