Go bother Karl Smith for a while

God bless Karl Smith!  If you don’t know, he’s one of the brightest and most respected econ bloggers, and he’s not an ideologue.

And he just endorsed my argument on consumption smoothing.  So I’m done.  If you have complaints, go put them in his comment section.  I shouldn’t have to carry the whole burden of Krugman attacks constructive debate for the entire right wing blogosphere.  My email box has so many comments spread out over multiple posts that I can hardly find my “important” emails from friends and co workers (Just kidding, comments are also very important to my blog.)

I’ll go back and read all the old comments today, but won’t respond to most.  If you really have something important, put it in the comment section of the “points 1-5” post.  But recently I’m just seeing people throw mud and hoping something sticks.  There are ground rules for comparative statics, and I think Paul Krugman, Wren-Lewis, Karl Smith and I basically agree on these rules.

My goal in the entire exercise was to bring Krugman and Wren-Lewis down from 100 to 50, and raise Cochrane up from 0 to 50.  I’ve completed the first project, now on to the second:

Here are some quotations from a John Cochrane paper that allegedly showed he didn’t understand Keynesian economics:

One form of “fiscal stimulus” clearly can increase aggregate demand. If the government prints up money and drops it from helicopters, this action counts as fiscal stimulus, since the money counts as a transfer payment.  In practice, our Treasury would borrow the money, and use it for tax rebates, subsidies, bailouts, or any of the many ways that our government sends people checks. Then the Federal Reserve would buy up the debt with newly created money.  The result is the same: A trillion dollars more money in private hands, just as if it had been printed and dropped by helicopters.  People naturally don’t want to sit on a trillion dollars of extra cash. They spend it, first creating demand for goods and services, and ultimately inflation.

This is perhaps the only prediction that is utterly uncontroversial among economists. It is a standard last-resort economic prescription to avoid a deflation.

Not very controversial, but this is:

Most fiscal stimulus arguments are based on fallacies, because they ignore three basic facts.

First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending.  Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both . This form of  “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.

Second, investment is “spending” every bit as much as is consumption. Keynesian fiscal stimulus advocates want money spent on consumption, not saved.  They evaluate past stimulus programs by whether people who got stimulus money spent it on consumption goods rather than save it.  But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

Third, people must ignore the fact that the government will raise future taxes to pay back the debt. If you know your taxes will go up in the future, the right thing to do with a stimulus check is to buy government bonds so you can pay those higher taxes.  Now the net effect of fiscal stimulus is exactly zero, except to raise future tax distortions. The classic arguments for fiscal stimulus presume that the government can systematically fool people.

The central question is whether fiscal stimulus can do anything to raise the level of output.  The question is not whether the “multiplier” exceeds one – whether deficit spending raises output by more than the value of that spending. The baseline question is whether the multiplier exceeds zero.2

If you read his entire paper, here’s what he meant to say.  The first order effects, the DIRECT effects of moving money from A to B net out to zero.  You have more G, and less C+I.  You’d need some other indirect effects.  Like a change in velocity (i.e. real money demand.)

Point two is also slightly incorrect.  It’s not so much that Keynesians “want” more consumption, rather they “assume” investment is fixed, and that tax cuts will boost AD via more consumption, or else not at all.  That’s similar to my critique of Wren-Lewis, but not well stated.

If you think I’m just making excuses for Cochrane when I say (regarding point 1) that he was implicitly holding V fixed, consider the next quote:

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 of course a Nick Rowe-type argument.  But I’ve never heard anyone complain that Nick doesn’t understand Keynesian economics.  The problem isn’t too much saving; it’s too much demand for money.  And the fiscal stimulus works, if it works at all, by reducing money demand.  Cochrane made a big mistake by not making this an “except if” comment right after his point one on fiscal fallacies.

But Cochrane is less monetarist than me, and thinks we need both more money and more government debt:

In sum, there is a plausible diagnosis and a logically consistent argument under which fiscal stimulus could help:  We are experiencing a strong portfolio, precautionary, and technical demand for government debt, along with a credit crunch. People want to hold less private debt and they want to save, and they want to hold Treasuries, money, or government-guaranteed debt.  However, this demand can be satisfied in far greater quantity, much more quickly, much more reversibly, and without the danger of a fiscal collapse and inflation down the road, if the Fed and Treasury were simply to expand their operations of issuing treasury debt and money in exchange for high-quality private debt and especially new securitized debt.

Sounds like Brad DeLong.  I’d focus on money alone, not money and T-debt.  And DeLong and I are not as worried about inflation down the road.  But the basic point is right.  If there is a NGDP problem, then we should boost nominal spending through some sort of monetary policy and/or debt swap policy, don’t waste billions on government spending programs that would not have passed a simple cost/benefit test.  Again, here’s Cochrane:

My analysis is macroeconomic, and does not imply anything about the specific virtues or faults of the Obama team’s spending programs. If it’s a good idea to build roads, then build roads. (But keep in mind the many roads to nowhere, and ask why fixing Chicago’s potholes must come from Arizona’s taxes funneled through Washington DC.) If it’s a good idea for the government to subsidize green technology investment, then do it. (But keep in mind that the internet did not spring from industrial policy to improve the Post Office, the word processor did not come from a public-private consortium to rescue the typewriter industry, and that a huge carbon tax is much more likely to spur useful green ideas, and the only way to spur conservation.) The government should borrow to finance worthy projects, whose rate of return is greater than projects the private sector would undertake with the same money, spreading the taxes that pay for them over many years, after making sure its existing spending meets the same cost-benefit tradeoff.

Exactly.

To summarize,  I’m certainly not defending Cochrane in the sense of saying he’s right, rather that he’s wrong in much the same way as Krugman and Wren-Lewis were wrong.  They all clearly understand their models, but sometimes made statements that are overly simplistic, and not accurate as stated.  Cochrane also seemed unaware of the fact that although new Keynesianism had abandoned fiscal stimulus in recent decades, some new Keynesians did favor it during a liquidity trap.

But inconsistencies happen all the time.  Krugman often says that open market purchases don’t work at the zero bound, and often says he supports programs like QE2.

One of my very first posts compared macroeconomic debate to a Tower of Babel.  One reason we think our opponents sound so stupid, is we use completely different frameworks (money vs. expenditure) and a completely different language.  And thus end up talking past each other.  But a sympathetic reading of Cochrane shows he knows his stuff, but expressed himself in such a way as to drive Keynesians up the wall.  He’d do better trying to persuade them using their own framework.

And of course this is just one more reason why we should all try to be more like Tyler Cowen.


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70 Responses to “Go bother Karl Smith for a while”

  1. Gravatar of Cthorm Cthorm
    19. January 2012 at 07:50

    I’m sure Morgan is going to be happy to see you say this:

    “I shouldn’t have to carry the whole burden of Krugman attacks constructive debate for the entire right wing blogosphere.”

  2. Gravatar of Cthorm Cthorm
    19. January 2012 at 08:00

    On Cochrane’s point:
    “First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending.”

    I don’t understand why he doesn’t go further and say “Every dollar of increased government spending must correspond to AT LEAST one less dollar of private spending.” Maybe I’m wrong, but my understanding of economics says that taxes have predictable incentive effects and higher taxes result in increased dead-weight loss.

    The details of those effects and the dead-weight loss are specific to the type of tax imposed. Higher income taxes result in less income produced overall, consumption taxes result in less goods produced overall (both assuming no black market/under the table labor). The only tax I can think of that is theoretically exempt is a land-value tax.

  3. Gravatar of Lee Kelly Lee Kelly
    19. January 2012 at 08:14

    Just reading those quotes, I find little to disagree with. I think you’re right: Cochrane just expressed himself in a way that irks Keynesians. The cynic in me says that it only bothers Keynesians because it puts a less positive spin on fiscal stimulus.

  4. Gravatar of Morgan Warstler Morgan Warstler
    19. January 2012 at 08:33

    Slowly the worm turns!

    Ok, ok, first Karl Smith is great example of bloggyworld cred and math.

