Nick Rowe presents the first plausible IS-LM model.

Everyone enjoys seeing at least one type of disaster.  Pyromaniacs like watching buildings burn.  Brad DeLong likes seeing new classical economists say really foolish things.  I like seeing people make the IS-LM model look absurd.

Nick Rowe has finally come up with a plausible version of the IS-LM model.  The most interesting feature is the upward sloping IS curve.  It also features an L-shaped LM curve (not a backward-L, as is usually assumed.)

I suppose it sounds like I am mocking Nick, but just the opposite.  I think Nick is right, the IS curve is upward sloping.  My satisfaction comes from elsewhere.

A couple years ago Brad DeLong did a post asking me to explain why I didn’t like IS-LM.  I wrote one of my typical ultra-long early posts, throwing everything against it I could think of.  But I so dislike IS-LM that I never learned it well enough to critique it effectively.  Nick does know it well enough, but also sees the problems.  He understands that easy money leads to fast NGDP growth, which leads to higher nominal interest rates.

So he’s work out what a correct IS-LM diagram would look like.  Does this rescue IS-LM?  I don’t see how.  It’s pretty clear that the new IS curve is simply a pictorial display of what we know about the economy from observation.  It’s not derived from any sort of basic theoretical model.  One can’t spend 70 years arguing that the IS-LM model is useful because it has a downward sloping IS curve, and then suddenly say; “Oops, the IS curve is actually upward sloping, but it’s still useful anyway.”  It’s just a pretty picture, nothing more.

Graphs such as S&D, and even AS/AD, are useful analytical tools.  They help us understand the impact of economic shocks.  IS-LM is just a picture, which reflects whatever assumptions one wants to make.

So yes, Nick did come up with the first plausible IS-LM model.  I don’t know if this was intention, but in doing so he showed just how worthless the model really is.  A model than is infinitely flexible—which can explain anything, explains nothing.

What would we do without Nick Rowe?  Here’s Nick on the Tea Party:

The Tea Party is much more powerful in Europe than in the US. Read Ambrose Evans-Pritchard to see an example. It’s just they don’t call it the “Tea Party” in Europe. It doesn’t seem to have a name over there, but that’s what it is.

The basic philosophy underlying the Tea Party is, at its crudest: “We’re not paying for them”. Who’s “we” and who’s “them” differs across two centuries and across the Atlantic Ocean, but it’s still recognisably the same philosophy. The Tea Party makes life difficult for the Lender of Last Resort, because the Tea Party wants some sort of guarantee it will get its money back. And that guarantee can never be made cast-iron. If it could, you probably wouldn’t need a Lender of Last Resort in the first place.

 

And here’s Nick on the euro;

This is the sort of thing that can happen when you don’t understand monetary theory well enough. Even those of us who thought the Euro was a bad idea didn’t really know it was such a bad idea. If we had really known it would end this way, we could have presented overwhelming evidence in a convincing enough manner to have been able to persuade everyone else it would end this way. And we couldn’t do that. So we didn’t really know it.

There are two big economic problems facing the world economy right now. The problem in the US is solvable. The problem in the Eurozone isn’t. It can’t get where it wants to be from here.

God it’s depressing.

Even Paul Krugman couldn’t write something that good.   Nick was completely right about the euro, but is also honest enough to acknowledge that it was partly due to luck.  Krugman knows more than almost anyone, but doesn’t know the difference between what he really knows and when he’s been lucky.


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69 Responses to “Nick Rowe presents the first plausible IS-LM model.”

  1. Gravatar of W. Peden W. Peden
    9. September 2011 at 19:18

    Nick Rowe is on fire right now, and not in a pyromaniac way.

    Scott,

    This is a general question re: IS-LM, so I’m sure you’ll realise that I’m complementing you by saying that you might not be able to answer, but here goes-

    What role, if any, do assets play in IS-LM?

    I’ve never read my way through an entire macroeconomic model other than Keynes’s in the General Theory and Friedman’s extended quantity theories, neither of which are exactly considered great examples of rigorous model building. One thing that I do know about income-expenditure models is that they can’t handle economies with private property i.e. assets, which seems to limit their usefulness outside of North Korea.

  2. Gravatar of edeast edeast
    9. September 2011 at 19:21

    He was working on a theoretical backing for it, it curves down until it slopes up. I spent a day trying to understand before I gave up and hope he has made more progress.

  3. Gravatar of marcus nunes marcus nunes
    9. September 2011 at 20:31

    Martin Feldstein on “The Euro” in 1997 (Foreign Affairs):
    Summary: Jean Monnet´s dream that European Integration would eliminate conflict may have been a delusion. France and other countries do not share Germany´s fixation on sound money – or its hegemonic vision. A European Central Bank would be unresponsive to local unemployment, while political union would remove competitive pressure within Europe for structural reform, prompting protectionism and conflict with the United States. A Europe of 300 million people and an independent military might be a force for world peace, but war is also a distinct possibility.
    Conflict? Most surely, albeit not of the military kind (so far!)

  4. Gravatar of Nick Rowe Nick Rowe
    9. September 2011 at 21:35

    Thanks Scott!

    I really like the ISLM, despite its flaws (which are fixable). (Sometimes I feel it’s only Paul Krugman and me, maybe Brad DeLong too, that still like the ISLM). But I really liked what you have been saying too. So I just had to make you ISLM-compatible. And that meant the IS curve just had to slope up.

    But when I started to think about it, I realised the IS curve really had a very good reason to slope up anyway. And that the reason we always drew it sloping down was a very bad reason.

    It’s a very old Old Keynesian idea. (Probably pre-dates the Old Keynesians even). Who the hell would want to invest in a recession, when you know you can’t sell the extra output that the extra capital goods can produce? You wait until the recession is over, when you can use the extra capacity. Sure, I haven’t worked it all out formally. But anyone halfway competent in math modelling (i.e. not me) could do it. (Actually, I think it already has been done, but despite searching I couldn’t find the paper that I vaguely remember having done something similar).

