DeLong and Waldmann defend the indefensible (i.e. Krugman)

This will be lots of fun for me.  And just so people don’t scold me in the comment section, first read the following disclaimer:

Disclaimer:  As you know, DeLong and Waldmann like to ridicule me in their posts.  Here’s what you don’t know:

1.  They’re just kidding.

2.  I enjoy receiving their attacks just as much as they like making them.

3.  They’re going to enjoy my ridicule just as much as I enjoy theirs.

For them, it’s all fun and games–intellectual jousting.  I’m sure Brad and John Yoo have a beer after work every Friday night.  Well, perhaps I should say it’s usually joking around.  But I figure anything that doesn’t kill me makes me stronger.  Last time Krugman responded to my criticism Ryan Avent pointed out that Krugman’s response actually supported my point.  And after reading the recent posts by DeLong and Waldmann, I feel like Hercules.

Let’s start with Robert Waldmann, who responded to my argument that both Keynes and Krugman unfairly characterized their opponents:

So to Keynes unemployment due to nominal wage rigidity and unemployment due to collective bargaining were ‘voluntary’ unemployment. The quotes are not scare quotes. He is quoting other economists (principally Pigou) and he uses the word with that sense throughout The General Theory of Employment, Interest, and Money.

This means that self declared “New Keynesians” would be called “classicals” by Keynes.

For the moment, let’s put aside Keynes’s patently absurd assertion that unemployment caused by sticky wages is “voluntary,” and instead focus on Waldmann’s argument that new Keynesian economists would be considered classicals by Keynes.  I agree.  Waldmann continues:

However, it shows reckless disregard for the truth to claim that what Keynes wrote about the classicals was dishonest, because those classicals were essentially New Keynesians. It is equally reckless to say that what Krugman wrote “the other side in this debate generally adheres, more or less, to something like what Keynes called the “classical theory“ of employment, in which employment and output are basically determined by the supply side. ” is dishonest.

He specified that he meant what Keynes called “the classical theory” making it clear to anyone with normal linguistic skills (including Gricean maxims) that other people use the phrase with another meaning. And that and gave a link which no one could be expected to actually click since Krugmanhas only occasionally stressed that the links are not decorative (indeed maybe only once).

Now everyone is sloppy sometimes. But Sumner was reckless and sloppy when accusing others of intellectual integrity and has earned some quiet time.

Gricean maxims–I’ll have to remember that one.  OK, let’s say that when Krugman uses the term “classicals” as a pejorative, he actually has a category in mind broad enough to include new Keynesians.  This morning Krugman showed his gratitude for Waldmann’s valiant defense by describing his own economic philosophy as follows:

For the record, I tend to think things through in terms of New Keynesian models, as in my old Japan paper, but often translate the results into IS-LM for simplicity. If that’s a crude, primitive approach, somebody should tell Mike Woodford.

Ouch!  Maybe next time Krugman, DeLong, and Waldmann should coordinate their talking points before going after me.

OK, enough sarcasm.  Why did I say Keynes’s attack on Pigou was indefensible?  Oddly enough, Waldmann provides the smoking gun, when he quotes Keynes as follows:

The classical school reconcile this phenomenon with their second postulate by arguing that, while the demand for labour at the existing money-wage may be satisfied before everyone willing to work at this wage is employed, this situation is due to an open or tacit agreement amongst workers not to work for less, and that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. If this is the case, such unemployment, though apparently involuntary, is not strictly so, and ought to be included under the above category of ‘voluntary’ unemployment due to the effects of collective bargaining, etc.

Keynes’s language may be a bit opaque for the modern reader, so it might take a moment for the utter absurdity of this statement to sink in.  Ironically, I didn’t even have to emphasize the nutty part; it’s already bolded in the quotation Waldmann provides.  Here’s what Keynes is saying:  Assume a nominal shock has reduced the price level by 10%.  In if a concerted agreement by all workers to cut their wages by 10% could produce full employment, then any unemployment associated with the lack of such agreement is “voluntary.”  You might think; “Well, that’s a weird definition of voluntary; obviously the individual worker in a giant auto factory can’t single handedly do anything about this problem, but maybe Keynes used the term “voluntary” in an idiosyncratic fashion.”  No such luck, as we see from a quotation just a bit further on in the chapter cited by Krugman and Waldmann:

Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment “” if there be such a thing (and who will deny it?). The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight “” as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.

Now Keynes is essentially saying “look around you; isn’t it obvious there is involuntary unemployment?”  Um, no.  Not unless you define “involuntary” in the way 99.9% of humanity would define it, i.e. as unemployed workers who are miserable and who would much rather be back at work.  But of course that sort of involuntary unemployment is very possible when wages are rigid in the aggregate.  It seems even the great John Maynard Keynes suffers from an occasional failure to adhere to Gricean maxims.  So Keynes uses extremely deceptive language in one section, understanding that no sane person can follow the impenetrable logic of the General Theory, and then uses a few choice bon mots to make Pigou look like a fool.  For those of you who don’t know, Pigou spent much of his career studying unemployment, so I imagine he wasn’t enthused by Keynes’s deeply disingenous remarks.  BTW, someone in the comment section said Keynes later acknowledged that he’d been unfair to Pigou in the GT, can anyone provide the citation?  I hope Waldmann will accept that apology if it is true, and I’m hoping he doesn’t maintain Krugman was temporarily insane when he referred to his own macro model as “New Keynesian.”

