Keynesianism as religion

If there is any intellectual framework that should have been discredited over the past decade it is old-style Keynesianism.  Unfortunately, just the opposite has happened.  Marcus Nunes directed me to a Noah Smith post that discusses the revival of old Keynesian ideas:

Another way of putting this is that Paul Krugman was right. Krugman has long advocated that macroeconomists learn to once again think in terms of simple simple Keynesian theory. And when more fully developed, complex models are needed, Krugman uses the kind of models that Christiano endorses.

As Christiano mentioned, the New Keynesian revolution isn’t so new. Even in the 1990s, economists like Greg Mankiw and Olivier Blanchard were arguing that monetary policy had real effects on demand. And at the same time, international macroeconomists were realizing that Japan’s post-bubble experience of slow growth, low interest rates and low inflation implied that demand shortages could last for a very long time unless the government rode to the rescue. Krugman, Adam Posen, Lars Svensson, and others were already referring to a Japan-type stagnation as a liquidity trap in the late 1990s, and warning that standard monetary policy of cutting interest rates wouldn’t work in that sort of situation. .  .  .

If economists gravitated toward anti-Keynesian theories, it was at least in part because evidence wasn’t strong enough to push them in the right direction. It’s just very hard to assess the impacts of fiscal stimulus. For example, Japan’s tremendous government spending binge in the 1990s looks to a casual observer like it had no effect, since the economy didn’t recover until years later — but government spending might have been the only thing saving the country from a deeper recession.

I certainly agree that Japan tells us a lot about the validity of old Keynesian thinking.  Here are some things it tells us:

1.  Depreciating the yen is a foolproof way of creating inflation.  Thus Keynes was wrong about monetary policy being ineffective at the zero bound.

2.  From 1993 to 2013 Japan ran up by far the largest peacetime fiscal deficits ever seen by a major economy.  And all that “stimulus” led to by far the worst growth in AD over 20 years ever seen by a major economy.  Roughly zero growth in NGDP over two decades.  And the Keynesian takeaway is that this was a great success, as it prevented an even more record-breaking fall in NGDP.  This is like a religious person who believes in the efficacy of prayer, prays for peace in 1939, and then later argues that his prayers prevented an even bigger war and Holocaust. Okaaaay . . .

3.  Then in 2013 Abe takes office and raises consumption taxes.  This fiscal tightening causes the debt to GDP ratio to level off at 250%.  Instead Abe relies on monetary stimulus, raising the inflation target.  And both inflation and NGDP growth actually increase, the opposite of the prediction of the old Keynesian model.

Of course I could go on and on.  There’s the letter signed by 350 Keynesians warning that the fiscal austerity of 2013 risked recession (growth actually sped up.) Or the fact that Keynesians don’t even know how to estimate the multiplier (as documented recently by Ryan Murphy.)

Smith points out that Paul Krugman realized in the late 1990s that the standard policy of cutting interest rates would no longer work at zero.  But he doesn’t tell you that everyone already knew that, even Milton Friedman.  AFAIK, not one economist in the entire world in the late 1990s thought that cutting interest rates when they were already zero would work. Perhaps you think I’m being too picky; what Smith really meant is that Krugman discovered that monetary stimulus no longer worked in Japan, and that fiscal stimulus was needed. Except that’s not true, in the late 1990s and early 2000s Krugman ridiculed the idea of using fiscal stimulus in Japan, and suggested that monetary stimulus was the obvious solution. Whatever “new facts” caused Krugman to revert to old Keynesianism more recently; it certainly wasn’t his famous 1998 study of Japan’s liquidity trap.  So what caused Krugman to change?  I’m not sure, but Smith hints at one possibility:

When evidence is sparse or inconclusive, things like sociology and politics often fill the gap.



42 Responses to “Keynesianism as religion”

  1. Gravatar of bill bill
    11. April 2017 at 06:39

    I recall Krugman posting at times over the years that RGDP growth per worker in Japan was actually reasonable. At least since 2000. I need to find those.