    But, so far, I have had no answer (from those who believe in liquidity traps) to my question: “Is this a liquidity trap?”

  5. Gravatar of Nick Rowe Nick Rowe
    9. September 2011 at 21:44

    I didn’t understand ISLM, by the way. Till Peter Howitt taught me Clower. Then it started to make sense.

  6. Gravatar of mbk mbk
    9. September 2011 at 23:02

    On the Euro, I still don’t understand why it implies fiscal and political union or Eurobonds or Euro breakup. Cities, counties, states in the US all sell bonds in the “USD currency union”. All the while they have no power over the national currency, don’t have national fiscal power, and can go bankrupt. No problem here. Why is the analogous situation a currency problem in Europe?

    I know that the problem in Europe stems from the dilemma, who should go bankrupt, the borrower states or the lending (private) banks? If neither is politically allowed to go bankrupt then yes, this now becomes a fiscal and currency problem.

    But at core this is just a problem of some (large) corporations (states in this case) who have raised too much money from imprudent lenders (banks). Both are somewhat at fault if one would like to give fault. And this is a practical problem for the lenders and the borrowers. But I do not understand why Europe’s state debt crisis has to be an in-principle currency union problem at core. On the contrary, it is only with Eurobonds and fiscal and political union, that it would indeed become a Europe wide fiscal and currency problem.

  7. Gravatar of Martin Martin
    10. September 2011 at 01:21

    @mbk
    It’s a somewhat long story, but the short story is that in the 2000’s when Germany was going through a recession it kept wages low and deficits low, but maintained AD by increasing its exports within the currency union. That is it sold goods for pieces of paper from the periphery saying IOU.

    Inflation throughout the Eurozone remained at 2%. Why is that important? Well because Germany was slowing down, maintaining 2% was expansionary for Germany, but it was similarly expansionary for the Eurozone countries not in recession. This led to an asset-bubble in the periphery.

    Now combine the asset-bubble with the IOU’s and you understand why Germans accepted IOU’s from the periphery: those IOU’s were backed by assets. Assets that were inflated with as a consequence that Germany could maintain AD through exports. Of course the asset-bubble could have popped up in Germany as well, but because a free flow of capital equalizes the return of all assets, the bubble popped up in the periphery.

    Because, when it came to net exports, the core countries were surplus countries and the periphery countries were deficit countries, the IOU’s of the asset-bubble got spread to the core countries. Now the bubble has popped balance sheets in the core and the periphery are under water, the core because they have to revalue the debt and the periphery because they revalued the assets without debt relief.

    What does this have to do with government debt? Well, government needs tax revenue and when most of the income goes to repaying those IOU’s, the government has less tax revenue, and needs to borrow more. Tax revenue could be increased by increasing income and income can be increased by default or by more exports. Exports in turn can be increased by lower real or lower nominal wages. The first is by lowering wages and the second is by devaluation. Considering the second is not an option, wages have to be lowered. This however also lowers income and therefore lowers tax revenue.

    And this brings us to the two option: lowering the real wage and maintaining the currency union will lead to sovereign default, and lowering the nominal wage is only possible by leaving the currency union. In order to maintain the currency union, if exports will not do, fiscal transfers have to be made by taxing consumers consuming the core goods and those are in the core countries.

    Hope this helps?

  8. Gravatar of Martin Martin
    10. September 2011 at 01:24

    Oh and before I forget, the reason we’re bailing out the periphery, is because the IOU’s of the periphery, including the government debt, is held in the core.

    And the reason they’re held in the core, is because that (exports) is how Germany maintained AD in its recession.

    Make no mistake this is a bail-out by the core countries for the core countries. If we were not holding the IOU’s, our governments would never consider bailing out the periphery.

  9. Gravatar of Martin Martin
    10. September 2011 at 01:35

    Scott, slightly off-topic, but considering the above, how much inflation do you think maintaining NGDP would lead to in the Eurozone?

    In another thread I made the comment that the ECB is basically on target price-level wise and is for this year slightly above its year-to-year target. You replied that this shows the folly of inflation-targeting.

    I doubt now whether that is such a folly, my guess is that it would lead to 8-9% inflation for several years before the private sector can clean up its balance sheet and income and with that (tax) revenue returns. In the mean time the economy will shrink. Fiscal stimulus in this will be merely an accounting gimmick to make the inflation-growth split more favorable.

    Given that two inflation-hawks @ECB recently left, I am guessing they’re going to go for the higher inflation.

  10. Gravatar of Nervorp Nervorp
    10. September 2011 at 02:57

    Professor Keen discusses the IS-LM model in his latest lecture – http://www.youtube.com/watch?v=DMPawqPVchI

  11. Gravatar of bill woolsey bill woolsey
    10. September 2011 at 03:30

    Martin:

    I don’t see how this works.

    You seem to be saying that if the Eurozone had NGDP targeting, there would be high inflation for several years and reduced production. That is, of course, possible. But your reason has to do with clearning up balance sheets and increase tax revenue. Why does cleaning up balance sheets and inadequate tax revenue result in reduced production?

  12. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 03:58

    Finally we get closer to you having to bend!

    Here’s Nick,

    “Rather, it is because I think that a sustained increase in demand for goods would have such a strong self-reinforcing effect on desired investment and consumption that interest rates would need to rise to keep output demanded equal to output. The marginal propensity to invest plus the marginal propensity to consume exceeds one, in other words.”

    And here’s me:

    “Liquidate the housing market, AND RAISE RATES further depressing house prices, let the guys with the cash buy up 12M houses for pennies on the dollar. Let the guys with cash FEEL GREAT about the economy. Bankrupt the giant banks, and let the small local banks go gangbusters. Reward the winners… and the economy will grow!”