    Years ago there was a company that ran deep analytics around meme origination and viral spread. The idea being that all bloggers could be identified on any given subject, and though some read very little their ideas would travel farthest AND fastest. Idea here being that, good ideas quickly make up for small audiences, even if bloggers don’t become famous in process.

    I found Karl in there (Scott I found through Pappy). Karl is a preferred arbiter elegante – he should rename his blog.

    It is also why I despise the HT. All links should be to the first thought, not the guy who’s blog you read. Nothing sucks more to reader than having to click though 7 articles (I think 12 is my record0, to get to first article.

    —-

    Anyway, I wish to Kee-Ryst DeKrugman would just say that even if the multiplier is LESS THAN ZERO, he/Matty/Stiglitz/et al still want to do income re-distribution.

    Hook the man up to a FMRI machine and lets actually get down to brass tacks.

    Look, that’s the real question. The real motive for most of what “Keynesians” say is they want to take money (though tax now or taxes later) and give it to people who are losing the game.

    There are many motives for this desire, but this is their prime directive.

    I say this and say this, but is gets no play: ALL ECONOMIC THEORISTS including Keynes, Hayek, Fisher, even Sumner have “small print” that taketh away from the headlines that their supporters trumpet.

    Keynes theories say CLEARLY that from 1999-2012, public employees should have only gotten pay raises at inflation.

    That’s $500+ BILLION a year Keynes says public employees should not get paid.

    The PROOF that DeKrugman isn’t an economist is that he DOESN’T SUPPORT the small print of Keynes. Because when Keynes violates DeKrugman’s real motive, DeKrugman isn’t intellectually willing to force adherence on his own team.

    Scott has small print, and he’s slowly going getting to it.

    Note: after reading DeLong’s obit on Friedman I’m considering no longer abusing him with Krugman.

    Scott, I’d still like to see you get into Cochrane’s use of futures – it seemed to me he was seeing upside in who got the printed money first.

  5. Gravatar of Doc Merlin Doc Merlin
    19. January 2012 at 08:54

    lol

  6. Gravatar of Derek Young Derek Young
    19. January 2012 at 09:06

    I’m not accustomed to snorting out my coffee while reading economics blogs, but your headline pulled it off. 🙂

  7. Gravatar of ssumner ssumner
    19. January 2012 at 09:25

    cthorm, I agree with you about the disincentive effects of taxes. But economists like to analyze issues one at a time, separating out supply side and demand side effects.

    Lee Kelly, That may be part of it.

    Morgan, I agree about Smith being excellent.

    You said;

    “Scott, I’d still like to see you get into Cochrane’s use of futures”

    I think Cochrane got his futures targeting idea from me. I once emailed it to him, and he said he hadn’t seen it before.

    Thanks Derek and Doc.

  8. Gravatar of Dave Schuler Dave Schuler
    19. January 2012 at 10:30

    One thing: it’s the other way around. The question is why Chicago taxpayers should be paying to fill potholes in Phoenix and funneling the money through Washington. Arizona is a net recipient of federal spending; Illinois a net donor.

  9. Gravatar of Vivian Darkbloom Vivian Darkbloom
    19. January 2012 at 11:10

    I’m not qualified to know if Karl Smith is right or not. This I will say, though: his argument strikes me as quite civil. He didn’t even suggest that his opponents were idiots, or end with a condescending remark such as “this is very sad”. It usually pays to be a scholar *and* a gentleman even (no especially) when what one is participating is not a game.

  10. Gravatar of John Schultz John Schultz
    19. January 2012 at 11:39

    C: “Every dollar of increased government spending must correspond to one less dollar of private spending … This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.”

    That’s a damn strong statement and seems blatantly wrong as he himself later says:

    C: “… 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.”

    Much better! Too bad, Cochrane buried this way after he laid down seemingly universal statements about how tax financed stimulus can’t possibly work simply due to accounting.

    S: “The first order effects, the DIRECT effects of moving money from A to B net out to zero.”

    I disagree, because Cochrane assumes that A would have spent it or it would have been lent to someone who would have spent it. That is not necessarily the case when banks are holding something like ~$1T on reserve at the FED.

    S: “The problem isn’t too much saving; it’s too much demand for money. And the fiscal stimulus works, if it works at all, by reducing money demand … Cochrane made a big mistake by not making this an “except if” comment right after his point one on fiscal fallacies.”

    Yeah, maybe you have a clueless / crippled central bank like the ECB that refuses to step in when it should.

    The fact remains that fiscal stimulus can work in such a scenario, even according to some of the most “right wing” economists you care to find. So people should be very circumspect about trying to make near universal proclamations that it can’t ever work.

  11. Gravatar of BW BW
    19. January 2012 at 12:02

    Dave Schuler,

    That’s exactly right — cities and the blue coastal states essentially subsidize all the interior states and non-cities. This is a basic fact of American civics, one that pretty much all college students know. It is disconcerting that a prominent economist seems not to know this.

    That’s a big flashing neon sign telling us that Cochrane might not be functioning in the plane of reality.

  12. Gravatar of BW BW
    19. January 2012 at 12:17

    The “stimulus money has to come from somewhere” argument is so, so frustrating. Step away from the models and observe:

    ** There is a LOT of cash sitting idle at central banks in the form of excess reserves **

    That’s where the stimulus money comes from. And when this cash is diverted into government-mediated spending, aggregate demand increases.

    It’s really not hard. Cochrane’s unwillingness to observe the world around him (on display also in that mind-boggling quote about the money flow from Arizona to Chicago) is a first-order reason why his writings are so preposterous. Casey Mulligan exhibits the same problem, but to a much greater degree.

    It’s ironic that, in our current debate, the efficient market guys at Chicago routinely ignore market data in making their arguments, whereas Krugman can point to mounds and mounds of real-time market information to support his case. It’s just amazing to think that Cochrane still believes big inflation is around the corner, when long-term interest rates are telling us exactly the opposite.

  13. Gravatar of Jason Jason
    19. January 2012 at 12:26

    Cochrane suffers from a writing style plagued with big declarative statements. From a Finance person, these types of shock value statements are all over his textbook and Finance articles as well. Many are wrong upon further inspection but they always get you thinking if you try to understand them.

    My least favorite Cochrane statement of the sort was when he said “If expanding the money supply made countries prosperous, Zimbabwe would be the richest country on Earth” John Cochrane

    Sometimes, Cochrane is just wrong. This is said by someone whose favorite paper of the last 10 years was a paper published by John Cochrane.

  14. Gravatar of BW BW
    19. January 2012 at 12:45

    Jason, that Zimbabwe quip is yet another of the mind-boggling nonsense that pervades this article.

    I don’t think it’s a writing style, though. It’s evidence of deficient analytical reasoning. I’m not saying that Cochrane is *incapable* of doing better (I don’t know and I don’t care), but this sort of thing is unacceptable even for college students.

    Again, observation of the real world matters. There’s a massive difference between QE or fiscal stimulus and Zimbabwe — differences of kind and of magnitude. Cochrane’s statement is either dishonest (i.e. ignoring those differences while aware that they are vitally important) or remarkably foolish (can it be that Cochrane doesn’t see how different Zimbabwe is from the U.S.?).

    Defending this turd of an article isn’t going to end well for Scott. Maybe he’ll post 20,000 words and then declare victory after his critics depart out of exhaustion and boredom.

  15. Gravatar of johnleemk johnleemk
    19. January 2012 at 13:02

    John Schultz:

    “I disagree, because Cochrane assumes that A would have spent it or it would have been lent to someone who would have spent it.”

    As a matter of accounting, all income is either consumed or saved. S = I by definition and therefore all non-consumed income is invested and contributes to national income. So the first-order effect of transferring money from the non-government sector to the government sector is 0. There may or may not be a balanced budget multiplier as a matter of second-order effect.

    “The fact remains that fiscal stimulus can work in such a scenario, even according to some of the most “right wing” economists you care to find.”

    The problem is this: fiscal stimulus needs first and foremost monetary accommodation to have any hope of working. And if we are going to have monetary accommodation, why not try monetary stimulus? It literally costs nothing.