Brad DeLong probably had the good sense to understand that my attacks on Krugman were accurate, and so he mostly tries to change the subject, or point out which parts of Krugman’s criticism of the right were accurate.  (And BTW, some of Krugman’s attack was accurate, as I acknowledged.)

I think Sumner oversteps here: Hawtrey and Hayek were definitely in the Eugene Fama camp. (Hawtrey changed his mind.) I don’t believe Keynes classified Fisher and Wicksell as “classical” economists. But I do agree with Scott that Pigou and Cassel have a legitimate beef.

Unfortunately, I haven’t had the good fortune to study Fama’s theories of macro, so I don’t quite know what this means.  But based on the criticism he got, I believe his  faux pas was denying that fiscal stimulus could boost aggregate demand.  If so, that has no relevance for my accusation that Keynes falsely accused his contemporaries of ignoring the problem of unemployment.  It’s one thing to argue that fiscal stimulus fails to boost AD, and quite another to argue that higher AD fails to boost employment.  As I recall, both Hawtrey and Hayek understood that fluctuations in AD (or nominal spending, or whatever it was called in the 1920s) did in fact affect employment.  Hawtrey’s (1946) book on the Great Depression is still the most accurate explanation of what went wrong, and yet is a very non-Keynesian book.  Hayek warned that “secondary deflation” could cause unemployment.  Their views on fiscal stimulus may have been primitive, but that has no bearing on my argument.

DeLong continues by quoting me:

What I find more worrisome is Sumner’s assessment of the current debate:

“In his recent post Krugman has misrepresented the views of those he disagrees with in much the same way that Keynes did.  I’ve read most of the economists that he ridicules (except Fama), and they do not believe that nominal shocks have no short run real effects.  There are debates about whether it is most useful to think about nominal shocks as being essentially monetary, or due to Keynesian expenditure shocks, and there are also disputes about how much of the unemployment in the current recession is due to insufficient AD and how much is due to structural problems. For instance, Cochrane holds NGDP constant when evaluating fiscal stimulus, as he assumes changes in NGDP are a monetary policy issue…”

To “hold nominal GDP constant when evaluating fiscal stimulus” is to go the full Treasury View. That’s one.

Sumner gives up on Fama. That’s two.

Actually, I said I never read Fama, not that I gave up on him, so I don’t see how Fama’s views are relevant to the accuracy of my criticism of Krugman.  I don’t know precisely what the “full Treasury view” is, but here’s what Cochrane said in the paper that was ridiculed by Krugman and DeLong:

My first fallacy was “where does the money come from?” Well, suppose the Government could borrow money from people or banks who are pathologically sitting on cash, but are willing to take Treasury debt instead.  Suppose the government could direct that money to people who are willing to keep spending it on consumption or lend it to companies who will spend it on investment goods. Then overall demand for goods and services could increase, as overall demand for money decreases.  This is the argument for fiscal stimulus because “the banks are sitting on reserves and won’t lend them out” or “liquidity trap.”

In this analysis, fiscal stimulus is a roundabout way of avoiding monetary policy. If money demand increases dramatically but money supply does not, we get a recession and deflation. If we want to hold two months of purchases as money rather than one months’s worth, and if the government does not increase the money supply, then the price of goods and services must fall until the money we do have covers two months of expenditure. People try to get more money by spending less on goods and services, so until prices fall, we get a recession. This is a common and sensible analysis of the early stages of the great depression. Demand for money skyrocketed, but the Fed was unwilling or, under the Gold standard, unable, to increase supply.

This is not a convincing analysis of the present situation however. We may have the high money demand, but we do not face any constraints on supply. Yes, money holdings havejumped spectacularly. Bank excess reserves in particular (essentially checking accounts that banks hold at the Federal Reserve) haveincreased from $2 billion in August to $847 billion in January. However, our Federal Reserve can create as much more money as anyone might desire and more. There is about $10 trillion of Treasury debt still outstanding. The Fed can buy it. There are trillions more of high quality agency, private debt, and foreign debt outstanding. The Fed can buy that too. We do not need to send a blank check to, say, Illinois’ beloved Governor Blagojevich to spend on “shovel-ready” projects, in an attempt to reduce overall money demand. If money demand-induced deflation is the problem, money supply is the answer.

Some people say “you can’t run monetary policy with interest rates near zero.” This is false. The fact of low interest rates does not stop the Fed from simply buying trillions of debt and thereby introducing trillions of cash dollars into the economy. Our Federal Reserve understands this fact with crystal clarity. It calls this step “quantitative easing.” If Fed ignorance of this possibility was the problem in 1932, that problem does not face us now.

Of course Krugman and DeLong “forgot” to quote that passage, as it would have spoiled their perfect “gotcha” moment.  As for the merits of the argument, all I can say is if that’s the “full Treasury view” then count me in.  (I had thought that the Treasury view was a denial that fiscal policy could boost AD, but I admit that my knowledge of the history of economic thought is more superficial than DeLong’s, so I may be mistaken on that point.)  As an aside, I do think Cochrane’s article was poorly organized, but that’s another issue.