    Reward the winners and the economy will grow. ALL THAT MATTERS is ROI for the winners. Who cares what happens to the losers?

    LOSERS CARE. Why do you care? hmmmm.

    Now then eggheads you will EAT IT and accept the world of the Tea Party and Germany.

    The message is not: “we’re not paying” OF COURSE we’re not paying, the message is “sell your stuff, change your life, earn less”

    So get busy. Start helping the losers sell their stuff, change their life, and earn less.

    The PIIGS and Obamacrats LOSE. They will be made to bend. In WWII terms, they are the Axis powers and they will surrender.

    Money exists for those people who OWN stuff, not people underwater on their house. Money exists for people who MAKE STUFF people want to buy, not for public employee and Fortune 1000 rentiers.

    Money exists for entrepreneurs, investors, people who vote and have all the guns.

    ULTIMATELY this is about power. The power to DECIDE.

    And you fools keep trying to make the weaker the stronger.

    hmm, the weaker the stronger, where have I heard that before?

    That’s called rhetoric. It is not economics.

    Real economics FAVORS those that drive the economy.

  13. Gravatar of Joe Joe
    10. September 2011 at 04:01

    I honestly can’t see how the euro can be broken up. Let’s take Greece. How can Greece leave the euro? If it does leave it will have to create it own currency. People say it can go back to the drachma, but they aren’t going back to anything they left because they essentially don’t have a time machine to take them back. The infrastructure for the old currency is gone.

    So lets say they issue a new currency. That’s all well and good, however they also have debts nominated in Euros and say a French supplier is not going to allow the Greek customer to pay the debt in Drachma. They want euros. The new currency would also be crushed and foreign debt would need to back by exchanging the crushed currency. The Greeks would also lose their position of influence through the councils of Europe and the ECB.

    There is no mechanism for Greece to leave the Euro as there is no mechanism for Germany to leave either. If Germany left their currency would appreciate to the point where they would have to do what the Swiss did and peg their currency to the old Euro as they would get so strong they wouldn’t be able to compete in the export markets. Despite their whining the Germans have actually done very well in Europe as their export businesses have done very well.

    The mechanism for adjustment is through internal price adjustment.

    In a sense I actually see a silver lining from this in way.

    The Euro means the economies will evetually look more and more like each other in terms of flexibility. Italy , Greece and the rest of the PIIGS will have to enact reforms that allow them more flexibility and more honest budgeting. They will begin to look like Germany in some ways.

    They will eventually do several things… Some of the PIIGS will have a controlled default and will be sin binned for a decade with the German boot firmly on their throat while others may actually muddle along for a while and get back up.

    Default is already there for Greece anyway as the market recognizes they will never be able to repay what they owe. There will be asset sales… did anyone know the Greek government own $300 billion of salable assets? Yep. They have one of the biggest collections of hard assets in Europe.

    Lastly I think that the ECB will eventually realize they will have to QE and target quantity of money.

  14. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 04:03

    My god, Nick continues…

    “Who the hell would want to invest in a recession, when you know you can’t sell the extra output that the extra capital goods can produce?”

    Answer: EVERYBODY with cash as soon as prices fall to their natural real level.

    There are 12M houses that the gvt. has tried to keep the winners from acquiring, in order to keep 12M idiots from having to start renting.

    Losers lose Nick. Fit that into your model and it all makes sense.

  15. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 04:13

    And there is Nick quoting Mish! Good for you Nick. Just let it roll over you, it won’t hurt, it only hurts the losers.

  16. Gravatar of Nick Rowe Nick Rowe
    10. September 2011 at 05:21

    Morgan: you have cause and effect switched. I’m saying if monetary policy were loosened, so that AD increased, that would allow investment in *newly-produced capital goods* and interest rates to rise. You are saying that if interest rates increased, that would cause people to buy more *old* capital goods (which is not “investment”) and increase AD??

  17. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 05:31

    W. Peden, I’m pretty sure these models abstract from any financial assets other than bonds and money. Perhaps someone will correct me if I’m wrong.

    edeast, I wish him luck.

    Marcus, Interesting quotation.

    Nick, I find it interesting that IS-LM proponents can say (for 70 years) “Look at this useful model, it shows how easy money lowers interest rates and raises output,” and then suddenly pivot and argue “Look at this useful model, it actually shows how easy money raises interest rates and output.” This tells me we were always wrong to assume that interest rates were the transmission mechanism for monetary policy.

    In contrast, the hot potato theory connecting M and NGDP is well grounded in micro theory. Produce more of something (exogenously) and it’s value will fall.

    Once we have modeled NGDP this way, all we need is a SRAS model to explain Y. And of course IS-LM tells us nothing about SRAS.

    It seems to me that IS-LM is trying to model the connection between M and i. But that’s really hard to do because it depends on liquidity effects, price level effects, Fisher effects, income effects, plus expectations of future monetary policy, etc., etc. I can’t imagine how a simple two dimensional graph to do that well. But I wish you good luck–I hope I’m wrong (Nah, actually I don’t hope I’m wrong, I’m a pyromaniac at heart.)

    As far as “Is there a liquidity trap” it always boils down to what you assume about monetary policy. Even Krugman admits there’s no liquidity trap if you replace the FOMC with Zimbabweans. It’s all about expectations of future monetary policy.

    Mbk, I used to share that view. I suppose some of the key differences are that Europe has greater diversity (is less an optimal currency area) than the US. There are huge differences in language and culture that make people reluctant to move. Then add on the fact that in Europe the big spending and borrowing is done at the national level, not the EU level. If Nevada were handling it’s own Social Security and Medicare it might be broke today.

