Nick Rowe on how Keynesianism also “failed”

Paul Krugman wrote an excellent essay on Keynesian economics for Vox.eu.  Krugman shares many of Keynes’s best characteristics; great intuition about the importance of aggregate demand, passionate belief that good policy can make the world a better place, and a witty writing style.  On the negative side he also has been known to take a few cheap shots at those with whom he disagrees.  Ironically, he comes close to absolving Keynes of the charge that he was unfair to “the classics,” even though Keynes most certainly was unfair:

I know that there’s dispute about whether Keynes was fair in characterizing the classical economists in this way. But I’m inclined to believe that he was right. Why? Because you can see modern economists and economic commentators who don’t know their Keynes falling into the very same fallacies.

Toward the end of the essay Krugman gets more political, and less fair to those on the other side:

“When monetarism failed – fighting words, but you know, it really did “” it was replaced by the cult of the independent central bank. Put a bunch of bankerly men in charge of the monetary base, insulate them from political pressure, and let them deal with the business cycle; meanwhile, everything else can be conducted on free-market principles.”

OK, if monetarism is defined as the K% rule, then one can argue that it did fail.  But of course there is much more to monetarism.  Here’s a wonderful comment written by Nick Rowe:

The monetarist revolution was a revolution in the assignment of policy targets to policy instruments.

In the 1970’s Keynesianism:

1. AD (understood as unemployment) was assigned to fiscal policy.
2. The composition of AD, between consumption and investment, (or, in an open economy, between domestic absorption and net exports) was assigned to monetary policy, via its influence on interest rates and exchange rates.
3. That left inflation without an instrument. So they hunted around, and cobbled together a rag-bag of policies termed “industrial policy”, which meant controlling monopolies in both labour and output markets.

And Monetarism:
1. AD (understood as inflation) was assigned to monetary policy.
2. The composition of AD, between G vs C+I (or, in an open economy, between C+I+G vs NX) was assigned to fiscal policy.
3. That left unemployment without an instrument. So the industrial policy ragbag was assigned unemployment.

Canada, indeed most countries, look very monetarist from the perspective of a 1970’s Keynesian.

To argue that monetarism failed because no one talks about the K% rule today, is about like arguing that Keynesianism “failed” because people no longer talk about incomes policies.  By the 1990s Friedman was endorsing Robert Hetzel’s proposal to target inflation expectations directly (via the TIPS spread.)  And of course there are a few bloggers trying to keep the flame of monetarism alive.


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11 Responses to “Nick Rowe on how Keynesianism also “failed””

  1. Gravatar of Richard A. Richard A.
    8. July 2011 at 14:25

    If one assumes that nominal GDP can be treated as the velocity corrected money supply, then those who believe that the FED should make nominal GDP smooth growing are monetarists.

  2. Gravatar of Scott Sumner Scott Sumner
    9. July 2011 at 04:59

    Richard, Yes and no. It is true that many NGDP proponents are quasi-monetarists, but they is no necessary link. Indeed I believe than many Keynesians would prefer NGDP targeting over strict inflation targeting. People like Yglesias and DeLong.

    Monetarists used to believe that V was fairly stable, at least when M was kept stable. That led them to favor targeting M. Keynesians usually countered that it would be better to target M*V, because V was unstable. Later on monetarists moved away from a strict k% rule, so the meaning of the term “monetarist” is now somewhat vague.

  3. Gravatar of William William
    9. July 2011 at 05:59

    Scott,

    I’m sure somewhere you’ve done a post on what defines a Keynesian vs. a Monetarist, but can you remind me? If the quasi-monetarist policy of NGDP targeting is adopted by the central bank, what’s left for the Keynesian to do?

  4. Gravatar of ssumner ssumner
    9. July 2011 at 08:07

    William, I haven’t because it’s really hard to do. Keynesians have split into new Keynesian and post Keynesians. The New Keynesians are half monetarist. And Quasi-monetarists have given up on k% money supply rules, and hence have moved somewhat in the Keynesian direction.

    When I use the term “Keynesian” I generally mean people who look at monetary policy from an interest rate perspective. I don’t.

