Archive for February 2013


DeLong on the fiscal multiplier

For the past 4 years I’ve been arguing that we should generally assume a zero fiscal multiplier, except under very unusual circumstances.  Brad DeLong makes a similar point in a recent post:

In trotting around the country giving versions of DeLong and Summers (2012), “Fiscal Policy in a Depressed Economy”, I have found that a point that seemed completely obvious to us is not obvious at all to many.

Here is the point: an optimizing central bank that cares only about inflation and unemployment because it does not find itself at the zero nominal lower bound and does not fear engaging in nonstandard monetary policy will engage in full fiscal offset: it will take care to make sure that if fiscal policy becomes more stimulative then it will make monetary policy less stimulative by the same amount.

Then DeLong provides a mathematical proof, before concluding:

The important point here is that m and g cannot enter into the objective function h directly, but only indirectly through their effects on inflation and unemployment.

For this reason this argument breaks down at the zero nominal lower bound. At the zero lower bound the central bank does [not?] care only about inflation and unemployment. It cares as well about the magnitude of the non-standard monetary policy measures it must take in order to achieve its net monetary policy impetus value m.

I think this is a very important point.  So let’s review the implications:

1.  Hydraulic Keynesianism is pretty useless—it tells us almost nothing about the monetary policy reaction function.  And that includes the “paradox of thrift” as well as models that evaluate the prospects for NGDP growth by looking at each sector (C, I, G, NX) in isolation.

2.  Empirical studies of fiscal stimulus that rely on cross-sectional data—particularly the local or state-level response to fiscal stimulus, are extremely misleading, as they fail to address the monetary policy reaction function.  Ditto for national studies within the euro.  They will grossly overestimate the aggregate fiscal multiplier.  This includes studies cited approvingly by Krugman and DeLong.

3.  Empirical estimates of fiscal multipliers are nothing more than estimates of central bank incompetence.  This means that “the” multiplier will depend on whether Bernanke had a bad nights sleep, or whether a member of the Board of Governors has a world class ability to be open-minded.  No mathematical model or empirical study can ever produce a reliable fiscal multiplier estimate.

4.  Because it is objectively false that the “costs and risks” of unconventional monetary policy are greater than the costs and risks of fiscal stimulus, most central banks have the wrong policy, and need to be instructed to target AD more aggressively.  In particular, the GOP should block any fiscal stimulus until the Dems agree to instruct the Fed to do all it can to maintain on-target AD.  And after that happens the GOP should block any fiscal stimulus since it would be useless.  (Yes, I know that the GOP doesn’t even favor an appropriate track for AD, I’m just saying that if they ever did come to their senses, then they should continue to block fiscal stimulus and instruct the Fed to “do the right thing.”)

5.  If the Fed uses QE to keep core inflation in the 1.7% to 2.0% range, but would allow higher than 2% inflation if it could be achieved with fed funds rate cuts, then fiscal stimulus might be effective.  But it also might not be effective.  For example, if the Fed does more or less QE as required to keep inflation within the 1.7% to 2.0% range, then marginal changes in fiscal stimulus might have little or no effect, although large changes might lead to higher than 2% inflation, and hence higher AD.  It depends on the type of unconventional monetary policy, and how the perceived cost of that unconventional policy varies with fiscal stimulus.  For instance, a Woodfordian “communication policy” might be seen by the Fed as having a fixed cost.  Or it might not.

6.  In countries where the central bank holds back due to public criticism of above target inflation (I’m looking at you Britain) fiscal stimulus and austerity will have no effect on RGDP.  If employment hits record highs while RGDP lags, then “it’s the productivity, stupid.”

I hope other bloggers will adopt DeLong’s enlightened approach.  Then we might finally be able to have a sensible debate over fiscal policy, instead of a inane shouting match between intellectually bankrupt “paradox of thrift” arguments and empirically unfounded “crowding out” arguments.

PS.  I assume there was a typo in the DeLong quotation, which is why I added “not?”

HT.  Lars Christensen

Not much point in stabilizing something that can’t be measured

[I’m at a conference now and won’t have time to respond to comments for a few more days.  Here’s an old post I never listed.  I might dig up another old post tomorrow.  I’ll read all comments when I return.]