    Martin, If we assume a 4% NGDP target for the eurozone, I don’t see where you get 8% inflation. How likely is it that RGDP falls 4% in an economy inflating at 8% (where real estate would be a good investment.) But I do agree that inflation would have risen somewhat after 2007. However wage inflation is much more important than price inflation, and that should have stayed around the usual level, as (equilibrium) wage inflation tracks NGDP in the long run.

    Thanks Nervorp.

    Morgan, I agree that Germany shouldn’t have to pay–but that includes bailing out its own banks–which are part of the problem.

    Joe, I am sympathetic to your argument. I’ve consistently thought a breakup of the euro (while possible) is less inevitable than many Americans seem to think. I think it’s 50-50 at most for Greece, and much lower for countries like Ireland.

  18. Gravatar of Nick Rowe Nick Rowe
    10. September 2011 at 05:37

    Nervorp: I started watching that Steve Keen video. The first thing he said about the ISLM model — that it assumes the money supply is fixed exogenously, so the money supply curve is vertical — is not correct. You *can* make that assumption in the ISLM model, if you want to. You can also assume the exact opposite, if you want to, and many Keynesians do. So I stopped watching at that point.

  19. Gravatar of W. Peden W. Peden
    10. September 2011 at 05:41

    Scott Sumner,

    That would explain some of my misgivings about them. For example, I love Tim Congdon’s definition of inflation as “too much money chasing too few goods AND assets”, but I wouldn’t begin to know how to explain that with IS-LM.

    It’s like Y = C + G + I + X. As you have said in the past, how does one explain the current crisis using such a definition of national income? No wonder Keynes and the Keynesians started messing around with exogenous wages.

  20. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 05:41

    “You are saying that if interest rates increased, that would cause people to buy more *old* capital goods (which is not “investment”) and increase AD??”

    Nick, that’s too cute by half.

    12M OLD houses bought for pennies on dollar, EVEN AT HIGHER RATES earn the buyers 10%+ YOY on rents that are FAR BELOW what the mortgage holder was paying bank. PLUS they own the house when it matures.

    Higher rates DO NOT cause buying. You need to stop putting noise on your opponents and answer what they really mean.

    Deep down this is about what I say it is about: POWER.

    And you need to start doing you metrics assuming Germany and the Tea Party will be calling the tune, so the question is how to SPEED UP the changes they want.

    Don’t fight the tide Nick. Spend some time thinking about what kind of society we are GOING TO give you, become an economist for said society.

    Miuke Sproul in your comments says:

    “Nick:

    If a bank has positive net worth it doesn’t need a lender of last resort.

    If a bank has negative net worth then it can be liquidated, with bank customers getting back (say) $.90 (valued in base money) on the dollar.

    Or that same bank could suspend convertibility, and the market will price its dollars at $.90 (base money) each.

    But if that bank gets a loan of last resort (i.e., a gift from the government), bank customers lose nothing but taxpayers lose $.10 on the dollar.

    Conclusion: The lender of last resort only transfers the $.10 loss from bank customers, where it belongs, to taxpayers, where it doesn’t belong.”

    You respond with VERY LITTLE of merit…

    “Suspension of convertibility would be one solution, but not a very good one if people need a medium of exchange.”

    And there again is you DEEP fucntional mistake…

    YOU do not get to sau what money is for, the people WHO MATTER get to say what money is for, you really want there to be a Technocratic Central Bank that has to make all these decisions.

    I see a powerful group of entrepreneurs, investors, hard asset holders, likely voters and gun owners WHO TELL the Central Bank what to do.

    And all evidence supports my position.

    So start looking at you model through the eyse fo the fols that matter, it will all make sense.

    You model SAYS create policies that kick out all supports on prices, make bankruptcy very easy, put all assets on the Internet and make it super easy to dig through the firs sale…

    WHILE YOU RAISE RATES.

    You raise rates to increase capital accumulation – see Mish, see Denninger.

    You drive prices down, so people still want to take loans even at higher prices.

    Please respond to the real argument.

    Please ADMIT I have not switched cause and effect.

  21. Gravatar of flow5 flow5
    10. September 2011 at 05:51

    Keynes’ liquidity preference curve is a false doctrine period.

  22. Gravatar of Nick Rowe Nick Rowe
    10. September 2011 at 05:57

    Scott: “This tells me we were always wrong to assume that interest rates were the transmission mechanism for monetary policy.”

    Answering this fully would take a full post. (As would answering W. Peden’s good question about what assets are in the ISLM, which i feel bad about not answering).

    Most people *talk* about the ISLM model as if interest rates were the monetary transmission mechanism. But we don’t *have to*.

    The root of the problem is that the Keynesian Cross is commonly seen as the Ur-model of ISLM. And if we start with the KC model, then build it up to the ISLM, then:

    1. We are forced to think of interest rates as the monetary policy transmission mechanism.

    2. We are forced to draw a downward-sloping IS curve, because the KC model would have an unstable equilibrium otherwise.

    But it is also possible to think of the cash balances approach as the Ur-model, then build it up to the ISLM. Which changes both 1 and 2 above.

  23. Gravatar of Martin Martin
    10. September 2011 at 06:09

    Bill:

    “I don’t see how this works.

    You seem to be saying that if the Eurozone had NGDP targeting, there would be high inflation for several years and reduced production. That is, of course, possible. But your reason has to do with clearning up balance sheets and increase tax revenue. Why does cleaning up balance sheets and inadequate tax revenue result in reduced production?”

    Bill, I am assuming that people want to have a certain cushion at the end of the period. If this cushion (Assets – Debt) is below a certain threshold then consumption is reduced until that threshold is reached.

    How I see it is, fall in (inflated) assets => reduced consumption to rebuild balance sheets => pattern of production does not match pattern of consumption => reduction in production (=> reduction in revenue => sovereign debt crisis.)

    The reason the pattern of production does not match the pattern of consumption is that those that build those patterns did not see that the consumers were increasingly more indebted to consume.