    Just as Keynesian economists implicitly assume I to be fixed, they also implicitly assume the stance of monetary policy is fixed at whatever is necessary to accommodate fiscal stimulus. But successful fiscal stimulus must by definition lead to inflation. And a central bank unwilling to tolerate or produce inflation (the two verbs are virtually synonymous in this case) will kill any fiscal stimulus enacted.

    BW:

    “That’s a big flashing neon sign telling us that Cochrane might not be functioning in the plane of reality.”

    Good job not responding to the question of why region A should contribute dollars to the federal government for region B to spend.

    “I don’t think it’s a writing style, though. It’s evidence of deficient analytical reasoning.”

    I would definitely say the same about Wren-Lewis and Krugman conveniently forgetting to mention the effect of I on national income, and about Keynesians generally assuming away the influence of monetary policy on aggregate demand. These instances of “deficient analytical reasoning” occur on both sides of the divide.

    Or, quoth Sumner, “[Cochrane is] wrong in much the same way as Krugman and Wren-Lewis were wrong. They all clearly understand their models, but sometimes made statements that are overly simplistic, and not accurate as stated.”

  16. Gravatar of Major_Freedom Major_Freedom
    19. January 2012 at 13:02

    John Schultz:

    C: “Every dollar of increased government spending must correspond to one less dollar of private spending … This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.”

    That’s a damn strong statement and seems blatantly wrong as he himself later says:

    C: “… 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.”

    John, those two passages do not contradict. He isn’t saying that if the government spends $100 more, that others will spend less out of the remaining pool of money available to be spent by someone. He is talking about the $100 the government spends. If the government spends $100, that means the private sector did not spend that same $100. That’s what he means by “crowding out” here.

    I think I now understand why you keep going astray. It’s because you’re taking the C+I+G=Y accounting relation and you are treating each variable as completely independent in the metaphysical sense, the way physicists do that in their physical equations. So when you consider something like G+100, you then keep it separate from all the other variables, and then ask “OK, given that we have G+100, it means government has 100 and is spending 100. So how will the other variables “react”? Will consumers take their money and spend more or less? Will investors take their money and invest more or less? Let’s make some assumptions like consumption smoothing or liquidity traps etc and see what happens.”

    You think in these confused terms, which then leads you to having to view each variable as always able to be boosted on its own, which of course is why you have to believe that people tend to hold too much cash.

    You can’t treat each variable as separate from the others in the metaphysical sense, such that if we have G+100, then we have to find out what consumers do what the money they have.

    You have to understand that the three “variables” are in fact interconnected. One can go up while another goes down, and not because they each react on their own, it’s because THE SAME MONEY can be used to raise one variable by being taken from another variable. So G+100 can occur, which in the accounting sense means C+I has to be -100. This is not because consumers and investors cut back on their consuming and investing using their own cash balances in response to the government on its own taking a separate 100 and spending it. It’s because if the government spends a $100 bill, it means the private sector cannot spend that same $100 bill. So if government spending is higher, then instantaneously it is the case that private sector spending is lower by an equivalent amount. Not over time, not in a sequential way. But in an accounting way.

    If you and I are the only ones who spend money, and I spend $100, it means you didn’t spend that $100, and so you spend $100 less than what you otherwise would have spent had you owned and spent the money instead of me.

    Now, whether you reduce your spending out of the money you have, AFTER I am in a position of spending the $100, is not what is meant by “Every dollar of increased government spending must correspond to one less dollar of private spending.” Cochrane is referring to the same $100 as having two facets, those who spend it, and everyone else who doesn’t spend it.

    The logic goes both ways, “Every dollar of increased private spending must correspond to one less dollar of public spending.”

  17. Gravatar of BW BW
    19. January 2012 at 13:20

    Johnleemk,

    “Good job not responding to the question of why region A should contribute dollars to the federal government for region B to spend.”

    Are you serious? It’s an inevitable consequence of spending by the federal government.

    Maybe it’s unjustified in the abstract to make people in NY pay for welfare recipients in Kansas (whether the recipient is ADM or a single mother of three). But money has to be collected from somewhere, and it is spent somewhere. Those two places are very unlikely to be the same.

    There is going to be geographic redistribution even if the government is as minimal as the most ardent libertarian would have it. Military bases are located somewhere. People from all over the country pay money to the government, which is spent in a few discrete places to the benefit of those local communities.

    In a complex economy with a modern administrative state, geographic redistribution is inevitably larger. The best way to reduce it, under the empirical conditions that hold in the U.S. in 2012, would be to index tax brackets to local cost of living. I await Cochrane’s proposal to that effect.

    The fact is that Chicago has been sending money to Arizonans for decades. Complaining that a stimulus package might slightly reduce that steady flow is vacuous — especially since it is not at all clear that the stimulus had that effect. I suspect, without looking at the data for lack of time, that the stimulus increased the cash flow from cities to non-cities and from rich blue states to poor red ones.

  18. Gravatar of RueTheDay RueTheDay
    19. January 2012 at 13:24

    “Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both.”

    Completely and totally false for an economy operating below capacity with idle real capital and unemployed labor. In such an economy, you absolutely can have both roads and factories. It is only in the case of an economy operating at capacity, with no idle capital or unemployed labor, that Cochrane’s tradeoff is real.

    This is exactly what Keynes meant when he said classical economists simply assumed full employment from the start and in so doing “assumed our difficulties away”.

  19. Gravatar of BW BW
    19. January 2012 at 13:27

    “I think I now understand why you keep going astray. It’s because you’re taking the C+I+G=Y accounting relation and you are treating each variable as completely independent in the metaphysical sense, the way physicists do that in their physical equations.”

    Yikes!! You are badly confused.

    In the equation C+I+G=Y, the variables C, I and G are completely independent.

    They become mutually dependent by the addition of other constraints or assumptions, such as S=I, C=C(Y-T), G = T – [Public Deficit], etc.

    That’s how economists do it, and physicists too.

  20. Gravatar of John Schultz John Schultz
    19. January 2012 at 13:29

    JLMK: “As a matter of accounting, all income is either consumed or saved. S = I by definition and therefore all non-consumed income is invested and contributes to national income. So the first-order effect of transferring money from the non-government sector to the government sector is 0. There may or may not be a balanced budget multiplier as a matter of second-order effect.”

    In national accounting where do excess reserves held at the central bank show up? I don’t think they show up at all. So, if the government can convince banks to give it some of those excess reserves in exchange for its bonds, then from which national accounting quantity was that money taken?

    That is, G goes up, what other variable goes down in a 1-to-1 fashion as a first, order direct effect?

    So, you saying S=I to me is a non-sequitur to what I said (which you didn’t quote): “That is not necessarily the case when banks are holding something like ~$1T on reserve at the FED.”

    JLMK: “The problem is this: fiscal stimulus needs first and foremost monetary accommodation to have any hope of working. And if we are going to have monetary accommodation, why not try monetary stimulus? It literally costs nothing.”

    Sure, to which I said:

    “Yeah, maybe you have a clueless / crippled central bank like the ECB that refuses to step in when it should.”

    I cede that a central bank can sabotage fiscal stimulus if it doesn’t like it.

    But then you also have places like europe where the ECB controls monetary policy for the whole continent, yet you have vastly different functioning national economies within it. In such a case, maybe Spain can engage in stimulative fiscal policy and the ECB doesn’t want to sabotage it because they’d have to whack Germany in order to counteract Spain.

    “Just as Keynesian economists implicitly assume I to be fixed, they also implicitly assume the stance of monetary policy is fixed at whatever is necessary to accommodate fiscal stimulus.”

    Two slanders against a whole class of people. Bravo!

  21. Gravatar of BW BW
    19. January 2012 at 13:31

    “This is exactly what Keynes meant when he said classical economists simply assumed full employment from the start and in so doing “assumed our difficulties away”.”

    Yep. This is why there is much truth when Krugman talks of a “Dark Age Of Macroeconomics.”

    Krugman just posted a whopper on his blog a little while ago. A massively overstated version of a directionally true statement. Sigh. He does that far less than his critics would have you believe, but if he didn’t do it at all, he would avoid adding fuel to the fire.

    Oh well. He is who he is, I guess.