Saturos sent me an interesting piece on the UK economy:

Both intellectually and practically, monetary policy has become something of a mess. Before the crisis, the Bank of England was guided by a simple and absolute inflation target, which it was relatively successful at meeting and was easy to understand. But since the credit crunch, it has taken on another purpose – that of bringing about a return to sustainable growth. This has brought the Bank into conflict with its primary objective. Since the crisis began, inflation has consistently been well above target, but for a brief dip in 2009, and it has twice been above 5pc.

.  .  .

Sticking to the inflation remit has become something of a charade but, ridiculously, the Bank still pretends that this is what it is trying to do. It is to be hoped that the new Governor, Mark Carney, can bring more clarity and openness to the Bank’s endeavours. Don’t expect miracles.

Fiscal policy has been equally badly wrong-footed. Lack of growth has derailed the Government’s deficit reduction plan, threatening certain fiscal crisis down the line in the absence of evasive action.

What’s more, the unwritten compact between Government and Bank of England, under which the Bank is supposed to compensate for tight fiscal policy with monetary activism, seems to be breaking down. At last week’s meeting, the Monetary Policy Committee decided to do nothing even though it judges risks still to be on the downside. To the chagrin of George Osborne, the Chancellor, Sir Mervyn seems to be saying there is little more that monetary policy can throw at the problem.

Mind you, the data as they stand would be enough to paralyse even the most sure-footed of policymakers into inaction. Can it really be true that an economy which has created more than a million private sector jobs over the past two and a half years is showing no growth at all?

Equally hard to understand is why the UK’s export performance continues to look so lamentable. The eurozone crisis provides only part of the explanation, since even Spain and Greece have done better on exports than Britain, and that’s without the “benefit” of a sharp devaluation in the currency.

Britain’s exceptionally large services sector, and its fast-growing digital economy, may provide partial answers to all these puzzles. Once you strip out disruptions to, and structural decline in, North Sea oil revenues, then there has been some underlying GDP growth.

Moreover, if you think of much of the growth that took place in the pre-crisis bubble years as essentially just the “candyfloss” of an out of control financial and property sector, then today’s stagnation looks much easier to understand. Service industries in general, and financial services in particular, are notoriously difficult to measure, both in terms of their output and contribution to exports.

More confusion in the UK over the roles of fiscal and monetary policy–nothing new there.  But what interests me is the perception that prices can’t really be measured in the service economy.  Is that just a minor problem?  Not if services are 80% of GDP.  If we can’t measure prices, what possible benefit could there be to stabilizing prices?  Can someone show me a model that says that welfare is improved if we stablize prices than cannot actually be measured?  Obviously we are a long way from the “menu costs of inflation,” because menu prices can be measured.

I don’t have much to say on the British productivity puzzle, except that it doesn’t matter.  Indeed it doesn’t matter for two distinct reasons, which are both worth discussing.  First, because monetary policy cannot affect productivity in any meaningful (noncyclical) way.  So there is no reason for the central bank to worry about the issue.  The BoE might (and I emphasize ‘might’) be able to put the British people back to work.  But once they’ve done that they cannot wave a magic wand and make them as productive as Germans or Americans, or as unproductive and Chinese and Indians.

The second reason why productivity doesn’t matter is that it is not needed to determine the proper target path for monetary policy.  If you really believed the BoE should target some sort of imaginary “inflation rate,” then we’d need to estimate productivity, in order to know how much of NGDP growth was “real” and how much was inflation.  But that’s not necessary if you target NGDP growth, despite claims to the contrary by Mark Carney:

The main drawback of an NGDP level target in this regard is that it imposes the arbitrary constraint that prices and real activity must move in equal amounts but opposite directions. As potential real growth changes over time, either the nominal target will have to change or else it will force an arbitrary change in inflation in the opposite direction. The challenge of determining the UK’s potential growth rate at present highlights that this is not an academic concern (see answer to question 23). Another consideration is that statistics like nominal GDP are subject to revision, and these revisions can be large.