DeLong continues:

The others whom Krugman mentions are Mulligan, Ferguson, Meltzer, and Laffer. Krugman is completely right about Mulligan and Ferguson. I don’t think Laffer has a coherent model of the economy at all. The only one of the six whom Krugman “ridicules” for whom Sumner has a case is Meltzer. And when I look back at Meltzer’s piece:

Notice what DeLong does, just because Mulligan and Ferguson might have been wrong about something, he assumes it somehow proves that my criticism of Krugman was unjustified.  OK, someone produce the Ferguson and Mulligan quotations that say severe AD shocks have zero effect on employment.  Laffer is a supply-sider who doesn’t place enough emphasis on demand shocks, in other words the exact opposite of DeLong and Krugman.  But unless my memory is faulty, he never argued the SRAS curve is vertical.  Meltzer’s views on money are similar to those of Milton Friedman, so I’d say that I have something more than “a case.”  Notice how DeLong changes the subject, and quotes a Meltzer passage where he overreacted on the bulge in the money supply.  Last year I also criticized Meltzer in my blog, and argued that Krugman would be proved right (as he was.)  Of course none of this has anything to do with my claim that Krugman falsely accused the right of believing that demand shocks don’t have any effect.  And that’s it, there’s no actual evidence that any of my assertions were wrong, just smoke and mirrors.

DeLong ends as follows:

So, Ezra, believe Paul.

Yes, if you want to stay in the cocoon of liberals who tolerate no criticism of Krugman but have fun calling right-wing intellectuals fools and knaves, then you should believe Paul.  If’ you prefer to emulate people like Matt Yglesias, who actually do try to occasionally understand the alternative point of view, I’d suggest getting outside that warm and cozy cocoon.

It seems like every time I criticize Krugman, others leap to his defense—and that just drives more traffic to my blog.  So let’s see what we can find in today’s Conscience of a Liberal.  How about this:

In the 1930s, competitive devaluation mattered largely because a number of countries were still on the gold standard, and were keeping interest rates well above the zero lower bound in an attempt to preserve their gold reserves. Devaluation relaxed this constraint by making the gold worth more in domestic currency, and hence was expansionary.

Actually, that’s not why devaluation worked.  The case I am most familiar with is the US, which devalued in 1933.  The gradual depreciation of the dollar sharply raised prices, but not because of interest rates or the money supply (which didn’t change much.)  Rather dollar depreciation led to expectations of a future expansion in the money supply once gold was fixed at a higher price.  Commodity prices rose immediately, due to both PPP and expectations of higher future prices.

The most famous example of a liquidity trap (albeit not called that at the time) was the spring 1932 OMOs, which failed to boost AD.  This was the only example cited by Keynes in the General Theory.  Krugman once cited Keynes’s views on monetary policy ineffectiveness when criticizing Milton Friedman:

Now, a word about Japan. During the 1990s Japan experienced a sort of minor-key reprise of the Great Depression. The unemployment rate never reached Depression levels, thanks to massive public works spending that had Japan, with less than half America’s population, pouring more concrete each year than the United States. But the very low interest rate conditions of the Great Depression reemerged in full. By 1998 the call money rate, the rate on overnight loans between banks, was literally zero.

And under those conditions, monetary policy proved just as ineffective as Keynes had said it was in the 1930s. The Bank of Japan, Japan’s equivalent of the Fed, could and did increase the monetary base. But the extra yen were hoarded, not spent. The only consumer durable goods selling well, some Japanese economists told me at the time, were safes. In fact, the Bank of Japan found itself unable even to increase the money supply as much as it wanted. It pushed vast quantities of cash into circulation, but broader measures of the money supply grew very little. An economic recovery finally began a couple of years ago, driven by a revival of business investment to take advantage of new technological opportunities. But monetary policy never was able to get any traction.

In effect, Japan in the Nineties offered a fresh opportunity to test the views of Friedman and Keynes regarding the effectiveness of monetary policy in depression conditions. And the results clearly supported Keynes’s pessimism rather than Friedman’s optimism.

Actually, Keynes and Friedman were both wrong, the problem in the US during 1932 was the gold standard.  The failure of the OMOs was due to an outflow of gold, due to devaluation fears.  So Krugman’s right about that—the gold standard was the problem.  But it’s wrong to look at this problem through the lens of interest rates, unless you want to argue that devaluation lowered real interest rates by raising inflation expectations.  And of course Japan never had any inflation because the BOJ raised rates any time inflation rose to 0%, thus driving the economy right back into mild deflation.  There’s no “trap” involved at all.

On the other hand Krugman’s right that competitive devaluations would be essentially like a coordinated policy of QE.

BTW, nice parrot Brad.



44 Responses to “DeLong and Waldmann defend the indefensible (i.e. Krugman)”

  1. Gravatar of JKH JKH
    4. October 2010 at 19:14

    “Of course Krugman and DeLong “forgot” to quote that passage, as it would have spoiled their perfect “gotcha” moment”

    Looks more the opposite to me, Scott.

    Fiscal policy increases private sector incomes and saving; monetary policy doesn’t.

    The Treasury view ignores the fact that fiscal policy creates the income and saving required to buy the debt.

  2. Gravatar of Benjamin Cole Benjamin Cole
    4. October 2010 at 20:52

    Typo near top: 1. They’re just kidding. Not “Their just kidding.”

    Sumner is winning this blog economic wrestling match. Tomorrow, the world!

  3. Gravatar of ca ca
    4. October 2010 at 21:13

    Keep up the good work Scott. I wish more center-right economists were willing to take on the prominent leftist economists more directly, and more often. I’m looking at you Greg Mankiw.

  4. Gravatar of r.d. r.d.
    4. October 2010 at 21:56

    Excellent take down!!!