  22. Gravatar of JimP JimP
    19. January 2012 at 13:32

    Calling Ben:

    Hey Ben – there’s not enough money around:

    http://www.businessinsider.com/hey-america-1861-called-it-wants-its-currency-back-2012-1

    I still just do not get this. Ben knows good and well that there is not enough money around and he just refuses to do anything about it. I think the whole thing is just totally sickening.

  23. Gravatar of RueTheDay RueTheDay
    19. January 2012 at 13:32

    @Major_Freedom:

    “If the government spends $100, that means the private sector did not spend that same $100.”

    Only if you hold V constant. Yet, empirically, V is not constant.

    Strangely, Sumner notes this in his post but then quickly moves on as if it’s an unimportant point or something. Rather, it’s the crux of the matter. V is not constant. Furthermore, M is not a substitute for V (increasing M may actually cause a further fall in V). BW was correct in his comment above when he said to step back from the models and observe what’s actually happening in the world now.

  24. Gravatar of BW BW
    19. January 2012 at 13:42

    “In national accounting where do excess reserves held at the central bank show up? I don’t think they show up at all. So, if the government can convince banks to give it some of those excess reserves in exchange for its bonds, then from which national accounting quantity was that money taken?”

    They don’t show up because they are a stock, not a flow.

    Anyone who says that Keynesian economics assumes a fixed I doesn’t know what he’s talking about. The classic Keynesian cross is often presented with a fixed I curve for ease of exposition, but the story holds if I has a non-zero slope.

    It would also be useful for Keynesian critics to explain why we shouldn’t believe that I is short-term constrained. People don’t want to invest in a recession, because their existing capacity is under-utilized. Thus, they save. And some of that saving gets loaned out, but some of it remains held in cash.

    You can define the flow of income to saved cash “spending” on “investment” if you like, but that doesn’t mean it has the same economic effects as income that flows to the building of factories or roads.

  25. Gravatar of johnleemk johnleemk
    19. January 2012 at 13:47

    John Schultz:

    “So, if the government can convince banks to give it some of those excess reserves in exchange for its bonds, then from which national accounting quantity was that money taken?”

    That sounds an awful lot like monetary policy. I thought we were talking about fiscal policy.

    “I cede that a central bank can sabotage fiscal stimulus if it doesn’t like it.”

    The fact of the matter is that you need monetary stimulus to occur before fiscal stimulus can be effective. Case closed.

    “Two slanders against a whole class of people. Bravo!”

    It is I think undeniable that Keynesian economists have a tendency to implicitly hold I fixed in the back of their minds, and implicitly hold monetary policy fixed as well. Any recommendation of fiscal stimulus is, as we all here seem to understand, contingent on first monetary stimulus occurring. Yet how many Keynesian economists have called on central banks to loosen monetary policy in conjunction with fiscal stimulus? It’s like hunting for a needle in a haystack.

    BW:

    “Are you serious? It’s an inevitable consequence of spending by the federal government.”

    I’m merely observing that your suggestion that Cochrane is unhinged from reality is ignoring that he wasn’t making a point about whether Arizona takes money from Chicago or Chicago takes money from Arizona. It is entirely irrelevant to his argument which is the case.

  26. Gravatar of John Schultz John Schultz
    19. January 2012 at 14:07

    JLMK: “That sounds an awful lot like monetary policy. I thought we were talking about fiscal policy.”

    Maybe you aren’t listening. The govt. prints up new bonds that banks holding excess reserves are willing to buy because they see govt. debt as safe and private sector debt as too risky. The govt., in turn, takes the newly lent money and spends it.

    C + I + G + (X-M)

    G goes up, right? Which of C, I, (X-M) went down in a 1-to-1 fashion as a first order, direct effect?

    I don’t think any of them did. In fact, what changed in a direct 1-to-1 fashion as a first order, direct effect is that Y went up by an equal amount.

    JLMK: “The fact of the matter is that you need monetary stimulus to occur before fiscal stimulus can be effective. Case closed.”

    Only if you contort yourself in defining what “monetary stimulus” means because you want to make the notion of successful fiscal stimulus impossible.

    Are you saying it is impossible for there to be excess reserves held at the FED without monetary stimulus first? Think harder.

    Even if I accept your premise, just because monetary stimulus is a necessary condition for fiscal stimulus to be effective doesn’t refute me. Perhaps the central bank is limited by law to only buy assets from banks (e.g. – ECB), but banks refuse to lend out any extra money the central banks gives them (in exchange for their bonds) and instead parks it back on reserve at the central bank or in their vaults.

  27. Gravatar of BW BW
    19. January 2012 at 14:12

    “I’m merely observing that your suggestion that Cochrane is unhinged from reality is ignoring that he wasn’t making a point about whether Arizona takes money from Chicago or Chicago takes money from Arizona. It is entirely irrelevant to his argument which is the case.”

    1. It’s not entirely irrelevant to his argument which is the case. If Chicago -> Arizona is the case, and then that net flow is reduced by a smaller reverse flow, then it’s really not a case of Arizonans paying to fill potholes in Chicago, is it? It’s Chicagoans paying to fill potholes in Chicago and a little bit less counterterrorism training in Flagstaff than in previous years.

    2. If it’s entirely irrelevant to his argument which is the case, why do you think he repeated the classic Republican misformuation? Was it just coincidence that he gave us a watered down version of the Welfare Queen theory (i.e. hard working Americans in inland states paying for profligate spending in cities?)

  28. Gravatar of John Schultz John Schultz
    19. January 2012 at 14:16

    JLMK: “Yet how many Keynesian economists have called on central banks to loosen monetary policy in conjunction with fiscal stimulus? It’s like hunting for a needle in a haystack.”

    You’re kidding, right? Do I dare invoke “he who must not be named?”

    Krugman has been screaming for a very long time now that both the FED and the federal government have been way too complacent about tolerating unused capacity in the economy. He has been calling for the kitchen sink to be thrown at the crisis we’re in for a long time now …

    [Jeebus!]

  29. Gravatar of BW BW
    19. January 2012 at 14:18

    “Yet how many Keynesian economists have called on central banks to loosen monetary policy in conjunction with fiscal stimulus? It’s like hunting for a needle in a haystack.”

    Um, pretty much all of them. Krugman alone has probably written close to 100K words over the last three years criticizing the ECB for not loosening monetary policy, criticizing the Fed for moving too conservatively with monetary stimulus and in particular the governors who want to increase rates prematurely.

    Where have you been?

  30. Gravatar of John Schultz John Schultz
    19. January 2012 at 14:18

    Oh yeah, Brad Delong too …

  31. Gravatar of BW BW
    19. January 2012 at 14:30

    Or Romer, Summers and so on. I’d like to hear one example of a Keynesian economist who was not in favor of monetary stimulus. Some of them might not have written much about it since interest rates have long been at the ZLB, and QE2 had a modest effect (as predicted by many). That doesn’t mean they didn’t favor it.

    This is yet another example of Keynesians being criticized according to uninformed distortions of their views, rather than their views themselves. This particulat distortion is odd, because I would have thought that *everyone* knew that Keynesians favored counter-cyclical monetary policy.

  32. Gravatar of ChacoKevy ChacoKevy
    19. January 2012 at 14:58

    BW: I think most of us recall Krugman stating that the Fed was out of ammo and that further monetary stimulus is moot at the zero bound. He later endorsed ngdp targeting, but not as forcefully as he wanted more fiscal stimulus.

    But to your Chicago v Arizona thing: do you have more information on the kinds of expenditures that go from rich blue cities to poor red states? I can understand the injustice in your pothole scenario, but is there more? It seems to me there exists the possibility that if the tax transfers you are talking about go towards nationwide benefit, then we should be doing it even more so! The CDC in Atlanta, NASA in Houston make more sense in terms of bang for the buck than if you moved it all to Chicago or NYC. Similarly, we should move the Pentagon to Birmingham, SEC to Louisville, and [insert Federal Agency of choice here] to [southern city in a poor state here] in the interests of expenditure efficiency. This would be a good idea while at the same time exacerbating the disparity you are currently identifying.

  33. Gravatar of Morgan Warstler Morgan Warstler
    19. January 2012 at 15:32

    BW,

    “Are you serious? It’s an inevitable consequence of spending by the federal government.”