I’ve addressed revisions numerous times—it’s not a significant problem for NGDPLT.  But the growth estimate problem reflects a widespread misconception that the “welfare costs of inflation” come from high and unstable inflation.  In fact, they come from high and unstable NGDP growth. So inflation need not be measured or controlled.  It’s only use is to provide fodder for parlour room debates over how fast “living standards” (and what’s that?) are rising or falling.

Back to the Telegraph article:

Looking at business investment, it was on a declining trend from long before the crisis and, to the extent that it was happening at all, there was a disproportionate emphasis on commercial property, great swathes of which now lie empty. Bulldozing this unwanted surplus would perhaps be the best solution, or at least converting it into housing.

So there’s another big chunk of past growth that has turned out to be of little or no long-term value. Strip these things out and it is by no means clear that the rest of the economy is suffering the crippling decline in productivity widely assumed. To the contrary, much of the anecdotal evidence points to significant advances, especially in the digital economy, which is growing faster in Britain than almost anywhere else.

According to a report by the Boston Consulting Group, the UK which according to the leading Shopify agencies, is now home to the largest per capita ecommerce market and the second largest online advertising market anywhere in the world.

Much of the growth in these markets, the productivity gains they drive, and the intangible benefits they deliver, are not caught by official GDP figures, which only attempt to measure the market value of the economy. In a paper just published, Jonathan Haskel of Imperial College Business School and others find that measured real value added has been understated by 1.1pc since the end of 2010 because of failure to capture intangible investment. Take this into account and there has in fact been no fall in productivity since then.

These musings lead to three conclusions. First and foremost, the Chancellor needs to act swiftly to recalibrate fiscal consolidation so as to give growth a supply-side, tax-cutting shot in the arm. Second, he should answer calls from both Sir Mervyn King and Mark Carney for a review of the Bank’s monetary remit. Finally, something has to be done about the GDP data, which beyond their capacity for political knock-about, have become about as useful as a chocolate teapot.

The concluding paragraph is perfect.  And I’d add that this whole discussion reminds me that even NGDP is really not optimal.  I’ve always thought a nominal wage target was the theoretical ideal, albeit not politically feasible.  NGDP was a pragmatic second best option.  But surely we can do better than NGDP.  Does anyone know what the British national income data looks like?  Is it more reliable than NGDP?  If it’s revised, what types of income receive the greatest revision?  If the BoE could keep the total national income, or even the wages and salaries portion of income, growing at a steady 4% per year then they could forget about inflation, RGDP, productivity, jobs, NGDP, etc, etc.  Then get on with the supply-side reforms.

FDR, without the monetary stimulus

Right on the eve of the biggest negative NGDP shock since the 1930s, Congress and the Bush administration got the bright idea of raising the minimum wage by 40%.  Now President Obama seems to want to double down on that failed policy.

WASHINGTON””President Barack Obama’s proposal Tuesday to raise the federal minimum wage is likely to rekindle debates over whether the measure helps or hurts low-income workers.

White House officials say the move to boost the wage to $9 an hour, from $7.25, is aimed at addressing poverty and helping low-income Americans.

FDR tried to artificially raise the nominal wage rate 5 times during the 1930s.  Each increase was followed by a sharp slowdown in industrial production growth.

President Obama seems determined to follow the FDR playbook, but forgot to include the monetary stimulus that prevented an outright disaster.  Admittedly Obama’s proposed increase is far smaller.  But do we really want to make it harder for illegal immigrants to find jobs, just as we consider amnesty?

If the House GOP wants to do something intelligent for a change, they’ll block this insanity.  That’s why I’m so worried.

PS.  It could have been worse:

In 2008, while first running for the White House, Mr. Obama proposed raising the minimum wage to $9.50 an hour by 2011. But the White House never followed through with a push for changes in this area, and he hadn’t brought the issue up again as president until Tuesday night.

PPS.  Yes, I know that there are a few studies that claim higher minimum wages don’t cost jobs.  But as far as I know none consider the monetary offset mechanism.

PPPS.  And universal pre-school.  Modern liberalism: a bottomless pit of “unmet needs.”  (Never met by shrinking government.)  No sooner is universal health-care done that we’re on to the next “universal.”