    When you invest as an entrepreneur that asset represents future cash flow. Just as giving a loan to someone with a certain income represents future cash flow. The difference is that a bank can see how much debt someone has before giving them that loan, but an entrepreneur cannot and invests regardless. An entrepreneur also does not see that people who produce to consume with them rely on consumers that are in debt to consume (because those consumers have the assets to do so.).

    That is why I think cleaning up balance sheets will result in a period of lower, if not shrinking, production. Trying to push NGDP back to trend then should result in a blip of high inflation and above average inflation over the period that the balance sheets are cleaned up. The inflation of course helps with that.

  24. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 06:30

    W. Peden, I’m currently reading Congdon’s new book, and plan to do a book review.

    Nick, What I really want to know is how IS-LM can be a useful tool. What insights into macro does it give us that the various monetarists approaches neglect?

  25. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 06:30

    Nick, And with the upward sloping IS, what happens when IS shifts right?

  26. Gravatar of W. Peden W. Peden
    10. September 2011 at 06:55

    Scott Sumner,

    Is that “Central Banking in a Free Society”?

  27. Gravatar of mbk mbk
    10. September 2011 at 08:59

    Martin,

    I have no problem with the points you make – yes, the EU’s politicians are currently pondering a trade-off between bailing out (“peripheral”) governments vs bailing out (“core”) banks, something the “core” voter does not seem to grasp. I don’t agree on the idea that Germany’s exports somehow caused this though, Germany didn’t just export to the periphery, it did so substantially to the entire world.

    The central irony is of course that without the self-fulfilling prophecies of fear of impending default the refinancing of the periphery’s government debt would not have been as expensive, debt service wouldn’t have exploded, and default risk would not have risen so quickly. What horrifies me about the world’s financial systems is exactly, that, lots of systemic positive feedback loops that are a control theoretic disaster. No engineer would be allowed to build a machine with these runaway feedback mechanisms at core. They are inherently unstable, they must be.

    But I disgress. My question was just very simply – anyone can default within an economy. Why is the possible default of one local national government, or of a bunch of banks, a survival question for the Euro as a currency, a medium of exchange? Corporations default all the time. Governments elsewhere, too. And as Joe rightly said, changing the debtor’s currency would lead to default just the same, plus apocalyptic cross European economic upheaval.

    Scott:

    Europe has less labour mobility and speaks many languages, but otherwise the economic contrasts are no worse than those within the US. Northern Italy, Switzerland, Austria, France, the UK, hey, Denmark – all virtually indistinguishable in wealth. The difference to the periphery is no worse than the difference between Milan and say Reggio di Calabria, within just Italy, or L.A. and Baton Rouge.

    And in response to the EMH question in the other thread – I do not claim the EMH is wrong, I claim the EMH does not predict everything. The EMH as I understand it does not state that the market price of a capital asset is an objectively correct prophecy of future returns. Yes this has some consequences for the likely result of any NGDP futures targeting: the actual NGDP will still show some volatility under such a regime.

  28. Gravatar of mbk mbk
    10. September 2011 at 09:18

    Morgan,

    you’re funny. I don’t know who you talk to on a day to day basis but the spirit of your talk isn’t actually how wealthy people think, it’s how the lower middle class thinks. Very moralistic, petty. You realize that a lot of very wealthy people int he US are Democrats. In Europe too, tons of socialists amongst the plutocrats. They don’t work with your methods, collapse one part of the economy so that the other can pick up the pieces for cheap. Systemically this is a very poor solution, that’s why.

    I do have some sympathy for the argument that the loser of an economic bet should rightfully – lose. I have that moral outrage too. But, get too many losers in an economy – a correlation of bad bets – and you decrease the total performance of the economy too much. And since wealthy people own a substantial part of the economy they do care about the size of the whole pie, not just some silly 12M mansion. Once you think systemically you’ll see that impoverishing one half of the people makes them into very, very poor consumers (and on top of that they’ll only be able to afford Chinese products! The horror!! The horror!!). So, wealthy people don’t usually thrive on impoverishing others so they can take their assets for cheap (basically, plunder the ruins). Because to live and thrive, they also need a fully functional economy.

  29. Gravatar of Kevin Donoghue Kevin Donoghue
    10. September 2011 at 10:47

    Nick: “We are forced to draw a downward-sloping IS curve, because the KC model would have an unstable equilibrium otherwise.”

    Wrong, I think. The stability condition is slope LM > slope IS. Or so my old Scarth (1983) textbook tells me. (Yes, he considers the case of an upward-sloping IS curve.) But really I switch off when you and Scott discuss IS-LM. You have a different version from the one I know, while Scott hates IS-LM so much he can’t actually study it.

    I suspect Brad DeLong is close to the truth when he says (quoting from memory) that every macro-model has an IS-LM representation. And that’s just the problem. It makes discussion a bit futile. Better to write down your own model and take it from there.

  30. Gravatar of marcus nunes marcus nunes
    10. September 2011 at 11:15

    Scott
    There´s still hope…keep bloging!
    There is a proliferation of economics blogs, with increasing numbers of economists attracting large numbers of readers, yet little is known about the impact of this new medium. Using a variety of experimental and non-experimental techniques, this study quantifies some of their effects. First, links from blogs cause a striking increase in the number of abstract views and downloads of economics papers. Second, blogging raises the profile of the blogger (and his or her institution) and boosts their reputation above economists with similar publication records. Finally, a blog can transform attitudes about some of the topics it covers.
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1921739##

  31. Gravatar of Martin Martin
    10. September 2011 at 11:30

    @mkb,

    “I don’t agree on the idea that Germany’s exports somehow caused this though, Germany didn’t just export to the periphery, it did so substantially to the entire world.”