  2. Gravatar of nickik nickik
    11. April 2017 at 07:09

    Great post! Good one to link to in the future.


    Or the fact that Keynesians don’t even no how to estimate the multiplier (as documented recently by Ryan Murphy.)

    Should be “know”.

  3. Gravatar of ssumner ssumner
    11. April 2017 at 08:15

    Bill, The growth may be OK, but it should be better. Japanese hourly worker productivity is quite low, far below the US and even well below Western Europe. There’s no excuse for that.

    Having said that, I don’t think productivity has anything to do with the AD shortfall that Smith and I are focusing on.

  4. Gravatar of ssumner ssumner
    11. April 2017 at 08:35

    Thanks nickik, I fixed it.

  5. Gravatar of rtd rtd
    11. April 2017 at 08:56

    Wonderful blog post. Smith’s pop-pieces have consistently shown him to be a black eye to economics profession. His disdain for and singular-focus on discrediting anything resembling a pro-Friedman feel is rather worrisome. Articles such as this are a great example of the public’s distrust of mass media and ‘experts’.

  6. Gravatar of Don Geddis Don Geddis
    11. April 2017 at 09:04

    I suspect you’re too in the trees about this topic, to have the proper “forest” perspective. When you say that there has been a “revival of old Keynesian ideas”, I bet this is little more than a resurgence of the realization that demand matters, that nominal shocks can have real effects. That’s something that Keynesianism and Market Monetarism have in common. Whereas you mostly focus on the differences, the places where MM is superior to Keynesian mistakes. That’s fine, but I bet “most people” instead are comparing supply-only macro theories (austerity, regulation, tightening the belt, etc.) to any hint at all that (nominal!) demand might matter too. I bet, for a great fraction of laypeople (and perhaps some economists as well), it was a complete shock that the Fed could quadruple the monetary base, with a result of no significant inflation.

    For people whose macro understanding got destroyed by the lack of subsequent inflation, they’re looking for a new understanding to process what they see. Any demand-side macro is roughly as good as any other. And Keynesianism is of course vastly more popular and available than MM.

    The fact that Keynesianism has additional failures about the ZLB and fiscal stimulus, is really in the weeds, compared to the major insight (shared with MM) that nominal demand matters (at all!).

  7. Gravatar of bill bill
    11. April 2017 at 10:07

    I agree. Japan’s issues are supply side issues. I think Krugman’s point (and it made sense, though he will later contradict this when it suits him) was that Japan’s RGDP growth per worker was within a tenth of a percent or two of US RGDP growth for the last 10 or 15 years. I think that’s interesting in that, if true (and I think it is), it’s a pretty big fact that very few people seem to be aware of.

  8. Gravatar of Student Student
    11. April 2017 at 10:21

    Good stuff… but a more appropriate title would be Keynesianism as a dumbed down religion.

  9. Gravatar of David R. Henderson David R. Henderson
    11. April 2017 at 10:47


  10. Gravatar of msgkings msgkings
    11. April 2017 at 11:51

    Here’s what I wonder about Japan, what exactly is the ‘problem’ with their model? They have low growth due to demographics, but per capita growth isn’t too shabby. They are a peaceful, prosperous nation with long life spans. What’s so bad about that?

  11. Gravatar of flow5 flow5
    11. April 2017 at 11:57

    What’s Keynesian about BuB’s inverted yield curve?

  12. Gravatar of sd0000 sd0000
    11. April 2017 at 12:47

    Bill, the numbers I’m looking at contradict your assertion.

    From the World Bank:

    GDP per Person Employed (constant 2011 PPP $)

    USA: 1.6% Annual Growth
    Japan: 0.8% Annual Growth

    USA: 1.6% Annual Growth
    Japan: 0.9% Annual Growth

    USA: 1.3% Annual Growth
    Japan: 0.9% Annual Growth

    Just eyeballing the list in excel, looks like U.S. actually had the 2nd highest growth in the periods of all (non-city-state) countries that could have been considered “developed” in 1991, behind only Sweden.