    Can you explain what you mean when you say Friedman was wrong about 1932? I thought he was also critical of the gold standard (especially as it was operating in that era).


  5. Gravatar of Fed Up Fed Up
    4. October 2010 at 22:24

    “Actually, Keynes and Friedman were both wrong, the problem in the US during 1932 was the gold standard.”

    Actually, the problem about the Great Depression was wealth/income inequality and too much debt.

  6. Gravatar of Fed Up Fed Up
    4. October 2010 at 22:26

    Regarding Japan, did they have high debt levels right before/during the early 1990’s?

  7. Gravatar of Daniel Daniel
    4. October 2010 at 23:48

    So Cochrane agrees that QE makes sense? Neat.

    By the way, when you say you “thought the Treasury view was a denial that fiscal policy could boost AD”, isn’t Cochrane’s line in that paper “Every dollar of government spending must correspond to one less dollar of private spending.” precisely such a denial?

    The only exception he allows in that paper is that if the government explicitly is expected not to eventually retire the new debt, government spending does not crowd out, but in that case the inflation induced would be “frightful to contemplate.”

    So on fiscal policy (as opposed to QE), Cochrane writes as if he does not believe that targeting a level of inflation or NGDP growth would work. In that paper, at least, he writes as if you can only choose between crowding out now, or horrendous unintended inflation later. So shouldn’t we say that Cochrane does indeed “deny that fiscal policy can boost AD”, or at least that it can do so without subsequent hyperinflation?

    But I’m very encouraged that Cochrane also thinks QE makes sense.

  8. Gravatar of John Butters John Butters
    5. October 2010 at 01:25

    Interesting post, but too long! I got lost trying to unpick the interesting bit — policy implications today — from all the scholarly stuff about who said what about whom over half a century ago.

    Krugman is influential partly because he is pithy. Sometimes he does a great job of boiling an argument down to its key premises, and then produces a single graph, say, that shows why he things a premise is wrong.

    I am not just trying to be unpleasant: I am ever more hungry for a good contra-Krugman blog, because I find him so persuasive and I don’t have the knowledge to challenge what he says. You could get there!

  9. Gravatar of Leigh Caldwell Leigh Caldwell
    5. October 2010 at 02:41

    Is it really worth it? The three of you all broadly agree on policy, so does it matter if DeLong’s opinion of your comment on Krugman’s characterisation of Keynes’s quotation of Pigou is exactly right?

    On Japan, today’s news:

    Particularly notable is this comment at the end:
    ‘The Bank has also “clarified” that rates will not be raised again until “price stability is in sight” (on condition that no problems are identified, e.g. financial imbalances).’

    Good to have some commitment to the future path of monetary policy I guess.

    From your previous posts, it seems that the BoJ has no explicit definition of “price stability” – but its history implies that it means precisely zero inflation. Given that, do you think this commitment is a useful one – will it be expansionary or not?

  10. Gravatar of W. Peden W. Peden
    5. October 2010 at 03:33

    Re: Japan, isn’t it also the case that broad money (as opposed to the monetary base) has grown stagnantly since 1990 in Japan? As one would expect, if the BoJ keeps raising interest rates whenever inflation heads above 0%.

    The “Japan is in a liquidity trap” is the one thing that Krugman says that really angers me, because it depends on a mix of equivocation (between a Keynesian liquidity trap and a Krugmanite liquidity trap) as well as one of Krugman’s most consistently annoying mistakes, which is to confuse the monetary base with the money supply.

    I have no problem with people saying something with which I disagree, but when people get into the business of argument by ambiguity, it’s very frustrating.

  11. Gravatar of scott sumner scott sumner
    5. October 2010 at 04:47

    JKH, No, monetary policy increases M*V directly, fiscal policy only works if it can induce people to speed up velocity, and also prevent the central bank from offsetting the effect. That’s certainly possible. But if the central bank is inflation targeting (as most are) it is widely understood that fiscal policy can’t stimulate at all.

    Benjamin, Thanks, I just corrected it.

    CA, Thanks.

    Thanks R.D. Friedman was right about the gold standard, but incorrectly argued the spring 1932 OMOs were somewhat effective. They weren’t.

    Fed Up, Why did too much debt cause NGDP to fall in half?

    Lots of countries have lots of debt, there’s only one Great Depression.

    Daniel, There’s no question that Cochrane’s statement was poorly phrased. He clearly meant that for any given supply and demand for money, fiscal stimulus can’t work. Unfortunately he didn’t say that until later in the paper. That’s why I said it was poorly written.

    But it’s hardly worth the criticism he got from K&D. How many times has Krugman said monetary policy is ineffective at the zero bound, while failing to mention that it is still highly effective if unconventional means are used?

    John, Yes, it was too long. Krugman does a good job of simplifying, but he often distorts the truth while doing so.

    Leigh, You said;

    “Is it really worth it? The three of you all broadly agree on policy, so does it matter if DeLong’s opinion of your comment on Krugman’s characterisation of Keynes’s quotation of Pigou is exactly right?”

    Is it worth it? For me, yes. For my readers, no. It’s a lot of fun being able to turn the tables when some other bloggers claim you are a fool.

    And this is really a question you should ask Krugman and DeLong. I often praise their views on monetary stimulus, yet they never praise my views. I find that odd, especially as they started out opposing me on the effectiveness of monetary stimulus, and now agree. I would think they’d want to thank me for pointing them in the right direction. Now they’re all over the Fed for being too tight, just as I was in late 2008.

