DeLong compounds his error by going after Lucas
Robert Lucas was my advisor at Chicago, so now it’s personal.
In a reply to my recent post on miscommunication among the macro elite, Brad DeLong misinterprets my argument, confusing nominal and real changes in GDP.
In claiming that Cochrane and Fama were really only making the tautological claim that “if we assume nominal GDP is fixed, fiscal policy doesn’t affect nominal GDP”, Scott is retconing.
That was not my claim. I claimed (and indeed showed) that both conceded that there might be a case where more nominal spending would boost real output, but in that case you just print money. But if printing money doesn’t solve the problem, neither does fiscal stimulus. Alternatively, if we assume NGDP is fixed by monetary policy, then there is no mechanism by which fiscal stimulus can raise real GDP. And unless I’m seriously mistaken, that happens to be true, even within the Keynesian model. Indeed especially within the Keynesian model (as supply-siders don’t always agree.)
I’m not sure Brad DeLong really understands how Chicago-types think. They compartmentalize. Roughly 99% of the time they look at the world with “real” models, where sticky prices and nominal shocks play no role. And then once and awhile they acknowledge, as a sort of aside, “well yes, deflation can have real effects, at least if wages and prices are slow to adjust.” If you grab a comment at random, they are going to be operating with a real model, without any output shortfall due to sticky prices.
DeLong makes things worse by implying that Robert Lucas also doesn’t understand the basics of demand-side macro, by including a Lucas quotation mocking fiscal stimulus right after the Fama and Cochrane quotations. Here’s what DeLong needs to think about. As of 10 years ago fiscal stimulus had basically been removed from elite macroeconomics. I’m not just talking about freshwater economics; I mean elite New Keynesian economics as well. Lucas knows this and so does DeLong. They also both know the reason, if you have an inflation targeting central bank, there really isn’t anything for the fiscal authorities to do (again, on the demand side.) The “Treasury view” holds in an inflation targeting world.
Now for a short period in late 2008 and 2009 the entire economic profession lost its head, and forgot everything they knew, or were supposed to know. The Keynesians forgot that the zero bound doesn’t stop central banks from inflating, and the right forgot that markets are efficient, and therefore that it’s a really, really, bad thing to let TIPS spreads plunge into negative territory. Brad DeLong published an article in early 2009 called “Four Ways Out” where he denied that monetary stimulus works in a liquidity trap. Fiscal stimulus was the only way out. To his credit, he did eventually rediscover the merits of monetary stimulus at the zero bound, and joined my crusade to have the Fed pump up NGDP. Indeed by earlier this year he was fighting off left wing skeptics of QE2, by pointing out that rumors of QE2 had boosted inflation expectations. So right now I’m much closer to DeLong than I am to Lucas.
What DeLong forgets is that among economists on the right there was much less belief in the liquidity trap bogeyman. Friedman taught at Chicago, and greatly influenced Lucas’ views on monetary policy. And we all know what Friedman thought of so-called “liquidity traps.” So when people suddenly started talking about fiscal stimulus in 2008-09, the right wing Chicago school reacted something like modern physicians would to a suggestion that leeches be brought back into medicine. The Fed determines NGDP, where’s the model that provides a role for fiscal stimulus? It’s right there in the Barro and Cochrane quotations I provide, in case anyone thinks I’m making this up. Their view is basically; “Nominal shortfall? Well in that case just print money; don’t build pyramids in the desert. But I don’t see a nominal shortfall.” Once the brief period of deflation was over, they (wrongly) assumed we didn’t even need more monetary stimulus.
I don’t want to let the right off the hook entirely. I see two big problems. They need to better understand that most economists see nominal shocks as having fairly long lasting effects, and also better understand the motivation of Keynesians. Yes, fiscal stimulus is just a backdoor way of boosting V, of making monetary policy effectively more expansionary. But the more sophisticated modern Keynesians know that. They correctly saw that the Fed was likely to fall behind the curve in terms of keeping NGDP on track. (Their mistake was in thinking that the Fed wouldn’t neutralize fiscal stimulus.) I also think the right underestimates how costly demand shortfalls really are. Lucas recently pointed out that NGDP just fell for a few quarters. But as Krugman showed in a recent post on wages, the distribution of nominal wage increases strongly suggests money illusion, and is inconsistent with any plausible model that assumes rationality. Furthermore, some of the structural problems the right points to, like extended UI benefits and higher real minimum wages, are themselves aggravated by the demand shortfall. Why do they think Congress suddenly raised maximum UI from 26 weeks to 99 weeks?
Another common misconception is that Lucas doesn’t believe demand shocks matter, a slur that DeLong thankfully avoided. But Krugman and Yglesias recently did make this charge, and I’ll take them to task in my next post.