  13. Gravatar of Brian Donohue Brian Donohue
    11. April 2017 at 14:02

    Great post, Scott.

  14. Gravatar of ssumner ssumner
    11. April 2017 at 14:26

    Don, You said:

    “I bet this is little more than a resurgence of the realization that demand matters, that nominal shocks can have real effects.”

    I very much doubt that Noah Smith was suggesting that recent events have confirmed Milton Friedman’s version of macro. Krugman has clearly shifted from New Keynesian to something closer to old Keynesian in recent years. New Keynesians used to believe in using monetary policy, not fiscal policy, even at the zero bound.

    Agree, that many conservatives got it totally wrong, and have been discredited.

    MMs are the only ones coming out of this looking good.

    Bill, Japan should be growing much faster than the US. Imagine if China started growing at the same rate as the US–it would be viewed as a complete disaster, and rightly so. Japan has fallen behind Singapore, HK and Taiwan (in PPP terms) and is about to fall behind South Korea. It should be doing better.

    Thanks sd0000.

  15. Gravatar of John John
    11. April 2017 at 14:48

    On the bright side, given how low interest rates continue to be in Japan, it seems like the government got a lot of infrastructure for free via their self-generated “liquidity trap.” Of course, I’m sure the Japanese people would be vastly better off with more private growth than more subways and bridges to nowhere, but stimulus hasn’t been harmful to japan, it just hasn’t been useful.

  16. Gravatar of Postkey Postkey
    11. April 2017 at 15:07

    “Concerning the empirical evidence, Posen (1998) argues that fiscal policy has been effective in Japan during the 1990s. In his view, actual fiscal spending has been smaller than the headline figures for the packages. He argues that fiscal spending has not been sufficiently large to stimulate the economy. A suitably sized fiscal expansion would, in his view, have been effective in ending economic stagnation and deflation. When the actual spending reached substantial size – in 1995, according to him – a recovery followed (in 1996).9 However, actual GDP-based expenditure data or statistics for the government borrowing requirement yield reasonably accurate measures of the fiscal stance. Yet, Posen provides no such empirical test of fiscal policy effectiveness. Using such figures, as cited above, we find that sizeable fiscal stimulation did take place and
    that it failed to stimulate the economy. Furthermore, there is no evidence that even the first-round effect resulted from the spending.”

  17. Gravatar of Matthew Waters Matthew Waters
    11. April 2017 at 15:09

    In defense of Krugman, the BOJ ended up having to do QE of the stock market to get around the zero-lower bound. That’s troubling for many reasons. For one thing, how does the BOJ vote in proxies? The EMH may say the QE does not affect prices, but I’m really unsure about that.

    If I had to choose between stock QE with expectations and fiscal stimulus, then I would choose stock QE with expectations. But if buying Treasuries got FOMC dissents, how would the Fed buying ETF’s go over? The stimulus and bank bailouts, with all their problems, was MUCH better than doing nothing and probably better than just QE of Treasuries. Unlike QE of stocks or negative rates, the stimulus and bank bailouts were politically feasible.

    If political feasibility is thrown out as a factor, then I want negative interest rates and restricted cash printing instead of bank bailouts, stimulus, or risky asset QE. That keeps the Fed in the realm of managing the dollar.

  18. Gravatar of Matthew Waters Matthew Waters
    11. April 2017 at 15:17

    OTOH, Krugman should not have become so intricately tied to what he knows is a second-best solution. The political side of Krugman gets him to sacrifice nuance for clarity.

  19. Gravatar of Benjamin Cole Benjamin Cole
    11. April 2017 at 15:41

    Nice post. Japan needs helicopter drops to finance tax cuts.

    But then, so does the US.