    You have it ASSBACKWARDS.

    The only reason KS puts up with being “United States” is flow of funds.

    I’m dead serious, the red states could do all kind of things that blue states would hate to make plenty of cash – competing openly for revenue in regulation, environment, criminality – just explode out S. Carolina on jobs to see what I mean.

    See 1986 and the highway funds used to force states to raise drinking age.

    Those of us who argue states rights are trying to GIVE rich liberals in California back their money PRECISELY because we want to let capitalism run free.

  34. Gravatar of johnleemk johnleemk
    19. January 2012 at 15:56

    John Schultz:

    You just described open market operations: http://en.wikipedia.org/wiki/Open_market_operation

    Of course the non-private sector component of Y doesn’t go down. There was no fiscal policy which changed the distribution of Y.

    “Are you saying it is impossible for there to be excess reserves held at the FED without monetary stimulus first?”

    At this point we are splitting hairs about the definition of monetary and fiscal policy — and unnecessarily so. The simple case is that ordinary fiscal stimulus — building roads to nowhere or to somewhere, etc. — cannot boost AD if the central bank reduces the supply of money.

    Guys,

    Re Krugman/DeLong/Summers/Romer, et al. — how many make it clear that for fiscal stimulus to work, monetary stimulus is necessary? It is difficult to find one who makes it clear that the fiscal authority is impotent to goose AD without the cooperation of the monetary authority.

    Yes, Keynesian economists call for stimulus, and non-Keynesian economists don’t. That’s to a first-order approximation true. But Keynesians today have failed to effectively communicate the discoveries of New Keynesianism — key points like the non-existence of the zero lower bound given rational expectations and the invention of the printing press, and the importance of monetary policy in determining AD.

    Poll the readers of these economists’ work and ask them which is more important — fiscal or monetary stimulus — and they will tend to say fiscal policy. This, despite everyone who is remotely informed about modern macro agreeing that monetary policy must cooperate if AD is to increase. Krugman’s coverage of the importance of monetary policy is almost nil relative to his persistent calls for larger and greater fiscal stimulus, when no fiscal stimulus of any size can succeed without the permission of the central bank. Dark age of macro indeed.

  35. Gravatar of BW BW
    19. January 2012 at 17:01

    ChacoKevy,

    Google a little bit and you will find a wealth of information about inter-regional transfers. Here’s one table that summarizes the flow of money.

    http://www.taxfoundation.org/research/show/266.html

    The partisan affiliation of the transfers is, I think, happenstance. The primary reason that money flows from California to Mississippi is that California is richer than Mississippi, and thus 1) its people pay higher tax rates on average and 2) they have more income to tax. Meanwhile, legislators from the inland states are very good at getting pork for their states because they have disproportionate representation in the Senate. Thus, Mississippi gets more pork spending per resident even as it is paying less in taxes. That’s a very simplified account. Again, you can find more by searching.

    In the case of cities, they tend to get much less road construction money per capita than outlying areas, for obvious reasons, and they typically pay much more in taxes because the cost of living pushes incomes up. Probably the biggest injustice in the tax code — much more than millionaires having to pay higher marginal rates than the middle class — is that a person earning $80K in Manhattan pays a higher rate earning $50K in rural Texas, even though the former earns a below average income and the latter might very well be rich.

    As far as I know, the close alignment between partisan affiliation and spending patterns is, to a first approximation, happenstance. California used to be a red or purple state, and I suspect they were subsidizing the inland state just as much back then.

    I don’t know what you mean when you say we should be doing those tax transfers “even more so.” I don’t follow your logic at all.

  36. Gravatar of BW BW
    19. January 2012 at 17:15

    “You have it ASSBACKWARDS.”

    That’s a nice sentiment. Polite, civil, and indeed quite eloquent.

    “The only reason KS puts up with being “United States” is flow of funds.”

    That, and the Consitution, and the loyalties that most Americans have to the United States of America. How does one respond to such such crazy talk. You really think Kansas is essentially extorting California, threatening to secede unless it keeps getting its allowance? Really?

    “I’m dead serious, the red states could do all kind of things that blue states would hate to make plenty of cash – competing openly for revenue in regulation, environment, criminality”

    They could, I suppose, if the Constitution didn’t prevent much of that, and if we didn’t have a federal government to set national standards. Indeed, that’s a primary reason we have a moderately powerful federal government, and a reason why the Founding Fathers had the foresight to author the Supremacy Clause.

    “Those of us who argue states rights are trying to GIVE rich liberals in California back their money PRECISELY because we want to let capitalism run free.”

    How quaint. If you screamed less and studied more, you might find out that states are not exactly bastions of free capitalism. Indeed, a great deal of federal legislation exists to *prohibit* more extensive state-level regulation — or, in the case of antitrust, greater state tolerance for competition-destroying collusion. I have no idea what percentage of federal regulation fits this description, but in general, the idea that “states rights” = “economic freedom” is grossly simplistic. And I haven’t even addressed interstate externalities, which are exceedingly difficult to mediate absent a strong federal authority.

  37. Gravatar of John Schultz John Schultz
    19. January 2012 at 17:31

    JLMK: “You just described open market operations:”

    Uh, no.

    Typically, the central bank and the govt. are independent entities today. You cannot legitimately ascribe the actions of one to the other as you are trying to do here.

    JLMK: “Of course the non-private sector component of Y doesn’t go down. There was no fiscal policy which changed the distribution of Y.”

    Are you sure you are reading my posts? Let me start over.

    Let’s say banks are scared and refusing to lend and instead holding lots of excess reserves on deposit at the FED and in their vaults. However, at the margin they are willing to use that money to buy safe govt. bonds at interest rates slightly higher than currently exist in the secondary market.

    The central bank will not add to or remove from its balance sheet due to disagreement on what to do amongst its steering committee.

    So instead, the govt. takes the initiative to act by creating new bonds and selling them on the open market. That pushes interest rates up and induces the banks to swap their excess reserves for bonds. The govt. takes the money it raised and spends it.

    G increases. What other national accounting terms decrease by the same total amount as a first order, direct effect as Cochrane claims must happen?

  38. Gravatar of BW BW
    19. January 2012 at 17:35

    “Poll the readers of these economists’ work and ask them which is more important “” fiscal or monetary stimulus “” and they will tend to say fiscal policy. This, despite everyone who is remotely informed about modern macro agreeing that monetary policy must cooperate if AD is to increase. Krugman’s coverage of the importance of monetary policy is almost nil relative to his persistent calls for larger and greater fiscal stimulus, when no fiscal stimulus of any size can succeed without the permission of the central bank. Dark age of macro indeed.”

    Please.

    I can’t speak to all of Krugman’s readers, and neither can you. I can speak for myself and my friends, and all of us realize that monetary stimulus is the *normal* form of counter-cyclical economic policy. It’s when monetary stimulus fails that fiscal stimulus becomes necessary.

    I’m not going to argue with you about whether the fiscal authority is “impotent” without the monetary cooperation, because 1) it’s not clear exactly what you mean by that and 2) I am not interested in, as you say, splitting hairs. This much is clear: contractionary monetary policy reduces the effectiveness of expansionary fiscal policy. Since monetary policy is, generally speaking, more powerful, the monetary authority will typically prevail. See Europe 2011. Whether a huge fiscal stimulus can be effective in the face of a slightly contractionary monetary policy is hypothetical. That’s not going to happen.

    As for Krugman’s coverage of monetary policy, you are simply incorrect. Either you don’t read what he writes (in which case you shouldn’t be opining on the matter) or you somehow ignored the dozens of posts critiquing the ECB’s monetary policy and its contribution to Europe’s many problems. He has also talked at length about QE2, and has given it a lukewarm defense — he didn’t think it would do all that much good, but he thought it was a good idea in principle.

    Indeed, remember that Krugman, above all, has championed the liquidity trap theory. What is a liquidity trap? It’s the state of affairs in which monetary policy loses effectiveness because the equilibrium interest rate is less than zero. Think about it. Monetary policy is at the foundation of Krugman’s pet theory. Liquidity trap is a monetary concept.