    In any case, I will continue to praise their views where appropriate, no matter how ungrateful they are to me.

    Regarding Japan, this is exactly the same policy the BOJ has been pursuing for 20 years. I see no sign anything will change. I plan a post on this later today.

    W. Peden, Yes, I’ve done many posts showing Japan is clearly not “trapped.” What does it tell you that they waited until today to act?

  12. Gravatar of JTapp JTapp
    5. October 2010 at 04:59

    FWIW– I’ve found DeLong’s characterization of different recessions informative and interesting:
    Monetarist recession – caused by excess demand for money.
    Keynesian recession – caused by excess demand for bonds.
    Minskian recession – caused by excess demand for safe assets.

    Is it just splitting hairs? It seems to me that several economists (Nick Rowe most recently) seem to use demand for money and demand for safe assets interchangeably.

    I wish we could have more uniform definitions of terms like “liquidity trap” as well. Delong seems to say a liquidity trap is only when cash and bonds become perfect substitutes. Krugman, meanwhile, calls lots of situations liquidity traps–as Dr. Sumner called him out on earlier this year.

  13. Gravatar of Nick Rowe Nick Rowe
    5. October 2010 at 05:00

    Scott: “Now Keynes is essentially saying “look around you; isn’t it obvious there is involuntary unemployment?””

    I’m not sure Keynes was saying that. (Or if he was, he shouldn’t have been). His own (weird) definition of ‘involuntary unemployment’ (I forget his exact words, and it’s so convoluted anyway) is that if an increase in P, given W, causes both the quantity of labour demanded and supplied to be bigger than previous employment, then the unemployment was ‘involuntary’. In other words, if a rightward shift in the AD curve can cure it, the unemployment was ‘involuntary’.

  14. Gravatar of Nick Rowe Nick Rowe
    5. October 2010 at 05:02

    But yes, it’s a rather dodgy way for Keynes to be arguing, since it’s so easy for him to mean one thing and everybody reading it to hear another thing.

  15. Gravatar of Nick Rowe Nick Rowe
    5. October 2010 at 05:07

    JTapp: “Is it just splitting hairs? It seems to me that several economists (Nick Rowe most recently) seem to use demand for money and demand for safe assets interchangeably.”

    What!! I certainly wasn’t using those “money” and “safe assets” interchangeably! I was quite clear that by “money” I meant “medium of exchange”, which is not the same as “safe”.

  16. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    5. October 2010 at 05:27

    JTapp: DeLong’s characterization is very important. I have a post that argues that we have excess demand for money, while the relative price of safe but illiquid assets has crashed after Lehman:

  17. Gravatar of scott sumner scott sumner
    5. October 2010 at 06:58

    Nick, I really don’t think his readers would have drawn that implication from “and who will deny it”. He’s claiming that there is obviously involuntary unemployment during the middle of the Great Depression. But there’s nothing obvious about his definition, it requires a leap of faith to assume unemployment is caused by:

    “an increase in P, given W, causes both the quantity of labour demanded and supplied to be bigger than previous employment, then the unemployment was ‘involuntary’. In other words, if a rightward shift in the AD curve can cure it, the unemployment was ‘involuntary’.”

    There is nothing we can see in the real world that would tell us whether unemployment is caused by prices being to low, or wages being too high. So obviously Pigou would not agree that his model is clearly wrong, he would deny it, as would most other interwar economists.

    In any case, a rightward shift in AD would also cure Pigovian unemployment caused by rigid wages, so that’s clearly not what he meant. People are always trying to defend Keynes, but the truth is that the GT is his worst book on monetary economics, worse than both the Tract and the Treatise.

  18. Gravatar of Nick Rowe Nick Rowe
    5. October 2010 at 07:09

    Scott: OK, I see your point. Actually, I would now say that Keynes slips from one meaning of ‘involuntary unemployment’ to another in that passage. The first time he must be using it in the ordinary sense (otherwise “who would deny it?” doesn’t work). The second time he must be using it in his own special sense, hence the “in the strict sense”.

    It would be so much better if he had talked about “deficient aggregate demand unemployment” instead.

    Keynes makes so much more sense after reading Clower and Barro-Grossman, on what Keynes should have meant. Because even if W fell, if demand for newly-produced goods were still too low, it wouldn’t help any. Constrained labour demand curve.

  19. Gravatar of ssumner ssumner
    5. October 2010 at 07:16

    Nick, Those comments make sense to me. But I still think Keynes was wrong about wages. The sharpest wage cuts in US history were in 1921, and led to an explosive recovery. He assumes that wage cuts will reduce prices. That may be true to some extent, but a rightward shift in AS will still increase output, even if prices fall. Of course Krugman follows Keynes in assuming that the AD curve is upward sloping at zero interest rates, but I find that completely implausible. In the Depression output fell sharply after FDR raised wage rates by executive fiat, exactly the opposite of what Krugman would predict.

  20. Gravatar of Morgan Warstler Morgan Warstler
    5. October 2010 at 08:01

    Seriously? Anther post where you guys all circle jerk and no one argues with the REAL opposition?

    Good lord.

    Just enough QE to keep us at 2% inflation starting from now… that’s what you’ll get. That’s all you’ll get. We aren’t going back to 2008.

    SO your policy goal then is anything that causes productivity gain deflation…

    Now can we move on to the good stuff?