  20. Gravatar of dtoh dtoh
    11. April 2017 at 17:44


    1. Duh.

    2. Slow growth in Japan is caused by high tax rates and regulations that have strangled investments that would increase productivity and long term growth. Fiscal spending policy won’t solve systemic supply side issues. Neither will monetary policy. Both fiscal and monetary can reduce unemployment caused by sticky wages.

    3. Duh.

  21. Gravatar of Postkey Postkey
    11. April 2017 at 23:54

    “Slow growth in Japan is caused by high tax rates and regulations that have strangled investments that would increase productivity and long term growth.”

    Not according to this analysis?

  22. Gravatar of The revival of old Keynesian ideas via /r/economy | Chet Wang The revival of old Keynesian ideas via /r/economy | Chet Wang
    12. April 2017 at 02:25

    […] The revival of old Keynesian ideas […]

  23. Gravatar of Arilando Arilando
    12. April 2017 at 04:26

    >Thus Keynes was wrong about monetary policy being ineffective at the zero bound.

    When did Keynes ever say that? Don’t confuse “keynesians” with Keynes. I don’t think the zero bound was even a topic of discussion when Keynes was around.

  24. Gravatar of qualia qualia
    12. April 2017 at 06:12

    Interesting how both Keynesianism and climate change theories rely on fictitious multipliers to dramatize their effects.

  25. Gravatar of LK Beland LK Beland
    12. April 2017 at 10:31

    Here’s a recent paper that defends the Keynesian view.
    (and its appendix

    They look at deviations from predictions, over the 2010-2014 period. They look at European countries+USA. They consider Eurozone countries and floating exchange-rate countries separately.

    It looks like shortfalls in government spending is highly correlated with shortfalls in GDP growth. The relationship is weaker for floating exchange-rate countries, but still statistically significant. They estimate the multiplier at about 2.

    A few interesting facts:
    1- The US is really an outlier (no shortfall in GDP, even though shortfall in spending was quite large).

    2- While shortfalls in government spending had a significant impact, changes in government revenues, tax rates and primary balance did not. Changes in VAT seem to be an important variable (which is somehow highly correlated to government spending).

    3- While the effect of government spending on GDP seems important both for fixed and floating exchange-rate (ER) countries, the effect on unemployment is large in fixed ER countries, but non-significant in floating ER countries.

    The absence of correlation with unemployment is a huge red flag. Also, their forecast for government spending is built to grow if GDP has a shortfall vs forecast!

  26. Gravatar of irredeemaplorable irredeemaplorable
    12. April 2017 at 12:17

    why dance around what is obvious?

    flooding the world with money, and/or huge deficits will prevent the mkt from clearing out the bad investments made during the runup.
    And thus you’ll never have fast growth going forward under that scenario.

    the bad investments have to be liquidated, period. Then growth will commence. How could it not?

    Why all the bullshit dancing around these irrefutable facts.

    Just call these freaking central planners out for what they are. Frauds.

    and to the religion reference as it relates to fiscal or monetary stimulus. of course it kept the recession from being worse. how could it not? if the mkt clearing effects of liquidation don’t take place, then the recession is not as bad as it would have been.

    It actually is the same with prayer, my friend. Don’t wait around forever to find out. at some point, it’s too late, yaknow?

  27. Gravatar of Charles R Williams Charles R Williams
    12. April 2017 at 13:18

    All quantitative macroeconomics is a pseudo-science that does not even rise to the level of religion. The problem is bigger than Keynesianism. There is no set of dials in the bowels of the Fed that can bring about full employment and stable prices. Playing with the dials in the illusion that you know something can only disrupt the economy.

    Let’s consider the multiplier. There is no such thing. Every spending decision has its own multiplier. There is no way to measure it. There is no reason to assume that it is stable over time. There is no reason to think there is a linear relationship. It is all abstract games.

    And the same critique applies to all quantitative macro-economics.