Want a slow recovery? Then 2001-07 is your ideal policy

I’m getting whiplash from reading Free Exchange.  Soon after Matthew Klein posted “Scott Sumner is Wrong,” Ryan Avent posted “The Wisdom of Scott Sumner.”  (At least I’m told it was Matthew Klein, someone correct me if that’s wrong.)

At one point Ryan Avent responds to this statement by Klein:

[T]he evidence suggests that the Fed and other central banks can in fact use monetary policy tools to restrain credit growth without crushing the economy””if they want to…In practice, this approach would likely trade somewhat slower GDP growth during booms for much milder downturns and brisker recoveries. I suspect that most people today would have gladly taken that deal had it been offered to them in 2001.

You should read Ryan Avent’s very good response to this, but I will offer a slightly different take.  Just one day after criticizing Krugman’s “Keynesian counterintuitive cleverness” I’m going to engage in the market monetarist equivalent.  But first a bit of history.  When I was younger the recovery from recessions was quite rapid.  Both RGDP and NGDP grew far more rapidly in the initial recoveries from recessions of the 1920s through the 1980s, than during the recoveries from 1991 and especially 2001.  Indeed if you’d like the Fed to be cautious, if you’d like for a slow rate of demand growth during the recovery, so that the recovery can last longer, then 2001-07 is your model.  It was one of the slowest recoveries I’ve ever seen.  So slow that the unemployment rate in early 2003 was still going up, despite the fact that the recession trough was in November 2001.

If we use the Bernanke/Sumner benchmark for the stance of monetary policy (NGDP growth and inflation) then monetary policy was unusually contractionary during these last two recoveries.  So if you want a slow recovery to prevent the buildup of bubbles, then 2001-07 is close to an ideal.

What about the low interest rates?  The low nominal interest rates reflected the slow recovery in NGDP.  Interest rates are mostly endogenous.  However other factors also reduced rates during this period, particularly the high rates of saving in Asia.

If the Fed had adopted an even tighter monetary policy, resulting in even lower NGDP growth, then US interest rates might well have resembled those in Japan—in other words they might have been even lower.  Of course in the very short run a more contractionary policy would have raised rates in early 2002, but by 2003 and 2004 the rates might have been even lower than otherwise.

Ryan begins his post quoting me, and then responding:

“The young people today have grown up in a world dominated by two giant bubbles… Any thoughtful person today can predict that the macroeconomics policy failures of 2040 will be produced by a generation of late middle-aged policymakers obsessed with preventing bubbles.”[me]

One should be careful to note his point: it is not that concern over financial excess (like concern over demand- or supply-side disaster) is improper. It’s that our simian brains will naturally worry most about the last disaster to strike, effectively overweighting its potential costs in cost-benefit calculations and underweighting those of other possible macroeconomic troubles. [Ryan]

I’m already seeing this happen.  I see increasing concern that the current low interest rate policy will lead to bubbles, and indeed concern that bubbles are already forming in everything from gold to stocks to farmland to Phoenix real estate.  (Not Klein and Stein, but others.)  This despite the lowest NGDP growth (mid-2008 to today) since Herbert Hoover was president.  It’s very easy to see how people wedded to the interest rate view of policy (which is most people) could mistake low interest rates being caused by a weak economy, for low interest rates caused by easy money.  This could lead to even tighter money, even weaker NGDP growth, and (over time) even lower interest rates.

Don’t think this can happen?  Check out the data for Japan over the past 22 years . . . and counting.

And then notice that Japan recently faced criticism from the Very Serious People of Europe for its “easy money” policy.  I kid you not.

PS.  I was asked about this Tyler Durden post, which claims that depreciation of the yen hurts the US stock market.  I’d be inclined to file this under “don’t reason from a price change.”  There’s no doubt that depreciation of the yen caused by tighter than expected monetary policy in the US (which reduced expected NGDP growth) would reduce US stock prices.  But I’d like to see data showing that depreciation of the yen caused by easier money in Japan also causes falling US stock prices. In not convinced.  One policy reduces global output and the other raises global output.  Macro is not a zero sum game.