    What policy changes will reduce wage friction? What policy changes reward the guys with cash? What policy changes tax consumption? What policy changes stop promoting housing? What policy changes increase job turnover? What policy changes oust Obama in 2012? What policy changes increase employment mobility?

    Frankly, if you don’t move on to these, and you just keep screaming QE! You look like you don’t want to see things FIXED, just papered over.

    That’s ought to be your blog title, “Papering over problems since 2008”

  21. Gravatar of JTapp JTapp
    5. October 2010 at 08:01

    Nick Rowe- I’m sorry if I misread one of your earlier posts.

    Themoneydemandblog- Thanks for the link. Rowe’s comments there are also helpful. The more I learn, the more I realize I have to learn.

    One concern I have is the overall obsessive focus of Keynesians on The Great Depression.

    I have students writing wikis on the Panics of 1873 and 1893 and find many similarities to the questions those recessions/depressions and our current mess. But hardly anyone writes blog posts about those episodes.

  22. Gravatar of Jason Jason
    5. October 2010 at 12:16

    Keynes may make sense if instead of a 10% shock, the shock is 50% versus a 2% shock. As Robin Hansen would say, coordination is hard, but I would consider deciding not to do something hard is voluntary.

    If the shock is small enough, people will likely take their chances on getting fired. If the shock is big enough they should rationally (and voluntarily) bargain to cut their losses (although behaviorally, they seem to not do this because of loss aversion — but is that voluntary or involuntary?).

    I would argue that there is some level of shock where a spontaneous order has a finite probability of arising and people shift behavior from individually taking a chance on getting fired to collective bargaining. If collective action does not occur in response to a large enough shock, then I could consider that voluntary because each individual did not work hard enough to nucleate collective action.

  23. Gravatar of Fed Up Fed Up
    5. October 2010 at 13:41

    “Fed Up, Why did too much debt cause NGDP to fall in half?”

    Debt defaults above capital set aside for losses caused one type of medium of exchange (demand deposits) to fall in supply. That caused demand and supply to start spiraling backwards in time towards a lower level. Notice that the debt probably caused demand and supply to spiral forwards in time when the debt was rising.

  24. Gravatar of Fed Up Fed Up
    5. October 2010 at 13:47

    W. Peden said: “… which is to confuse the monetary base with the money supply.”

    Could you expand on those two differences? Thanks!

    Is the “money supply” that matters the one that can be used to purchase goods/services and financial assets?

  25. Gravatar of Fed Up Fed Up
    5. October 2010 at 13:55

    “Lots of countries have lots of debt, there’s only one Great Depression.”

    Are they supply constrained? How much is foreign debt? Are they able to try to net export their way out of a too much debt problem? What would happen in Japan if gov’t debt didn’t rise?

  26. Gravatar of W. Peden W. Peden
    6. October 2010 at 06:22

    Fed Up,

    I will use the British taxonomy, if I may, simply because it’s the one with which I am most familiar-

    Narrow money (M0 in Britain): notes & coin + operational deposits at the central bank. Sometimes called “high-powered” money.

    Broad money (M4 in Britain): notes & coin + bank and building society deposits + wholesale deposits + CODs.

    Both have a statistical relationship with inflation, but M4 measures what I would call the “true” money supply, since it includes anything that can be used to be used as a medium of exchange with reasonably short notice, which is how I would define money.

    For example, government borrowing in the UK is largely accomplished by borrowing from the banks. If the government borrows a short-term bond from a bank, that bank can count that bond as part of its bank reserves, because it can fairly quickly convert it into a medium of exchange. So short-term government borrowing means that banks can lend more to the public without worrying to much about their liability/asset ratio. In contrast, long-term government borrowing (say a 15-year bond) cannot be counted as part of bank reserves, because the bank cannot cash it in at short notice.

    Broad money would include short-term government bonds held by banks (as part of bank deposits) while excluding long-term government bonds held by banks. Narrow money excludes both.

    There are various intermediate measures that exclude various things. In the UK, these are M1, M2 and M3. There was a lot written about these measures back in the 1970s and 1980s (when M3 was the standard definition of broad money) but they are now largely ignored in favour of M0 and M4, which are the only monetary aggregates still published by the Bank of England.

    The various monetary aggregates diverge over historical periods. Sometimes, this divergence can be very important: during the 2008-? crisis, narrow money grew significantly in the US. People who regard narrow money as the causally important aggregate (like many in heterodox schools and some monetarists) predicted that inflation was on the cards.

    However, those of who regard broad money as more causally important looked at broad money growth, which has been stagnant or falling in the US since 2008, and predicted deflation/low inflation. A good example of a monetarist who mostly looks at broad money would be Tim Congdon, who has done a fair bit of research into the Japanese Lost Decade where stagnant broad money growth since 1990 (even during periods of timid and abortive monetary stimulus) arguably played the primary role in the decline of the Japanese economy.

    So the distinction between narrow money and broad money, which might seem to be the kind of arcane terminological dispute that makes up much of monetarist theory, is actually the difference between predicting inflation that doesn’t happen and realising the need for monetary stimulus.

  27. Gravatar of scott sumner scott sumner
    7. October 2010 at 05:28

    JTapp, The data is not as good for those earlier depressions.

    Jason, The collective action problem is far too hard at the national scale.

    W. Peden, Thanks for answering Fed Up’s questions.

    Fed up, Even if money demand rose, that begs the question of why the Fed didn’t increase the money supply.