  28. Gravatar of ssumner ssumner
    12. April 2017 at 13:32

    John, Well there’s the opportunity cost to consider.

    Matthew, You said:

    “In defense of Krugman, the BOJ ended up having to do QE of the stock market to get around the zero-lower bound.”

    I wouldn’t say they had to—there were better ways of doing monetary stimulus.

    Arilando, You asked:

    “When did Keynes ever say that?”

    Dec. 31, 1933, in the New York Times.

    Qulaia, Unfortunately there is no monetary offset to climate change.

    LK, I’ve seen several studies that found there is no effect once you remove the countries with fixed exchange rates.

    I agree about the unemployment red flag.

    Iredeemaplorable and Charles, Well thanks for clearing that up!!

  29. Gravatar of LK Beland LK Beland
    12. April 2017 at 14:12

    “I’ve seen several studies that found there is no effect once you remove the countries with fixed exchange rates”

    Yes, but Krugman and others are now pointing to some studies focusing on floating exchange rate countries that show a large effects. But these seem pretty dubious to me (such as the example above, that “shows” a multiplier effect on GDP, but not on unemployment!).

  30. Gravatar of Arilando Arilando
    13. April 2017 at 08:52

    I don’t see Keynes adressing specifically the zero lower bound in that letter, and he speaks favorably of lower interest rates as a way to help the recovery.

  31. Gravatar of ssumner ssumner
    13. April 2017 at 09:43

    Arlindo, I guess the discussion there was of monetary policy ineffectiveness, not specifically the zero lower bound. So you are correct. In my view the entire General Theory only makes sense if viewed as a model to address the zero lower bound. That’s also Hicks view, and also Milton Friedman’s view. I realize that’s not everyone’s view, but if you don’t assume a zero bound problem then neither the General Theory nor Keynes’s famous advocacy of fiscal stimulus makes any sense.

    One problem is that Keynes was often quite vague in his writings. Thus at one point in the GT he says he knows of no example of the zero bound issue, and then a couple paragraphs later (p. 207) provides just such an example (The US QE of the spring of 1932.)

  32. Gravatar of Major-Freedom Major-Freedom
    14. April 2017 at 09:27

    Anti-market monetarism is just Keynesianism with only the money printing machine as opposed to a combination of the money printing machine and the Treasury.

    Monetarism is a religion because it fills the gap created by an absence of evidence that socialism is superior to free markets, including in money.

  33. Gravatar of Postkey Postkey
    15. April 2017 at 00:31

    ” . . . climate change theories rely on fictitious multipliers to dramatize their effects.”

    Quite right. 97% of climate scientists are ‘fooled’?

    “A new survey of over 12,000 peer-reviewed climate science papers by our citizen science team at Skeptical Science has found a 97% consensus among papers taking a position on the cause of global warming in the peer-reviewed literature that humans are responsible.”

  34. Gravatar of Postkey Postkey
    15. April 2017 at 01:24

    “In my view the entire General Theory only makes sense if viewed as a model to address the zero lower bound.”

    The G.T. is an attempt to point out, that, usually, a free market capitalist system will not, automatically, eliminate any involuntary unemployment?

    However, Keynes does not exclude this possibility.

    “A reduction in money-wages is quite capable in certain circumstances of affording a stimulus to output, as the classical theory supposes.”

    In ‘certain circumstances’ the fall in money wages and the price level will increase the real stock of money and lead to an increase in aggregate demand and income/output.

    His conclusion is, however:

    “In the light of these considerations I am now of the opinion that the maintenance of a stable general level of money-wages is, on a balance of considerations, the most advisable policy for a closed system; whilst the same conclusion will hold good for an open system, provided that equilibrium with the rest of the world can be secured by means of fluctuating exchanges. There are advantages in some degree of flexibility in the wages of particular industries so as to expedite transfers from those which are relatively declining to those which are relatively expanding. But the money-wage level as a whole should be maintained as stable as possible, at any rate in the short period.”