    Exports have to be financed in one way or another. German banks have PIIGS IOU’s because Germany exported to PIIGS.
    Germany had three options in the 2000’s: 1. fiscal stimulus. 2. external devaluation. 3. internal devaluation. 2 & 3 would increase exports whilst 1 would increase debt.

    Guess what they did:
    http://research.stlouisfed.org/fredgraph.png?g=27r

    The red line shows the CPI difference between Germany and Greece, whilst the blue line shows exports (you can draw this line for almost any EMU country). Two things that are noteworthy: 1. before over 1991-1999 Germany was neither a surplus nor a deficit country. 2. in 1999 the exchange rates for the euro zone were basically fixed.

    By the way the difference also tells you how much Greece has to cut wages/prices to be able to export to Germany and thus to repay Germany.

    Ultimately the question though is is the borrower responsible for borrowing too much or is the lender responsible for lending too much.

    Note: I do not mean to imply that Germans are morally responsible, I just want to show that one does not go without the other. Germany had her recovery through exports instead of mopping up and spending the savings in the system, with as a result she now can mop up savings to provide debt relief to Greece.

    “Why is the possible default of one local national government, or of a bunch of banks, a survival question for the Euro as a currency, a medium of exchange?”

    I have thought about this a little bit more now and come to think of it that that is the wrong question to ask. Survival is a political question.

    The question that is interesting – interesting because you can think about the answer – I think is what are the consequences of a Greek default within the Eurozone on the other members and a Greek default outside the Eurozone on the other members. The answer to these questions determines how the member states will respond. That’s cost-benefit.

    Survival depends on how people in the core countries will respond to the mayhem caused by a default. It could undercut the little support there is for the European project and propel right-wing populist and nationalist parties to power. It is fun for speculation but I don’t think there is a clear answer.

  32. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 11:43

    mbk,

    I am funny. But dude, trust me I deal with wealthy people all day. I deal with the kind who invest in start-ups, and I’d say none of us think like lower middle class people…. we think like people who survive even without Big Government.

    I don’t care if you have sympathy for the argument, your meek intellectual defense will not stop what is coming down the line:

    1. There will not be mortgage forgiveness, the tapes of MBS properties are now being liquidated in large blocks, the process has just really begun, and here’s the TWIST: hedge funds and the like CAN’T rally make a go of it, because you have to BE A LANDLORD. As in you have to run a new kind of company that rents thousands of houses – this is a kind of company that does not EXIST today, and in five years there will be a number of fast growing players in the space.

    2. The jobs bills that comes out of the GOP House and then the Rick Perry Presidency will FAVOR Tea Party style entrepreneurs and investors – local big shots are going to get lower taxes, and Warren Buffet’s crowd – the liberals you speak of – they are going to PAY MORE.

    It is very easy to segment out the “good capitalists” from “bad capitalists” – the good ones don’t need BIG GOVERNMENT to survive.

    Pay close attention to the new rhetoric out of Sarah Palin, she sounds like every word I have written at Big Government for the past two years.

    It resonates with GOP base – the base that runs the GOP, truly this country, because the GOP runs this country.

    3. Public employee unions are done. Ten years from now they will be int he same shape as the private sector unions are today.

    Think about that: by choking off the $$$ funding that Dems get from public employees, progressives are going to have to re-evaluate their strategy for building their utopia.

    It seems obvious more and more liberals are going to start screaming for states’s rights – they will pull back into their Blue Utopia and that means keeping their money at home.

    This is what happens over the next 5-10 years.

    And during that, we will very likely make a move to targeting NGDP, but we will do it AFTER the pro-market reforms are made – so that we get the credit.

  33. Gravatar of John Thacker John Thacker
    10. September 2011 at 11:48

    Speaking of the Euro, I always refer to this article in the January 2010 Econ Journal Watch: “It Can’t Happen, It’s a Bad Idea, It Won’t Last: U.S. Economists on the EMU and the Euro, 1989-2002.”

    In it, two European economists explain that US economists were wrong to be skeptical of the EMU and the Euro, and that they were wrong for the wrong reasons. That was in January 2010; now it seems like the US economists may have been right, though possibly still for the Wrong Reasons.

  34. Gravatar of John Thacker John Thacker
    10. September 2011 at 11:49

    “Pay close attention to the new rhetoric out of Sarah Palin, she sounds like every word I have written at Big Government for the past two years.”

    It’s the new old rhetoric from her, because it’s how she won and governed in Alaska, and why McCain chose her. It was only after the bizarre loathing and loving of her for personality / cultural / whatever reasons by different sets of people that she embraced her other role, for the big bucks.

  35. Gravatar of Martin Martin
    10. September 2011 at 12:00

    Scott:

    “Martin, If we assume a 4% NGDP target for the eurozone, I don’t see where you get 8% inflation. How likely is it that RGDP falls 4% in an economy inflating at 8% (where real estate would be a good investment.)”

    How likely? It happened at least twice in your life-time.:P

    http://research.stlouisfed.org/fredgraph.png?g=27y

    Ok, ok, unfair, I know, different macro-economic conditions.

    In all seriousness: Euro NGDP is at least 10% below trend and I believe that the bursting of the asset bubble and the repairing of the balance sheets will lead to anemic growth if not negative growth as I do not see how monetary policy – apart from (probably) reducing the nominal debt burden through inflation – will be effective in the eurozone.

    I think fiscal policy might, as that will result in borrowing and spending the savings. Then again building a pyramid and counting it towards RGDP strikes me as slightly disingenuous.

    “But I do agree that inflation would have risen somewhat after 2007. However wage inflation is much more important than price inflation, and that should have stayed around the usual level, as (equilibrium) wage inflation tracks NGDP in the long run.”

    That makes sense, I agree. There are collective bargaining contracts in the NL and from what I know, they do bargain for raises to compensate for inflation, but in difficult times, when NGDP falls for example, this puts a lid on wage inflation. I don’t think though that this will put a lid on wages in an environment with higher inflation, which might be another reason why the ECB wouldn’t want to push NGDP back on trend.