    If you’re complaining that he doesn’t consistently write over and over again “it’s good for the Fed to keep interest rates at zero or else the economy might contract” . . . oh, wait, he does write that frequently, in response to the inflation “hawks” who are convinced that low rates and QE2 have put hyperinflation just around the corner.

    So let me start again. If you’re complaining that he doesn’t continue to write about monetary policy ad nauseum, consider that nausea isn’t a primary goal of bloggers.

  39. Gravatar of Major_Freedom Major_Freedom
    19. January 2012 at 17:38

    RueTheDay:

    “If the government spends $100, that means the private sector did not spend that same $100.”

    “Only if you hold V constant. Yet, empirically, V is not constant.”

    No, it does not require V to remain constant. One act of spending $100 makes it impossible for the private sector to spend that same $100.

    V has nothing to do with this.

    And even if we did take V into account, you won’t be able to observe the difference anyway, because again it’s a counterfactual.

    If the private sector spends the $100, then there will be a V associated with it.

    If on the other hand the government taxes and spends that $100, then there will be a V associated with that.

    Whatever choice is made, you cannot observe the counterfactual V, so to say “Only if you hold V as constant” is incoherent. There is always only a single V that we observe, on account of what choices are made. Making one choice with a means results in all other possible choices becoming impossible using those same means.

  40. Gravatar of Major_Freedom Major_Freedom
    19. January 2012 at 17:45

    BW:

    “In the equation C+I+G=Y, the variables C, I and G are completely independent.”

    No BW, they are most certainly not independent. If G goes up, then that money cannot also be spent by people who are in the C+I category, which means C+I is otherwise reduced. When I say that, I don’t mean reduced over time subsequent to the increase in G. I mean the increase in G itself. If the government spends a sum of money, it means the private sector does not spend that same money.

    C+I+G are all exactly and completely offsetting with each other, because these are the only ways money can be spent. If C spends 100, then both I and G cannot spend that same 100. If I spends 100, then both C and G cannot spend that same 100. If G spends 100, then both C and I cannot spend that same 100.

    “They become mutually dependent by the addition of other constraints or assumptions, such as S=I, C=C(Y-T), G = T – [Public Deficit], etc.”

    You’re talking temporally, I’m talking cross sectionally, in the accounting sense.

  41. Gravatar of ssumner ssumner
    19. January 2012 at 18:08

    Dave, I agree.

    Vivian, Good point.

    John, Very good points, but I think this is slightly more complicated:

    “I disagree, because Cochrane assumes that A would have spent it or it would have been lent to someone who would have spent it. That is not necessarily the case when banks are holding something like ~$1T on reserve at the FED.”

    I don’t see the issue as what that particular person did with the money. Even if saved, it will boost investment. Rather I see the problem as being that they might increase their real demand for base money. If the supply doesn’t increase to meet that demand then prices (and NGDP growth) fall, and if wages are sticky you get unemployment.

    Not saying you are wrong, most people look at it your way. I’m just saying my perspective is slightly different.

    BW, The “cash” at the central banks is a liability, it’s not money available for the government to spend.

    And Cochrane’s example of potholes, was just that–an example.

    You said;

    “It’s ironic that, in our current debate, the efficient market guys at Chicago routinely ignore market data in making their arguments, whereas Krugman can point to mounds and mounds of real-time market information to support his case. It’s just amazing to think that Cochrane still believes big inflation is around the corner, when long-term interest rates are telling us exactly the opposite.”

    This is the area where I separate from the Chicago school, and where I’m most similar to Krugman. Indeed even more obsessed with market data than Krugman himself.

    Jason, Good critique.

    RueTheDay, Yes, except virtually none of the “classical” economists from Hume to Irving Fisher did assume full employment. Keynes simply invented a myth. Ironically he was right about the New Classical economists (in some cases, not Lucas) but they weren’t alive yet.

    John, Saving is a flow and ERs are a stock. Furthermore ERs are not net wealth, they are both an asset and a liability. So ERs are not national “saving.”

    (Not sure if I’m responding to you of the guy you are criticizing.)

    Jimp, Let’s pray that something happens next week.

    BW, You said;

    “Krugman alone has probably written close to 100K words over the last three years criticizing the ECB for not loosening monetary policy, criticizing the Fed for moving too conservatively with monetary stimulus and in particular the governors who want to increase rates prematurely.”

    Interestingly when I called on Krugman to join me in early 2009 in support of QE, he refused, saying it wouldn’t work. Later he supported it. In early 2009 DeLong published a paper saying monetary policy was ineffective at the zero bound. I published a reply saying it could be. Later he started demanding the Fed ease, and has joined me in calling for NGDP targeting. So I agree that the Keynesians are getting much better on this issue. In early 2009 it was basically just us market monetarists calling for easier money.

    You said;

    “Or Romer, Summers and so on. I’d like to hear one example of a Keynesian economist who was not in favor of monetary stimulus.”

    Romer cited me in her 2011 NYT column, as proving the “logic” for NGDP targeting. Summers has been a complete disaster, ignoring monetary policy completely, which is one reason those Fed seats sat empty in 2009 and 2010.

    Stiglitz opposed monetary stimulus, last time I looked.

    Chacokevy, BTW, Lots of liberals don’t know that Texas is a net sender of money to Washington.

  42. Gravatar of RueTheDay RueTheDay
    19. January 2012 at 18:23

    @Major_Freedom:

    “No, it does not require V to remain constant. One act of spending $100 makes it impossible for the private sector to spend that same $100.”

    How so? Remember, we’re talking about a situation where there is idle real capital and unemployed labor, so there are no capacity constraints. Presumably, we’re also talking about an economy with a developed financial system and the existence of credit. I’m trying to understand what you imagine is the constraint here. You seem to be envisioning some sort of primitive hard currency creditless system where all purchases require the immediate physical tender of tangible payment media (gold coins, seashells, etc) where the constraint is the fact that only one person can possess that specific item of payment media at a time. That’s nothing at all like the actual economy in which we all live.

  43. Gravatar of John Schultz John Schultz
    19. January 2012 at 18:28

    ss: “I don’t see the issue as what that particular person did with the money. Even if saved, it will boost investment.”

    C: “First, if money is not going to be printed, it has to come from somewhere … Every dollar of increased government spending must correspond to one less dollar of private spending … This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.”

    If excess bank reserves exist that can be induced off the sidelines by new issuance of govt. debt, then (1) no new money is printed / created by the central bank and (2) Cochrane’s crowding out argument is wrong. He basically admits this himself later on when he discusses liquidity traps.

    Am I misunderstanding the accounting or something?

  44. Gravatar of BW BW
    19. January 2012 at 18:29

    “BW, The “cash” at the central banks is a liability, it’s not money available for the government to spend.”

    What are you talking about? Of course it’s a liability. I thought you were all about being polite and not insulting people.

    Cochrane asked where the stimulus comes from. The answer is that pile of cash sitting at the Fed. Indirectly. The government spends money; to do so, it issues debt; private actors buy the debt; they buy it with the money sitting idle at the Fed.

    I don’t get it. You were offended when Krugman explained the Keynesian cross to you. Yet you just made me explain to you an Econ 101 theory. Perhaps you ignored the phrase “government mediated,” which is different from “government.” If you aren’t going to take the time to read carefully what others write, how can you complain that others don’t read you carefully enough?

  45. Gravatar of BW BW
    19. January 2012 at 18:38

    “Interestingly when I called on Krugman to join me in early 2009 in support of QE, he refused, saying it wouldn’t work. Later he supported it. In early 2009 DeLong published a paper saying monetary policy was ineffective at the zero bound. I published a reply saying it could be. Later he started demanding the Fed ease, and has joined me in calling for NGDP targeting. So I agree that the Keynesians are getting much better on this issue. In early 2009 it was basically just us market monetarists calling for easier money.”

    That’s a different issue than what was said earlier, that Keynesians don’t call on banks to loosen monetary policy. Krugman and DeLong’s views that QE weren’t likely to be effective have nothing to do with a lack of interest in monetary policy, as originally claimed. They had different views of what happens at the ZLB.