    Falling wages and prices are de-stabilising for a ‘free market’ system.

    He concludes, therefore, that it is better to increase the real stock of money {M/P} by increasing M, rather than by waiting for P {and W} to adjust.

    Fiscal policy is barely mentioned.

    What he does say, {and this makes him the bete noir of the Republican right?} is:

    “Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative.”

    D.J.T. has been reading the G.T.?

  35. Gravatar of Steve F Steve F
    15. April 2017 at 09:58

    Scott, question:

    In my undergraduate econ education, when we use models regarding monetary policy, it is always the ones that show how expansive open market operations become approximately ineffective when at the ZLB due to the liquidity trap and no more declining of short-term interest rates. What models do you use to show how central banks can push up inflation and output at the ZLB by using unconventional policies like asset purchases, forward guidance, negative interest rates, ect.?

  36. Gravatar of Postkey Postkey
    18. April 2017 at 00:32

    “Of course I could go on and on. There’s the letter signed by 350 Keynesians warning that the fiscal austerity of 2013 risked recession (growth actually sped up.)”

    ‘warren mosler writes:
    “First, I had been looking for 4% growth for 2013 and scaled back to 2% due to the tax increases and sequesters, and I thought it would continue to weaken until deficit spending increased.
    Turns out there was an increase in private sector deficit spending/credit expansion on oil and gas exploration and production that offset the 2013 fiscal adjustments and further expanded in 2014 to further support GDP growth.” ‘

  37. Gravatar of Postkey Postkey
    18. April 2017 at 23:32

    “Except that’s not true, in the late 1990s and early 2000s Krugman ridiculed the idea of using fiscal stimulus in Japan, and suggested that monetary stimulus was the obvious solution.”

    He was right about ‘monetary stimulation’, but not the type he was thinking about?

    “Using credit creation to measure M, equation (6) indicates that economic growth is only possible, if credit is created either via the banking system or the central bank, and used for transactions that are part of GDP. Interest rates are not part of the model.”

  38. Gravatar of Emerich Emerich
    21. April 2017 at 17:07

    Scott, speaking of depreciation as a foolproof way of creating inflation, how about a post about “currency manipulation”, and presumably, its self-defeating nature. In virtually every media story, and even many academic articles by economists, it is taken for granted that currencies can be manipulated. But if depreciation is offset by inflation, “manipulation” is self-defeating, as I believe you have pointed out. Is it then a short-run long-run issue? “Manipulation” has real effects in the short run, but not the long run, like manipulation of the money supply? Does China’s massive accumulation of dollar assets have nothing to do with a aim over many years to keep the RMB lower than it otherwise would have been? Seems to me this is a topic that could use more light and less heat nowadays.

  39. Gravatar of ssumner ssumner
    23. April 2017 at 18:25

    Steve, Keep in mind that asset purchases are not really “unconventional policies”. Asset purchases, AKA open market purchases, have been the Fed’s standard policy tool for decades. They have been used to target the fed funds rate.

    My model is the simple monetarist S&D for money model. An increase in the supply of base money creates excess cash balances, and the public’s attempt to get rid of these excess balances drives up inflation.

    Alternatively, you can create inflation by reducing the demand for money, via lower interest on reserves.

    Emerich, I’ve done many posts on that topic, some over at Econlog. I am currently writing a paper on currency manipulation.

  40. Gravatar of Steve F Steve F
    26. April 2017 at 08:11

    Scott, thank you for the reply. Is the model subject to the ZLB and the liquidity trap?

  41. Gravatar of Steve F Steve F
    26. April 2017 at 10:25

    I should rephrase my question. My professors teach that in that model, there is a ZLB and that further expansion of base money doesn’t encourage the public to get rid of the excess cash balances due to liquidity trap. So, how is it that you avoid the liquidity trap in the model? Or do you use other models to show how expansionary monetary policy at the ZLB can increase Y?

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