  36. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 13:00

    Thacker, Breitbart raves about her for the same reason, he insists on waiting to see if she gets in whenever I bang on him to declare for Perry.

    He thinks her biography would win over a big swath of anti-corporate Dems if they would pull their head from their ass and breathe.

    All I can say is it is coming. Buffett is going to get his wish, his taxes and GE’s are going up. And everyone I know, ours are going down.

    Deep down the left has a real problem with local big fish, it bothers them, they intuit thats what real Republican wealth looks like, its WHY they only know how to play to one kind of wealth – its their doom.

  37. Gravatar of Richard W Richard W
    10. September 2011 at 13:05

    This week may well in time mark the beginning of the end for the eurozone as currently constituted. The CHF peg, Trichet’s astonishing press conference attacks on Germany, Stark’s resignation, market rumours of imminent Greek default all point to us being in the end game.

    Who knows what will replace the current set up because there is no significant common European identity that is required to make the monetary union work. That is the thing that Americans tend to overlook. Hardly anyone in Europe thinks of themselves as European. In a crisis national interest overrides all other considerations. The electorate of the south will not tolerate the austerity of internal devaluation and the electorate of the north will not tolerate what they see as bailouts of the south.

    What should be remembered is Germany were none too keen on the euro from the outset. It was a French inspired project and every promise made to the German people about the euro has been broken. Germany has massively benefited from the euro. However, I don’t blame the German people for their growing hostility to the whole project.

    The thing about the euro is the architects of the project knew about all the flaws and contradictions from the outset. They knew from the beginning that there would be a crisis. However, they thought that they would be able to control the crisis and use it to create a closer political union. They did not bargain on the national hostility and they are so arrogant that they do not for a moment think financial markets should have any bearing on them. The last three years of ECB press conference denialism has demonstrated the arrogance in abundance. To these people financial markets should be subservient to politics and technocrats and convey no informational content.

    I just do not think that there is the political will for a common eurobond, or a fiscal union. Without that the monetary union will not work. I think the more likely outcome is that the euro will contract to a euro-core currency of the north. The problem is if they introduced that next week, the currency would have a 30% appreciation vis-a-vis the USD. Markets are expecting something big in terms of the euro or recession. Anyone who has been following the German DAX will know that it has been hammered recently. I think that European policy makers have lost control of events and as soon as the next few weeks could see some dramatic changes.

  38. Gravatar of Nick Rowe Nick Rowe
    10. September 2011 at 14:33

    Scott: “Nick, What I really want to know is how IS-LM can be a useful tool. What insights into macro does it give us that the various monetarists approaches neglect?”

    Good question. Answering it would take a post. (I’m gathering up the thoughts to do it someday soon).

    Scott: “Nick, And with the upward sloping IS, what happens when IS shifts right?”

    First, all the stuff that normally shifts it right (like an exogenous reduction in desired savings) will now shift it left.

    An exogenous increase in desired savings will now shift the IS right, and (if the LM is steeper) cause interest rates to fall, and Y to fall (or P to fall). (Because desired velocity falls).

    Kevin: “Wrong, I think. The stability condition is slope LM > slope IS. Or so my old Scarth (1983) textbook tells me. (Yes, he considers the case of an upward-sloping IS curve.)”

    1. You misunderstood me. I was talking about the *Keynesian Cross* (“KC”) model being unstable, if mpc+mpi>1. The KC model is equivalent to ISLM with a horizontal LM. I agree with what you say Scarth said.

    2. Which Scarth is that? Canadian Bill Scarth from McMaster (previously from Essex)?

    3. Why does Scarth’s IS slope up? Is it mpc+mpi>1?

  39. Gravatar of StatsGuy StatsGuy
    10. September 2011 at 20:37

    It’s been a while since I had to read a post three times to understand it. Here’s my question for Nick –

    The down sloping IS line implies a particular causation – that, holding everything constant, a reduction in interest rates will increase investment. In moving to the upward sloping line, my read of your explanation is that businesses invest less when rates are low, so when IS clears at a higher rate, businesses invest more and output increases. In essence, you are arguing procyclicality.

    However, I’m not sure that your upward sloping version “holds everything else constant”. The issue is causality and time. Or, as Scott would say, ‘never reason from a price change’. Or, why did interest rates drop anyway?

    Here’s a quote from one explanation of the downward sloping line:

    “The curve is downward sloping because, given the initial point A where S=I, an increase in income leads to an increase in savings and causes an excess supply of savings in the financial market. Then, in order to restore the equilibrium in the financial market, we need a fall in the interest rate: this fall reduces savings, increases the investment rate and leads savings to become again equal to investment.”

    If the slope were upward, then if Y were to exogenously increase (tech bonanza?), how does this play out? Savings increases, causing rate to increase, causing people to invest less… ?? Savings decreases causing people to invest more… ?? I’m struggling.

    I think your argument is that when Y increases, the RATE moves first and savings follows because the rate anticipates real investment which anticipates real income in the future. But if this is true, we shouldn’t be talking about Y at all anyway, but rather about expectations of future Y. Your argument is that a low Y causes expectations of low future Y (and low investment), but that doesn’t necessarily follow at all. Toward the end of a traditional (inventory or capital depreciation driven) business cycle, low current Y is followed by a surge in Y. But this isn’t a traditional cycle, it’s a debt deflation cycle. That, IMHO, is why both monetary and fiscal stimulus are failing to trigger real long term investments (lack of commitment to future stimulus, created by massive political incentives to withdraw stimulus just as soon as the immediate crisis is over).