    Stiglitz opposes monetary stimulus? Really? Or opposes QE? Those aren’t the same thing. Saying that monetary policy loses traction at the ZLB isn’t the same as saying that monetary policy is irrelevant.

  46. Gravatar of johnleemk johnleemk
    19. January 2012 at 19:41

    John:

    I see what you’re driving at now. I refer back to Sumner: “The first order effects, the DIRECT effects of moving money from A to B net out to zero. You have more G, and less C+I. You’d need some other indirect effects. Like a change in velocity (i.e. real money demand.)” You are talking about the implications of a change in V.

    BW,

    Krugman is a New Keynesian; of course he appreciates the effects of money. This harks back to the earlier discussion about Wren-Lewis; nobody is saying Wren-Lewis actively thought Y = C + G or that your average Keynesian actively thinks AD can only be goosed by fiscal stimulus. (Funnily though, people have been saying Cochrane and Lucas actively think AD can never be goosed by fiscal stimulus — even though all examples I’ve given here are, I think, errors of the same kind.)

    The problem rather is that each of these people made implicit assumptions in their thinking which they failed to consider and clarify. Average Keynesian thinking, the kind which dominates the economic journalism we read, talks purely about the role of fiscal policy in boosting output and the role of monetary policy in controlling inflation as if they are completely separate, even though the two are sides of the same coin. Even though modern macro understands that monetary policy needs to accommodate fiscal policy for it to succeed, it is taken for granted by otherwise intelligent people (including many economists) who pen op-eds and blogs that monetary policy will create such accommodation as necessary.

    On another note, I don’t think you have described Krugman’s views accurately enough. Monetary policy is not impotent when rates are zero. Monetary policy can be made as long as the monetary authority is willing to convince the markets that it will do whatever it takes to boost the money supply/NGDP. This was the whole point of Krugman’s work in the ’90s about Japan — the BOJ could have been more aggressive even at 0% rates if it had been willing to take the aggressive steps to make people believe it would do anything to stimulate. The ZLB only exists if the central bank is unwilling to do this. I do not think Krugman has changed his views as whatever I have read of him on this subject over the years has been consistent with what he stated in the ’90s on the ZLB; he just for whatever reason prefers to exhort fiscal stimulus.

    Anyway, it looks to me like we are repeating ourselves again, on a different set of issues, so I probably won’t respond again. I’ve seen this exact discussion play out before, it doesn’t seem like we’ll be adding anything novel.

  47. Gravatar of BW BW
    19. January 2012 at 20:00

    “On another note, I don’t think you have described Krugman’s views accurately enough. Monetary policy is not impotent when rates are zero. Monetary policy can be made as long as the monetary authority is willing to convince the markets that it will do whatever it takes to boost the money supply/NGDP. This was the whole point of Krugman’s work in the ’90s about Japan “” the BOJ could have been more aggressive even at 0% rates if it had been willing to take the aggressive steps to make people believe it would do anything to stimulate. The ZLB only exists if the central bank is unwilling to do this. I do not think Krugman has changed his views as whatever I have read of him on this subject over the years has been consistent with what he stated in the ’90s on the ZLB; he just for whatever reason prefers to exhort fiscal stimulus.”

    You’re right, Krugman hasn’t changed his views.

    The reason that he prefers to exhort fiscal stimulus is that he thinks it is very difficult for a central bank to drive real rates far below zero. He’s written about this many times. Banks find it hard to convince the market that they want inflation when everyone knows that they don’t really want inflation. I don’t know if that’s true, but that’s his view.

    You must read different economic journalism than I do. Or maybe I don’t read it carefully;I tend to skim the news. But I’ve always thought that the media reports monetary policy as counter-cyclical. I see headlines like “Fed to cut rates to stimulate demand” or “Fearing recession, Fed cuts rates” or “Unsure of recovery, Fed keeps rates low” and so forth.

  48. Gravatar of John Schultz John Schultz
    19. January 2012 at 20:24

    JLMK: “I do not think Krugman has changed his views as whatever I have read of him on this subject over the years has been consistent with what he stated in the ’90s on the ZLB; he just for whatever reason prefers to exhort fiscal stimulus.”

    These days most central bankers seem content so long as inflation is somewhat positive and at or below their target. They only seem to really get a bee in their bonnet when their inflation target is overshot. Dual mandate, schmule mandate.

    OTOH, the people, and therefore (estimably) their govt., care much more about things like persistent high unemployment.

    So while the central bank might be content so long as inflation is 1-2% and take a “wait and see” approach (this all sounds SO familiar), the federal govt. might decide to take stimulative action, which the central bank would not counteract so long as it didn’t drive inflation above target.

    Maybe it’s because he thinks there is a better chance that pressure can be effectively brought to bear on the govt. to act than the central bank? Or maybe it’s because he thinks the central bank actions necessary to get the desired effect are simply too far out of character for central bankers?

  49. Gravatar of John Schultz John Schultz
    19. January 2012 at 20:41

    JLMK: “I see what you’re driving at now. I refer back to Sumner: “The first order effects, the DIRECT effects of moving money from A to B net out to zero. You have more G, and less C+I. You’d need some other indirect effects.” Like a change in velocity (i.e. real money demand.)””

    Maybe I’m being pedantic, but even Sumner’s description still seems too strong to me:

    The government takes money from a bank (A) and gives that money out to the population (B). The DIRECT effects of this action do NOT net out to zero. The DIRECT, first order effects are that you have more G and no less C+I.

    JLMK: “You are talking about the implications of a change in V.”

    I thought I was talking about lowering banks’ actually held reserve ratios, which increases M through the money multiplier effect.

    Maybe let’s just leave it at: it increases M*V (aka GDP)?

  50. Gravatar of TGGP TGGP
    19. January 2012 at 20:53

    Could someone drop a link/cite to Bennett McCallum’s paper on 10 models of sticky-wage macro with different implications? That sounds interesting.

  51. Gravatar of ChacoKevy ChacoKevy
    19. January 2012 at 21:22

    “Lots of liberals don’t know that Texas is a net sender of money to Washington.”

    That’s such a specific data point, that I would bet most people don’t know that one way or the other.

    I’m going to read more about what BW is talking about, but I suspect that, in the Chicago-AZ example, that there isn’t a lot of there there. All of us in Chicago know a dozen or so people that worked their professional careers here, but then retire in AZ to watch Cubs spring training. So it’s important to identify what the expenditures are when talking about net transfers. It would make sense that AZ would take in obscene amounts of cash just on retirement entitlements, and not necessarily potholes. And there would be nothing wrong with that.

  52. Gravatar of ssumner ssumner
    20. January 2012 at 07:24

    John, That’s right.

    Sorry BW, I have some slow commenters on occasion, and remember that a brief comment is not the same as a long blog post. It’s easier to misinterpret.

    I disagree about Krugman and DeLong, They’ve obviously changed their views. Krugman’s basically admitted that he now agrees with me, after earlier criticizing my views.

    And of course his views have changed radically from the late 1990s, when he insisted monetary policy was the right approach for the BOJ, and fiscal stimulus would be a big mistake.

    TGGP, I don’t recall the paper, but it was in a footnote.

  53. Gravatar of happyjuggler0 happyjuggler0
    20. January 2012 at 09:35

    Speaking of bothering someone else, Cochrane has a post where he discusses (mostly) the reaction to his original stimulus post. More to come it seems.

    http://johnhcochrane.blogspot.com/2012/01/stimulus-and-etiquette.html#more

    P.S. You have to scroll to the top of the page after clicking the link, I can’t figure out how to post to the top, the permalink doesn’t seem to work “properly”.

    P.P.S. I apologize if someone already posted this link, I didn’t read all the comments here.

  54. Gravatar of Major_Freedom Major_Freedom
    20. January 2012 at 10:49

    RueTheDay:

    “No, it does not require V to remain constant. One act of spending $100 makes it impossible for the private sector to spend that same $100.”