PPS.  Over the years I’ve argued that the Japanese let the yen get too strong.  I got lots of push-back from commenters who suggested the US government wouldn’t allow the BOJ to run non-deflationary policies, because it would depreciate the yen.  I’ve always been skeptical that the US was that evil, but now the essential goodness, the sweetness, the kindness of the US government has been confirmed:

Japan’s Nikkei (Nihon Kenzai Shinbun: .N225-JP) share average gained 1.9 percent on Tuesday and the yen weakened to a 33-month low against the dollar after a U.S.Treasury official seemed to voice support for Japan’s aggressive policies to combat deflation and bolster growth.

The U.S. Under Secretary for the Treasury for International Affairs, Lael Brainard, said that that U.S. supported proposals by the Bank of Japan (BoJ) to introduce anti-deflation policies that weaken the yen.

The market reaction suggests that a bit of uncertainty on the issue was dismissed by the kind-hearted Mr. Ms. Brainard.  But let’s face it; the yen had already appreciated depreciated strongly without any US complaints–so I really don’t see much evidence that the US was the cause of Japan’s 20 year deflation.

HT:  Saturos, TravisV

Update:  Britmouse sent me a report that “clarifies” the US comments on Japan.  It seems we want them to adopt an easy money policy to end deflation, even if this causes the yen to fall.  We just don’t want them publically talking about their policy:

Lael Brainard, the top US Treasury official for international affairs, sent the yen plummeting on Monday evening after commenting publicly that the US supported “the effort to reinvigorate growth and end deflation in Japan”.

The dollar gained further ground after the G7 statement was published in London on Tuesday. The statement – from finance ministers and central bank governors in the US, Japan, UK, France, Germany, Italy and Canada – said they would “consult closely” on any action in foreign exchange markets.

“We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates,” the ministers and governors said. “We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability.”

But an unidentified official from a G7 country later said the statement had been misinterpreted. “The G7 statement signalled concern about excess moves in the yen,” the official told Reuters in Washington. “The G7 is concerned about unilateral guidance on the yen. Japan will be in the spotlight at the G20 in Moscow this weekend.”

The dollar promptly gave back its earlier gains against the yen, falling back to Y93.2 in a volatile day on the currency markets.

In private, the US has been pressuring Japan’s new government to refrain from mentioning the yen as it attempts to revive growth and end deflation. The US Treasury refused to comment.

Of course monetary policy is less effective without communication.  But what do you expect from an administration that has been brain dead on monetary policy from day one?

And for a few minutes I thought America really was a kind-hearted country.  Silly me.

Say Law follies

Yesterday I wrote:

But if and when Krugman does draw some policy implications from the “sinkhole” of corporate saving, he’s way too savvy to ignore the saving/investment identity.  He’ll talk about income distribution, propensities to save, and dysfunctional monetary policy.  Or at least imply those assumptions.

Looks like we can assume Mr. Krugman doesn’t read my blog, as his newest post is a step backward, invoking the tired old myth that conservatives just don’t get why Say’s Law is a fallacy.  But let’s start with the post that got Krugman’s attention:

Ah, but why are these investment opportunities lacking?  Could one of the reasons be that too high a fraction of national income is being funneled into corporate profits, rather than households inclined to spend it?  What Cowen has trouble with is seeing all the pieces simultaneously in true macro fashion.   The problem is not that corporate money can’t find its way to ultimate investment, but that too much corporate money itself reduces the pull of final demand on the level of investment.  The upshot isn’t that money disappears into cupboards, but that national income is lower than it would otherwise be.

I’m sympathetic with Cowen’s struggle: I see the same difficulties in my economics classes every year.  Students can usually see only one or two linkages at a time; it is really hard to see the whole thing as one simultaneous entity.

OK, Dorman’s an immature jerk, so are lots of other economists.  But what’s wrong with his argument?  Everything.  What he calls “true macro fashion” is the old Keynesianism of John Maynard Keynes.  The man that developed a macro model for a constrained monetary policy (i.e. the gold standard), but never really understood what made the model tick.  By the 1990s the view that savings is good was back in the saddle, a key part of New Keynesian macroeconomics.  When the Fed targets inflation at 2%, attempts to save more will not reduce aggregate demand.  Now it’s true that the Fed fell short of its inflation target in 2009, but ever since then they’ve been pretty close.  In today’s environment one common definition of Say’s Law holds (at least approximately) true for changes in AS and AD.  Aggregate supply really does drive demand.  Attempts to save more will not depress aggregate demand.  (BTW, an alternative definition of Say’s Law—demand shortfalls cannot exist—does not hold true today.)