HT: RGV
Tags:
21. July 2011 at 18:26
I don’t say this lightly…
I was RIGHT! (victory dance)
You should have walked over and bitch slapped DeKrugman at that conference.
You are going to have to go back over the real vs. nominal thing, maybe 4 or 5 times, lots of layman examples, but if you quickly follow up repetitive jobs where Dekrugman made his basic mistake – use small, non-economic phrases, he’ll have to go fetal.
This of course…
“I’m not sure Brad DeLong really understands how Chicago-types think. They compartmentalize. Roughly 99% of the time they look at the world with “real” models, where sticky prices and nominal shocks play no role. And then once and awhile they acknowledge, as a sort of aside, “well yes, deflation can have real effects, at least if wages and prices are slow to adjust.” If you grab a comment at random, they are going to be operating with a real model, without any output shortfall due to sticky prices.”
Is gold.
DeKrugam starts off with PRICES ARE STICKY!!!!!! WAGES ARE STICKY!!!!!
The error of their ways is an assumption of pleeb-pride in not accepting pay cuts.
The funny thing is they are the same crowd (see Matty) that HATES high unemployment… because employers “can” depress wages.
But if it can happen, then they ain’t sticky!
I’ve said it before, what DeKrugman does is not economics.
Off to use a Groupon to depress prices in Chicago!
21. July 2011 at 19:34
Whatever you do, please don’t let DeLong respond in your comments. Delete anything he posts here. Or truncate it misleadingly. He’s really the worst.
21. July 2011 at 19:48
“(Their mistake was in thinking that the Fed wouldn’t neutralize fiscal stimulus.)”
Is this true?
I’m still trying to pin down what exactly the Fed’s target is. You said they are targeting core inflation to my earlier question (thanks!), so I pulled core data. I’ll repeat a bit of my comment on your Economist article post, cause I want to make sure my methodology is right.
“I took the seasonally adjusted CPI for all Urban Consumers: Less Food and Energy from the Fed site. Then I look at the percentage change compared to 12 months earlier. Starting with 2008 data, I’m getting a high of 2.53% in August 2008 and a low of .59% in October of 2010. June compared to last June was 1.64% higher.
Is this the right data to look at? Is that the right methodology?”
If that’s right, I guess my next question is, what is the inflation target? I’m assuming you mean 2%, but they seem to be missing that pretty severely. If that was their target, it’s hard to see any evidence they neutralized the stimulus.
21. July 2011 at 20:29
So I read DeLong’s response, and couldn’t figure out why Lucas was even included. Where did he come from? The whole debate was between Cochran, Fama and Barro on the one side, and Krugman and DeLong on the other. Why did he bring Lucas in? What am I missing?
22. July 2011 at 02:22
“Alternatively, if we assume NGDP is fixed by monetary policy, then there is no mechanism by which fiscal stimulus can raise real GDP. ”
Have the people who believe that really searched for possible mechanisms, or do they just mean that in their simple little models there is no mechanism?
Do we have any reason to believe that monetary policy is sufficient if your objective is to tackle unemployment during recessions, for instance?
22. July 2011 at 06:20
Morgan, Stay away form the personal insults–I had to delete one of your comments. In any case, that sort of comment just hurts your cause, as people can write you off as a hater. Donuts have nothing to do with one’s ability to do macroeconomics. DeLong is very smart.
Thomas, He deleted one of mine–but I think it’s an advantage for me that I don’t delete comments unless crossing the line in obscenity or libel or something like that. I let people attack me here.
Charlie, I partly agree and partly disagree. I was very critical of them letting the core fall to 0.6% last year, but they did finally take action and boost it much closer to 2%. Obviously they aren’t doing as good a job as I’d like, but policy isn’t completely adrift either. Now lets say no fiscal stimulus is done in 2009. Then the core falls to 0.6% much faster, and the Fed does QE2 much sooner. By not doing QE2 much sooner, they neutralized much of the effect of fiscal stimulus (not all, but much of it.)
onliberty, I wondered about that too.
Luis, It’s hard to think of a mechanism by which fiscal stimulus could affect AS (except for cuts in MTRs, obviously.)
22. July 2011 at 07:27
Scott,
You wrote:
“I’m not sure Brad DeLong really understands how Chicago-types think. They compartmentalize. Roughly 99% of the time they look at the world with “real” models, where sticky prices and nominal shocks play no role. And then once and awhile they acknowledge, as a sort of aside, “well yes, deflation can have real effects, at least if wages and prices are slow to adjust.” If you grab a comment at random, they are going to be operating with a real model, without any output shortfall due to sticky prices.”
I think this is an insightful statement. But you have the advantage of having been educated at Chicago, although you clearly are well steeped in nominal models.