    “How so? Remember, we’re talking about a situation where there is idle real capital and unemployed labor, so there are no capacity constraints. Presumably, we’re also talking about an economy with a developed financial system and the existence of credit. I’m trying to understand what you imagine is the constraint here. You seem to be envisioning some sort of primitive hard currency creditless system where all purchases require the immediate physical tender of tangible payment media (gold coins, seashells, etc) where the constraint is the fact that only one person can possess that specific item of payment media at a time. That’s nothing at all like the actual economy in which we all live.”

    Put it this way. Suppose there is $100 between the two of us. If you spend that money, then I couldn’t have spent that money, correct? Similarly, if I spend that money, then you couldn’t have spent that money, correct? Well, that’s all that is being considered here.

    You spend more, I spend less. I spend more, you spend less. There is only $100 to be spent, and both of us can’t spend the same $100 individually.

    Well, the same principle is the case if I called myself government and you called yourself the private sector.

  55. Gravatar of BW BW
    20. January 2012 at 11:24

    “I disagree about Krugman and DeLong, They’ve obviously changed their views. Krugman’s basically admitted that he now agrees with me, after earlier criticizing my views.”

    I didn’t say he hasn’t changed his views. He’s just not changed his views as to the importance of monetary stimulus, which was the original question. The question of whether monetary policy can be effective at the ZLB is a much narrower and more technical question.

    It’s good that Krugman changes his views as a result of discourse or new data. If more of the Very Serious People did this (to use his term) instead of digging their heels in the sand all the time, the world would be much better off. This is a general observation, not aimed at anybody in particular.

  56. Gravatar of To To
    20. January 2012 at 13:29

    @Major_Freedom

    “You spend more, I spend less. I spend more, you spend less. There is only $100 to be spent, and both of us can’t spend the same $100 individually.”

    No, there is not only $100 to be spent if we can borrow freshly printed money from the Fed (which ordinarily lends freely at the target rate) or if we are *both* sitting on $100 and you won’t spend yours anyway (that’s excess reserves at the fed).

    The gold standard is gone, dude.

  57. Gravatar of Morgan Warstler Morgan Warstler
    20. January 2012 at 13:38

    BW,

    “How quaint. If you screamed less and studied more, you might find out that states are not exactly bastions of free capitalism.”

    You miss the point ENTIRELY. States can be all kinds of things, if there are 50 of them, with devolved power, I still get the competitive market effects I claim, no matter what each does pro or anti in any sector of their economy.

    It’s that ugly thing Obama calls a “race to the bottom” get it?

    Capitalists call it divide and conquer.

    Look dude, you can’t really argue on this. Right now there is X competition between states, what you have 29 GOP governors asking for is MORE.

    That’s a majority of states who disagree with your assumptions of fact.

    Today, SCOTUS through some more power back to the states on gerrymandering.

    And by June, they’ll do it again on Obamacare.

    I’ll say it again: IF the flow of funds stopped, the financial leverage that rich states have over big states would get toppled by THE US CONSTITUTION.

    The one you referenced? What it did was let a Senate representing a bunch of small poor states VETO anything they want.

    Stop the money and you clip the only ties that bind.

  58. Gravatar of John Schultz John Schultz
    20. January 2012 at 14:04

    Can somebody help me work through the following step-by-step example?

    Assume a closed economy in static equilibrium. Assume that the central bank will not change the size of its balance sheet, alter its rates or drop money from helicopters.

    The government hires some workers to perform labor intensive work. The govt. instantaneously taxes $X from the people and transfers it to the workers’ accounts (assume the govt. is hooked into everyone’s bank accounts and can do this) to pay for the work, which they then do.

    The same total amount of money is available to the banking system to intermediate and lend out. Furthermore, assuming $X isn’t gigantic then there should be enough liquidity in the banking system that the redistribution between bank accounts should not disrupt overall bank lending and borrowing.

    The savings of the net tax payers directly drops by $X. G directly increases by $X. We can’t say that the savings of the workers directly increased because then we’d be double counting the transfer: once as increased govt. expenditure and again as increased worker savings.

    After the tax, the net tax payers are poorer and you can reasonably argue that they will therefore consume less in order to save more than they did in the other timeline to rebuild their stock of money, but that behavior change will end up as a wash. The workers are richer and you can reasonably argue that they will therefore consume more, but that higher consumption will come out of their newly enlarged bank accounts, decreasing their savings, so that behavior change will also end up as a wash.

    So, it looks to me like the net effect of this exercise is G: +$X, C+I: -$X => Y: +$0.

    Am I missing anything? Does unemployment or interest rates or anything else come into play with an effect?

  59. Gravatar of John Schultz John Schultz
    20. January 2012 at 14:09

    Or the velocity of money?

  60. Gravatar of John Schultz John Schultz
    20. January 2012 at 14:23

    What if we change the example to consider debt financing instead of immediate taxation?

    G goes up directly by $X and C+I goes down directly by $X to buy the bonds. What’s different in this version?

    One major difference is that the lenders really aren’t any poorer — the bonds they bought are worth what they paid for them. So it is incorrect to say S goes directly down by $X now.

    Another difference is that interest rates probably go up slightly. How does that affect C and I?

    Some Ricardian Equivalence effect likely comes into play because people expect that future taxes will go up.

    Anyone care to take a stab?

  61. Gravatar of John Schultz John Schultz
    20. January 2012 at 14:49

    If the workers were unemployed and would have remained unemployed absent govt. intervention then does that matter?

  62. Gravatar of John Schultz John Schultz
    20. January 2012 at 15:08

    Or am I hopelessly confusing stocks with flows and how they are accounted to calculate GDP?

  63. Gravatar of ssumner ssumner
    21. January 2012 at 12:35

    Happyjuggler, Yes, I saw that.

    BW, I certainly agree with the idea that one should keep an open mind.

    John, You said;

    “Assume a closed economy in static equilibrium. Assume that the central bank will not change the size of its balance sheet, alter its rates or drop money from helicopters.”

    You are assuming the impossible. The only way to hold rates constant is to adjust the balance sheet as money demand changes.

    The rest of what you discuss is a possible equilibrium, but you’d need to examine many more factors.

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  65. Gravatar of Major_Freedom Major_Freedom
    22. January 2012 at 11:25

    To:

    “You spend more, I spend less. I spend more, you spend less. There is only $100 to be spent, and both of us can’t spend the same $100 individually.”

    “No, there is not only $100 to be spent if we can borrow freshly printed money from the Fed (which ordinarily lends freely at the target rate) or if we are *both* sitting on $100 and you won’t spend yours anyway (that’s excess reserves at the fed).”

    What are you talking about? You do have a cash balance, yes? I do have a cash balance as well. OK, so whatever our cash balances, are, that is what the $100 represents. Pick any cash balances you want, the argument remains.

    “The gold standard is gone, dude.”

    I wasn’t depending on gold standard thinking, nor advocating for it.

  66. Gravatar of John Schultz John Schultz
    22. January 2012 at 19:57

    SS: “You are assuming the impossible. The only way to hold rates constant is to adjust the balance sheet as money demand changes.”

    I meant that the central bank’s lending rates (e.g. – overnight lending) were held constant, not general interest rate(s) or the rate of inflation.

    The point of that assumption was to say that the central bank is effectively paralyzed so you don’t need to worry about it not liking the fiscal expansion and trying to swamp it.

  67. Gravatar of John Schultz John Schultz
    22. January 2012 at 20:01

    I’m trying to follow a step-by-step example, with reasonable assumptions about the way people react in the real world, to see whether or not it is likely or possible that government spending more can trigger a short run expansion in the economy.

    In effect, I’m trying to “follow the money” to see if more total economic output should occur or not.

    Surely, economists should be able to tell a relatively story about how such an expansion by the government flows through the economy. Then you can show how your particular model reflects something similar.

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  69. Gravatar of ssumner ssumner
    24. January 2012 at 07:25

    John, You said;

    “The point of that assumption was to say that the central bank is effectively paralyzed so you don’t need to worry about it not liking the fiscal expansion and trying to swamp it.”

    That doesn’t help, because it’s not the central bank lending rate that matters, it’s market rates. If market rates soar it could end up crowding out private investment.

    The bigger problem is that economics is full of all sorts of hidden indirect effects, which often work through expectations. “Following the money” is not a good way to do macro analysis.

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