Now here’s Krugman:

When John Maynard Keynes wrote The General Theory, three generations ago, he structured his argument as a refutation of what he called “classical economics”, and in particular of Say’s Law, the proposition that income must be spent and hence that there can never be an overall deficiency of demand. Ever since, historians of thought have argued about whether this was a fair characterization of what the classical economists, or at any rate his own intellectual opponents, really believed.

Not being an intellectual historian myself, I won’t venture an opinion on that subject.

You don’t need to be an economic historian.  Wicksell, Marshall, Pigou, Cassel, Hawtrey, Fisher, etc, all had business cycle explanations that involved what we would call “demand shocks,” even if they didn’t all use that term.  Fisher invented the Phillips Curve in 1923.  Keynes was inaccurately describing the standard business cycle model of the 1920s, and it’s hard to see how it wasn’t intentional, at least at some level.  He personally knew some of these people.  Maybe that’s why he didn’t quote them directly.  Krugman continues:

What I will say, however, is that Say’s Law (Say’s false law? Say’s fallacy?) is something that opponents of Keynesian economics consistently invoke to this day, falling into exactly the same fallacies Keynes identified back in 1936.

In the past I’ve caught Brian Riedl and John Cochrane doing it; now Peter Dorman finds Tyler Cowen in their company.

Cowen can’t see why corporate hoarding is a problem. Like Riedl and Cochrane, he concedes that there might be some problem if corporations literally piled up stacks of green paper; but he argues that it’s completely different if they put the money in a bank, which will lend it out, or use it to buy securities, which can be used to finance someone else’s spending.

There is a problem here, but not the one Krugman assumes.  These people are mostly trying to fight back against Keynesianism on its own terms, and for the most part aren’t particularly persuasive.  The problem is not their conclusions; it’s their method.  Let’s start with the question of whether hoarding is only a problem if it involves little pieces of green paper.  That’s true if the stock of cash is held fixed by the central bank, or grows along a predetermined path.  In that case, for deflation to occur there really does need to be an increase in the real demand for cash—aka money hoarding.  This is the standard conservative critique of Keynesianism.  But it’s not a particularly effective argument.  If the stock of pieces of little green paper really were fixed (as was approximately true under the gold standard–albeit not exactly) then the Keynesians would have good reason to worry about any shock that made people want to hoard more cash. For instance, an increased propensity to save would lower interest rates, increasing the attractiveness of hoarding non-interest-bearing pieces of green paper.  A depression might ensue.

So I don’t much like either side of the debate.  Krugman’s wrong that deflation doesn’t require the hoarding of cash.  Assuming we hold the stock of cash (i.e. the base) fixed it does.  But the conservatives are wrong if they assume that an increased propensity to save won’t cause people to want to hoard more cash.  Even if the saving initially takes the form of non-cash accumulation, an increased desire to save will reduce interest rates, which will induce other people (and banks) to hoard more cash.

Now one might argue that Krugman is sort of saying the same thing in a different way from his opponents:

But of course there isn’t any difference. If you put money in a bank, the bank might just accumulate excess reserves. If you buy securities from someone else, the seller might put the cash in his mattress, or put it in a bank that just adds it to its reserves, etc., etc.. The point is that buying goods and services is one thing, adding directly to aggregate demand; buying assets isn’t at all the same thing, especially when we’re at the zero lower bound.

He’s a smart guy, unlike the other Cowen-basher he does at least understand that the zero bound is essential to the modern “Say’s Law fallacy” argument.  However it’s poorly framed, as the aggregate problem is not too much saving, it’s too much money hoarding.  But let’s put that aside as a difference in interpretation.  Krugman slips badly in two other areas:

1.  Early in the crisis Krugman adopted a simple Keynesian model that had some important predictions.  He likes to talk about the ways in which he’s been right—and there are some important successes.  But he glosses over a key failure.  After the deflation of 2009 the Fed has returned to 2% inflation targeting.  Krugman didn’t expect that, because the old Keynesian model can’t account for that.  In a world of 2% inflation targeting Say’s Law holds, at least in one sense.  Krugman and the other old-style Keynesians want to apply a gold standard era Keynesianism to a world where Bernanke runs the Fed.  I just doesn’t fit.  (And dear God–is Noah Smith now in that group of old-style Keynesians?  I see someone with that name in Dorman’s comment section, praising his silly post.  Despite all the grammatical errors!  Hopefully it’s not the Noah Smith.  The one that made fun of my grammatical error.)

