Keynes on fiscal expectations traps

As you know, I am not a Keynesian.  I especially disagree with Keynes’ view that nominal interest rates are the appropriate indicator of the stance of monetary policy.  He was quite blunt about that; except under hyperinflation, high rates meant tight money and low rates meant easy money.  Period.  End of story.

I recently dug up this passage in an old article of mine:

In The Means to Prosperity (1933) Keynes argued that only an expansionary fiscal policy could raise world prices, but also noted that this policy might conflict with the need for a low long-term rate of interest:

“It is at this stage that a certain dilemma exists; since it may be true, for psychological reasons, that a temporary reduction of loan-expenditure plays a necessary part in effecting the transition to a lower long-term rate of interest.  Since, however, the whole object of the policy is to promote loan-expenditure, we must obviously be careful not to continue its temporary curtailment a day longer than we need.”  (Reprinted in Collected Writings, Vol. IX, p. 353-54.)

The more you think about this passage, the more bizarre it appears:

1.  Keynes was working on the General Theory in 1933; this was when his views were at their most Keynesian.  The Means to Recovery was a policy-oriented tract written during the period where his pessimism about monetary policy had reached its apogee.

2.  When he expresses a fear that fiscal stimulus could lead to higher long term interest rates, he is essentially saying that monetary policy would be effectively tightened by fiscal stimulus.

I don’t recall his exact reasoning, it may have been partly a crowding out story, but I vaguely recall it was also partly an international confidence story.  Big deficits could lead to a loss of confidence in a country’s ability to repay its debts (perhaps due to fear of devaluation.)  This seems pretty close to the issue raised by Statsguy in the comment section of one of my recent fiscal expectations trap posts.

However you interpret this, the implications are rather mind-boggling.  Here is Keynes in 1933 saying something to the effect; “Be careful with fiscal stimulus.  If it starts to raise long term rates you may need to end it temporarily.”  Not exactly the impression of Keynes we get from the history books.

And how about that last sentence?  If you like to think about macro in theoretically rigorous terms, how can you not squirm reading that nonsense?  If rates start to rise, hold back for a little while, but not “a day longer than we need”?  I guess that means that if the bond market was terrified of the Treasury debt auction on Tuesday, maybe by Thursday they’ll have forgotten all about it.  (Perhaps Keynes was too British to suggest the Greek approach.)  Do you think he actually has a model, or is he just winging it?

Keynes is really over-rated as an abstract thinker.  He was a superb practical macroeconomist, but a mediocre theoretician.



4 Responses to “Keynes on fiscal expectations traps”

  1. Gravatar of Doc Merlin Doc Merlin
    5. June 2010 at 14:20

    Even Keynes isn’t as Keynesian as some Keynesians. 🙂

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. June 2010 at 17:10

    A common problem with thinkers and disciples. Marx was not as Marxists as some Marxists, Freud as Freudian and some Freudian and Kuhn as Kuhnian as some Kuhnians.

    Etienne Gilson expressed the problem quite well when he wrote:
    … whereas a master holds his conclusions as conclusions, his disciples receive them as premises, with the consequence that their own conclusions can never be the master’s conclusions.

  3. Gravatar of Christopher Hylarides Christopher Hylarides
    6. June 2010 at 05:13

    It’s no different with any followers of any ‘messiah’. I tend to sympathize with the Austrian school, but man their acolytes…

  4. Gravatar of scott sumner scott sumner
    6. June 2010 at 05:37

    Doc, Yes, that’s right. At times Keynes was very non-Keynesian (for instance late in his life, and in 1923.)

    Lorenzo, I like that quotation. Excellent.

    Christopher. I hear you.

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