  5. Gravatar of david glasner david glasner
    10. July 2011 at 07:21

    Scott, Monetarism failed because it there was no theoretical underpinning to it. It was a collection of random insights that had no theoretical framework other than a recycled Keynesian liquidity preference theory renamed the quantity theory of money and a spurious Chicago oral tradition that was supposed to disguise the theft of Keynesian intellectual property. When Friedman tried to write down his theoretical framework, the result was embarrassing. And the k percent rule was totally inconsistent with the Keynesian demand for money which Friedman tried to cover up by empirical work falsely suggesting that the demand for money is highly stable and interest elastic. The one solid empirical study supporting that was later disavowed by its author David Laidler much to Friedman’s displeasure. That’s why once Friedman was no longer around to control the Chicago department it quickly veered off in another theoretical direction that had no organic connection to any of the work that he had been doing. Instead we got Lucas and New Classical economics and then, ugh, real business cycle theory. Monetarism simply fell apart because there was no there there. I am being deliberately provocative, in the Krugman style, but there is good scholarly basis for my invective. None of this should be understood as a defense of Keynesian economics of course.

  6. Gravatar of ssumner ssumner
    10. July 2011 at 08:39

    David, I agree on the K% rule, and its theoretical underpinings. But I see that as only a tiny portion of Friedman’s monetarist contributions:

    1. A more sophisticated understanding of superneutrality and the Fisher effect.

    2. Showing that low interest rates don’t mean easy money, and vice versa.

    3. The monetary trnasmission mechamism works through many asset prices.

    4. The Phillips curve isn’t stable.

    5. Price controls don’t work.

    6. Fiscal stimulus is very weak.

    7. Tight money caused the Great Contraction.

    8. The US silver policy cause depression in China.

    9. Much of the instability of velocity is due to unstable monetary policy.

    10. Fixed exchange rates don’t work very well, and the eurozone is a fragile structure.

    And I’m sure there are dozons more. The Keyneisans knew none of that in the 1960s. Much of what I learned about monetary policy I learned from Friedman. That’s not to say your points are wrong, just that it’s not the whole story.

    Every macro framework is false in some sense, including Keynesian economics, or course.

  7. Gravatar of david glasner david glasner
    10. July 2011 at 09:20

    Scott, Obviously we have a half-empty, half-full situation. I am focused on Friedman’s role in the Monetarist counterrevolution which even I, unlike, say, Krugman, would agree had its positive aspects. However, I think that his contribution to monetary theory was in many respects negative, because he dumbed it down. Every point that you raise in his favor is in some degree valid, but in not more than two or three cases was he original, and in the six instances in which you credit Friedman for an argument that Hawtrey had made earlier, Friedman made the argument worse not better. By the way, you left out his theory of the consumption function which is universally regarded as a truly wonderful combination of theoretical and empirical work.

  8. Gravatar of david glasner david glasner
    10. July 2011 at 09:22

    Scott, Obviously we have a half-empty, half-full situation. I am focused on Friedman’s role in the Monetarist counterrevolution which even I, unlike, say, Krugman, would agree had its positive aspects. However, I think that his contribution to monetary theory was in many respects negative, because he dumbed it down. Every point that you raise in his favor is in some degree valid, but in not more than two or three cases was he original, and in the six instances in which you credit Friedman for an argument that Hawtrey had made earlier, Friedman made the argument worse not better. By the way, you left out his theory of the consumption function which is universally regarded as a truly wonderful combination of theoretical and empirical work. But it wasn’t monetary theory!

  9. Gravatar of W. Peden W. Peden
    10. July 2011 at 10:36

    There’s also his contributions to statistics generally, which also wasn’t monetary.

    Actually, one of my favourite Friedman ideas was both original and largely ignored: university bonds. Instead of tuition fees or free-at-the-point-of-use higher education, why not take a very small percentage of each graduate’s annual income? There was an interesting piece by a Scottish thinktank on that subject recently, which is very relevant because the Scottish higher education system is caught between Scylla and Charibdis right now.

  10. Gravatar of ssumner ssumner
    11. July 2011 at 18:27

    David, You may be right, but very few economist ever come up with “2 or 3” original ideas. I’ll defer to your expertise on Hawtrey.

    W.Peden, That’s interesting, I don’t recall that he developed that idea.

  11. Gravatar of The new monetarism: what we learned from the 1970s | PARTISANS The new monetarism: what we learned from the 1970s | PARTISANS
    5. December 2011 at 17:36

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