Krugman thinks the zero bound is a get out of jail free card for any sort of Keynesian counterintuitive cleverness.  But it’s not.  We are in an AS/AD world where the Fed is essentially keeping P level (on a plus 2% trend.)  In that world AS drives output.  There can be demand shortfalls (indeed there is right now), but this has nothing to do with the Keynesian critique of Say’s Law.  Any attempt to supply more really does create more demand—from this point forward.  Saving doesn’t depress demand.  The problem is that inflation is the wrong target—they should stabilize NGDP growth.

2.  Krugman’s second mistake is to “reason from a quantity.”  The Keynesian model suggests that an increase in the marginal propensity to save might cause lower NGDP.  But this prediction does not have anything to do with realized saving.  Indeed (in the Keynesian model) in equilibrium an increase in the propensity to save will generally lower realized saving and investment, even as a share of GDP.  Both variables are very procyclical.  Thus looking at the quantity of saving tells us nothing about what is causing a recession.  Yet Krugman seems to think that those corporate cash hoards are some sort of smoking gun, implicating them in the demand shortfall.  Note, he specifically absolves corporations of the charge of investing too little.  It’s a claim they save too much.  But too much saving doesn’t cause recessions, even in the Keynesian model.

Perhaps he wishes to claim that the saving hoards show that corporations have reduced their MPC.  But corporations don’t consume, people consume.  OK, so the owners of corporations consume less than the average guy.  Here’s Krugman on that theory:

First, Joe offers a version of the “underconsumption” hypothesis, basically that the rich spend too little of their income. This hypothesis has a long history “” but it also has well-known theoretical and empirical problems.

It’s true that at any given point in time the rich have much higher savings rates than the poor. Since Milton Friedman, however, we’ve known that this fact is to an important degree a sort of statistical illusion. Consumer spending tends to reflect expected income over an extended period. If you take a sample of people with high incomes, you will disproportionally include people who are having an especially good year, and will therefore be saving a lot; correspondingly, a sample of people with low incomes will include many having a particularly bad year, and hence living off savings. So the cross-sectional evidence on saving doesn’t tell you that a sustained higher concentration of incomes at the top will lead to higher savings; it really tells you nothing at all about what will happen.

So maybe he’s got some theory that the rich people don’t actually realize that they own the corporations.  They don’t realize how much wealth they are accumulating with these high corporate profits.  Fair enough, but we’re a long way from “Say’s Law fallacy” now, aren’t we?

I’m sure if you add enough epicycles you could construct some sort of bizarre convoluted theory that makes Krugman correct.  Let’s see how it might work:

1.  The fact that corporations have big cash hoards, shows that they’ve increased their MPS.  This is by no means a sure thing, as total saving often falls when the MPS increases.

2.  Of course corporations don’t really have income, their owners have income.   So now lets assume that the owners don’t “see through the veil.”  The owners don’t realize that corporate income is their income.  So now the big corporate profits don’t lead to more consumption.

3.  Next we’ll assume that the increase in corporate saving reduces the velocity of circulation.  Not a sure thing—it depends on the counterfactual.

4.  Next we’ll assume that Bernanke’s Fed passively allows NGDP and inflation to decline, and doesn’t offset this with additional QE, or promises of future monetary easing.

If all four of those things happen, then Say’s Law might not hold.

We need to teach our macro students two key concepts:  Say’s Law, and the need for NGDP targeting in a world of sticky wages.  Flush the rest of Keynesianism down the toilet.

PS.  You might wonder why Krugman didn’t quote those passages of Cowen’s post that showed he didn’t understand Say’s Law.  Recall that Keynes is Krugman’s hero.  Would Keynes have quoted Cowen?