  28. Gravatar of Jim Glass Jim Glass
    7. October 2010 at 06:00

    someone in the comment section said Keynes later acknowledged that he’d been unfair to Pigou in the GT, can anyone provide the citation?

    My memory from reading Moggridge’s bio of Keynes is that JMK’s peers complained to him that he was being unfair to the “classicals” and Pigou in particular, and that he replied yes, he knew that but he was trying to “raise a dust” to get his new ideas appreciated.

    I don’t have that book with me so I can’t quote its telling of the episode. But some Googling found related references:

    [] “Keynes Knew He Was Caricaturing Pigou”

    p.16 of 30, plus other references. I enjoyed this quote, from among the cited complaints by Keynes’s compatriots:
    Harrod to Keynes (1935): Keynes must stop the “guerilla skirmishing” and “destructive” attacks on the classicals. “No further criticism of the classical system is required. All your subsequent criticism is fussy, irrelevant, dubious, hair-splitting and hare-raising.”

    [] Moggridge, on Keynes’ “rhetorical device”.


    “Despite Harrod’s pleas, he insisted on forcefully criticising orthodoxy in the General Theory, though he did allow that his critique may need modification as a result of being ‘too keen’ (CW VII xxi). As he emphasised in 1935, ‘I *want*, so to speak, to raise a dust; because it is only out of the controversy that will arise that what I am saying will get understood’.” [Emphasis in Origninal]

    [] From Patinkin’s Palgrave entry on Keynes…

    … Keynes wrote to Roy Harrod in August 1935, in reply to the latter’s criticism that Keynes’s discussions of the classical position were carried out in an unduly polemical style that exaggerated the differences between the two positions. In Keynes’s words:

    “… I am frightfully afraid of the tendency, of which I see some signs in you, to appear to accept my constructive part and to find some accommodation between this and deeply cherished views which would in fact only be possible if my constructive part has been partially misunderstood. That is to say, I expect a great deal of what I write to be water off a duck’s back. I am certain that it will be water off a duck’s back unless I am sufficiently strong in my criticism to force the classicals to make rejoinders. I want, so to speak, to raise a dust; because it is only out of the controversy that will arise that what I am saying will get understood.” (JMK XIII, p. 548; italics in original).

  29. Gravatar of ssumner ssumner
    8. October 2010 at 14:51

    Jim Glass, Thanks, I might use that.

  30. Gravatar of Fed Up Fed Up
    10. October 2010 at 16:32

    scott sumner said: “Fed up, Even if money demand rose, that begs the question of why the Fed didn’t increase the money supply.”

    That is because right now I believe that all new money is debt. However, an economy can’t grow supply more than demand when there is mostly enough supply already. There were more goods being produced than the workers could buy without debt. Earlier they had bought them with debt and didn’t realize the demand for labor was falling due to productivity gains. It hit their budgets (you would probably called them balance sheets) when the workers needed the same or more hours or a wage increase causing debt defaults. They were probably some demand effects when some people went bankrupt because of speculating in stocks when the margin rate was 10%.

    In today’s terms, there was an AS shock that was not handled properly and later showed up as an AD shock. The fed was trying to price inflate with the wrong medium of exchange.

  31. Gravatar of ssumner ssumner
    11. October 2010 at 05:48

    Fed up, It doesn’t seem to me that you addressed my point. There is no “wrong” medium of exchange.

  32. Gravatar of Fed Up Fed Up
    11. October 2010 at 22:55

    “Fed up, It doesn’t seem to me that you addressed my point. There is no “wrong” medium of exchange.”

    Is there a difference between creating more medium of exchange with currency along with no bond backing and creating more medium of exchange with demand deposits from debt? I think so from a budget and time perspective.

    The way the system is set up now, I don’t believe the fed can directly increase currency (they probably wouldn’t want to anyway). The fed can lower the fed funds rate to zero or near zero and even create excess reserves, but if no one is willing or able to go into debt, is there any increase in the money (medium of exchange) supply?

    I believe I am also assuming that excess savers don’t spend more when interest rates are lowered.

  33. Gravatar of ssumner ssumner
    12. October 2010 at 05:13

    Fed up, If they want to increase currency, just put a negative interest rate on reserves. Or set a higher inflation target.

  34. Gravatar of Fed Up Fed Up
    12. October 2010 at 19:32

    “Fed up, If they want to increase currency, just put a negative interest rate on reserves.”

    Will the currency then just sit on the balance sheet of the banks?

    And, “Or set a higher inflation target.”

    I assume that is about increasing debt, not currency. If it is about more currency, I don’t understand that at first glance. If it is about more debt, I’m not sure that will work because it will only take most people’s budgets further into negative earnings growth territory.

  35. Gravatar of ssumner ssumner
    15. October 2010 at 15:27

    Fed up, No, currency in banks IS reserves.

  36. Gravatar of Fed Up Fed Up
    15. October 2010 at 17:32

    I’m not sure how a negative interest rate is put on currency. However, it seems to me you’re trying to bring up the crazy ideas of the rich and the bankers to start taxing currency as a fix for the Great Depression.


  37. Gravatar of ssumner ssumner
    17. October 2010 at 05:57

    Fed Up, Negative interest on currency held by the public is a crazy idea. Negative interest on vault cash is a sensible idea. But only on vault cash holdings above twice normal bank vault cash holdings. That would make it so most banks wouldn’t have to mess with paying interest on vault cash.

  38. Gravatar of Fed Up Fed Up
    20. October 2010 at 22:40

    “Fed Up, Negative interest on currency held by the public is a crazy idea.”