But as much as you might like, this doesn’t excuse the Chicago school. If they seem befuddled by our current predicament, and are grasping at bizarre explanations for the slow recovery, it’s because of that compartmentalization and the fact thay spend 99% of their time on the wrong side of the divide with respect to our current problems. They are making themselves look silly and irrelevant, and that’s tragic for an institution with such a noble history.
P.S. More than one of my comments have failed to have been posted by DeLong, usually when I present historical evidence of the effectiveness of monetary policy in the face of liquidity trap type situations. As an economic historian DeLong should know better. My only guess is that his own ideological blinders get in the way.
To your credit Scott I can’t ever remember you deleting one of my comments, although on occasion I wish I had the ability to delete my own.
22. July 2011 at 07:28
“Luis, It’s hard to think of a mechanism by which fiscal stimulus could affect AS (except for cuts in MTRs, obviously.)”
Government investment in public goods, does not raise AS? In a zero transaction world you’re right, but with transaction costs, there is role for government for producing public goods. Fiscal stimulus does not always have to consist of digging holes and filling them up again 😛
22. July 2011 at 08:01
Scott,
so if monetary policy gives you the NGDP you want, but unemployment is at 9%, you have arrived at the best that can be done?
22. July 2011 at 08:56
Luis,
If unemployment remains high/output remains stagnant despite reasonable NGDP growth, that is an indicator that the problem lies on the AS side, which monetary policy can do nothing about.
22. July 2011 at 13:00
The Fed may fall behind the curve, but surely the answer to that isn’t fiscal stimulus involving, e.g., rail funds that take a year to be awarded and another year for construction to start. Too much of the fiscal stimulus was slow, long term pet projects. Shovel ready was an illusion.
22. July 2011 at 14:02
John Thacker,
One can criticize ARRA for many things but being too slow is not one of them. Of the original $787 billion in spending/tax cuts that was authorized all but $121 billion already went out as of the end of March. If one trusts the VAR analysis the maximum effect rate wise was achieved in 2009Q4 (nearly two years ago) and the maximum level effect was reached in 2010Q2 (over a year ago). It has been in withdrawl since 2010Q4 and consequently the major models are showing it to currently be a net drag on growth rates.
As it turns out time was never really a factor because the monetary policy response has been less than satisfactory. In the final analysis fiscal stimulus is never really necessary as long as the Fed does its job.
22. July 2011 at 17:31
Mark, But why single out Chicago, every single elite department in America is befuddled by the slow recovery? Forbes just did an article, and mentioned me as the only one pushing monetary stimulus. That’s not quite true of course, but what a sad comment that they had to name me, and not some Harvard or MIT professor.
Luis; You said;
“so if monetary policy gives you the NGDP you want, but unemployment is at 9%, you have arrived at the best that can be done?”
The best you can do with m-policy. Then you need to pursue other reforms to make the economy work more efficiently.
John. Good point.
Mark, It’s even worse. Even if the Fed doesn’t do its job, it may sabotage fiscal stimulus–as it did in 2009. The Fed refrained from QE2 in 2009 because of fiscal stimulus, thus negating its effect. If there is no fiscal stimulus in 2009, the Fed does much more.
22. July 2011 at 18:41
Scott wrote:
“Mark, But why single out Chicago, every single elite department in America is befuddled by the slow recovery?”
Because you singled out Chicago (in response to DeLong singling out Chicago). Duh!
BTW, don’t forget I’m a UC dropout, so I’m somewhat familiar with the culture. And furthermore, a lot of important people were Chicago dropouts, such as Kurt Vonnegutt and Will Geer. So who knows?
And you wrote:
“Forbes just did an article, and mentioned me as the only one pushing monetary stimulus. That’s not quite true of course, but what a sad comment that they had to name me, and not some Harvard or MIT professor.”
You give me inspiration. Maybe someday Forbes will do an article on some unknown but spastically enthusiastic professor of economics at Rowan University. (i.e. Mark A. Sadowski the economics guy!)
23. July 2011 at 11:14
Mark, OK, but then why does Krugman single out Chicago, why not single out Princeton, the school that gave us Bernanke?
Regarding Forbes; believe me, if I can make it, anyone can!
23. July 2011 at 11:35
But why are you so sure that once you have arrived at the best you can do with m-policy that fiscal policy – managed expenditure – has no roll?
23. July 2011 at 21:12
“Mark, OK, but then why does Krugman single out Chicago, why not single out Princeton, the school that gave us Bernanke?”
lol! I think we know full well why Krugman singles out Chicago and not Princeton!
24. July 2011 at 07:15
Luis, If AD is on target, then obviously fiscal policy can’t improve AD. It may be able to improve AS through supply-side reforms, but that’s a separate issue. I’m talking about demand side policies.
onliberty, Yes we do.