    Tell that to the dallas fed and from:

    “Strategies for Overcoming the Zero Bound

    A number of strategies have been proposed for pulling the economy out of a zero-interest-rate trap. These range from the radical to the mundane and from the practically difficult to the eminently practicable. We will examine several such strategies. We first consider the boldest, though also the most difficult to implement: eliminating the zero bound altogether. We then examine modifications to standard policy that avoid some of the problems we alluded to earlier. These more workable approaches may require the coordination of Fed policy with that of other actors””either foreign central banks or domestic fiscal policymakers””or may allow the Fed to act unilaterally.

    The most daring suggestion for escaping the zero-interest-rate trap is to eliminate the zero lower bound altogether. How can this be done? As we noted earlier, the zero bound on interest rates exists because money pays a sure nominal interest rate of zero. No one would be willing to hold any asset that pays a negative nominal rate, as long as zero-interest money is available as a store of value.

    The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate by imposing some type of “carry tax” on currency and deposits. A tax on money holdings of 0.5 percent per month, for example, would mean that money, in effect, pays a negative nominal interest rate of roughly -6 percent. Market interest rates would then be free to fall into negative territory, and the Fed could continue to cut short term rates, with -6 percent as the new lower bound.

    It’s easy to envision such a system with regard to deposits at the Federal Reserve or transactions deposits at banks; for the most part, the technology to implement such a system is already in place. The main difficulty””both technological and political””lies in imposing such a tax on currency. In the 1930s, Yale economist Irving Fisher proposed such a system, in which currency had to be periodically “stamped,” for a fee, to retain its status as legal tender.[1] The stamp fee could be calibrated to generate any negative nominal interest rate the central bank desired.

    While the technology available for implementing such a system is more sophisticated today than in Fisher’s time, enforcement still seems a mammoth problem. It would require physical modifications to currency and some means of tracking the length of time each piece spends in circulation.

    Given the technological hurdles of implementation, a carry tax on money is probably not a feasible response to circumstances that might arise in the near term, though it merits study as a possible long-run solution to the zero bound problem. With the technology in place to (on occasion) impose a carry tax, a central bank would be free to target a very low average inflation rate, knowing that if severe downturns arise it could temporarily drive the nominal return on money below zero.”

    Granted the next paragraph says:

    “Without such a mechanism available, it’s likely that central banks will try to avoid the zero-interest-rate bound by simply aiming for higher long-run rates of inflation””which also amounts to taxing individuals’ money holdings, more consistently though less overtly, by eroding their real purchasing power. Thus, the average tax on money balances might actually be lower if the technology to impose a carry tax were developed. At the same time, we must acknowledge that””as is the case with all instruments of taxation””there is no guarantee that policymakers would not abuse the carry tax once the means to collect it were in place.”

  39. Gravatar of Fed Up Fed Up
    20. October 2010 at 22:46

    “Negative interest on vault cash is a sensible idea. But only on vault cash holdings above twice normal bank vault cash holdings. That would make it so most banks wouldn’t have to mess with paying interest on vault cash.”

    I think I need to hear some pluses and minuses to that idea.

  40. Gravatar of Scott Sumner Scott Sumner
    21. October 2010 at 05:53

    Fed up, Google my ‘reply to Mankiw’ (the moneyillusion) from last year for IOR.

    That Fed quotation is their way of saying it’s a crazy idea.

  41. Gravatar of himaginary himaginary
    23. October 2010 at 09:16

    “So to Keynes unemployment due to nominal wage rigidity and unemployment due to collective bargaining were ‘voluntary’ unemployment. The quotes are not scare quotes.”

    I think Waldmann misread Keynes here. The correct interpretation should be:

    “So to Pigou according to Keynes, unemployment due to nominal wage rigidity and unemployment due to collective bargaining were ‘voluntary’ unemployment. The quotes *are* scare quotes.”

    As you noted, the assertion that unemployment caused by sticky wages is “voluntary” is patently absurd. Keynes used that absurdity as a tool to criticize Pigou. Your statement, “of course that sort of involuntary unemployment is very possible when wages are rigid in the aggregate,” is what Keynes might have said.

    And as for wage cut, he admits that “a flexible wage policy and a flexible money policy come, analytically, to the same thing” (Chapter 19 of GT). So, in this sense, he seems to be on the same page with you. However, at the same time, he points out four obstacles peculiar to wage cut: (1)feasibility of uniform wage reductions, (2)maintainability of fairness among workers, (3)increase in the burden of debt, (4)adverse effects on investment due to deflation expectation. I think these are fair points to make.

  42. Gravatar of Scott Sumner Scott Sumner
    24. October 2010 at 07:23

    himaginary, I just re-read the GT chapter on classical economics, and I can’t agree with you. Keynes pretty clearly asserts that unemployment due to sticky wages are voluntary.

    I also disagree with Keynes’s assertion that wage cuts reduce AD, so I don’t agree those are “fair points to make.”

  43. Gravatar of Fed Up Fed Up
    27. October 2010 at 18:06

    I tried googling ‘”reply to mankiw” moneyillusion’. I don’t think it showed up. I found 4 entries, 3 not including this one.

    “I also disagree with Keynes’s assertion that wage cuts reduce AD, so I don’t agree those are “fair points to make.””

    How does that work?

  44. Gravatar of ssumner ssumner
    4. November 2010 at 17:19

    Fed Up,

    Here it is:

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