    Of course, I’m not even certain I understand the IS line to begin with since I’ve seen no evidence that savings and investment equillibrate when there are bimodal risk perceptions about the returns on future investment, and the financial markets are dysfunctional. The IS curve is supposed to be how the “real” and “financial” economies talk to each other, however it’s not clear that they could use a good marriage counselor. And, maybe, a couple bottles of wine. And a trip to St. Thomas.

    And here’s one more thought for you: with the advent of massive financial instrumentation to permit better any which way on the market, a financial actor who believes the world is really getting worse will take that lower interest rate and simply stuff into a massive short on asset values. Shorts and longs can balance out, while positions grow in size (and political stakes intensify) due forced “cheap” leverage. If people truly believe in long term (10 year) low/negative growth, why not bet against all the dumb money which is desperately seeking returns? Why does investment have to respond at all lower rates in the absence of expected demand, and where is that demand going to come from anyway when future income is going to be allocated to debt service? The Fed is constrained by it’s silly commitment to 2% while facing commodity input inflation which is being driven by developing country demand. We’re shifting from a Romer growth model back to a Solow growth model. So much for the “puzzle” in the 90s.

  40. Gravatar of CA CA
    10. September 2011 at 20:43

    Brad DeLong responds:
    http://delong.typepad.com/sdj/2011/09/department-of-huh-scott-sumner-edition.html

    Also, Robert Waldmann comments in the comments section. That guy reeaallly doesn’t like you very much Scott.

  41. Gravatar of mbk mbk
    10. September 2011 at 21:16

    Martin,

    your graph doesn’t relate to the only thing I took exception to in your comments, which is, that German exports to EU periphery directly link to Greek debt. I believe these relationships are a lot more complicated. And yes, “fault” lies with borrower, lender, and the US-triggered international financial tsunami.

    Morgan,

    the kind of economic model you’re gushing about for the US, with rent-seeking from distressed assets and other “white elephants”, cheap services rendered by an impoverished underclass to a small upper class etc, all this already exists, in many African countries. Maybe the tea party should seek concrete advice from there?

  42. Gravatar of Morgan Warstler Morgan Warstler
    10. September 2011 at 23:13

    mbk,

    with unemployment in some black zip codes pushing past 30-40%, you are STUMBLING past the benefits:

    1. They all get a guaranteed income.
    2. They provide each other (labor is local) super low cost services.
    3. There is no longer excess capacity, there is great signalling (this point is a killer), and the haves of the world no longer think people are gaming the system.
    4. PROFIT is being derived from their labor, likely by black entrepreneurs.
    5. It costs significantly less than current gvt. programs.

    Now you can blather on about African villages all you want, but you haven’t come close to solving the problem like I have.

    Real solutions require the agreement of the hegemony (the Tea Party), once you ACCEPT that you can start to piece together what the future looks like.

    Try it. Take whatever problem you are trying to solve, and assume it MUST get the approval of the top 30-40% or so of American likely voters, who consistently vote conservative.

    Then don’t try to win them against grain, create policy that conforms to their world view.

    Doing it for GI, is no different than doing it for NGDP.

  43. Gravatar of Martin Martin
    10. September 2011 at 23:43

    @mkb,

    Exports by Germany to the periphery link to periphery debt, sovereign and private. Your objection was that Germany also exported to the rest of the world, I don’t see how that is a problem. The rest of the world is not in a currency zone together with Germany. Therefore, an increase in Eurozone exports to the rest of the world will be partially offset by an appreciating Euro. Just think of the Eurozone, for this purpose, as one country where the member states are comparable to US-states.

  44. Gravatar of Nevorp Nevorp
    10. September 2011 at 23:57

    Nick: I recommend persevering as i thought he gave some interesting historical context to the model. Best regards.

  45. Gravatar of Cahal Cahal
    11. September 2011 at 02:24

    Nick Rowe seems to have demonstrated the enormous conformation bias present in academic economics whilst watching the Keen video. Knowing it would challenge him, he looked for anything that might resemble a mistake and took it as an opportunity to stop watching the video immediately.

    I regard the IS/LM model as garbage – it purports to be a static snapshot of a dynamic process, and it doesn’t even achieve that well. It complete neglects the irreducible uncertainty which was central to Keynesian theory.

    I mean come on: Keynes explicitly rejected it and then Hicks did too. If the guy whose theories the model is supposed to represent AND the guy who MADE the model thought it was garbage, why does anybody even use it?

  46. Gravatar of Kevin Donoghue Kevin Donoghue
    11. September 2011 at 02:35

    Nick,

    Sorry, when you wrote “if we start with the KC model, then build it up to the ISLM” it didn’t strike me that you had a horizontal LM curve in mind. Anyway the William M. Scarth in question is (or maybe was) at McMaster. His stability condition is basically the same but because I = I(r,Y) you have three partial derivatives to consider instead of two: dI/dr, dI/dY and dC/dY. Call them a, b and c respectively. Then the slope of the IS curve is (1-c-b)/a.

    Cahal,

    You are misrepresenting both Keynes and Hicks quite badly. Both drew attention to the limitations of IS-LM, but that’s a far cry from rejecting it. All models have limitations.

  47. Gravatar of Kevin Donoghue Kevin Donoghue
    11. September 2011 at 02:39

    BTW I had the publication date of Scarth’s book wrong. s/b: Macroeconomics: An introduction to advanced methods (1988).

  48. Gravatar of Nick Rowe Nick Rowe
    11. September 2011 at 05:21

    Kevin: That’s the same Bill Scarth. Good economist. Yep. His IS curve slopes up for the same reason mine does. (Or seems to, because it depends on his interpretation of dI/dY.)

    CA: I added a few comments on Brad’s post.

    StatsGuy: (Not a full answer):

    “The issue is causality and time. Or, as Scott would say, ‘never reason from a price change’. Or, why did interest rates drop anyway?”

    When we are looking at one equation in a multiple equation model, it is OK to reason from a price change. We do this when we move along a demand curve, for example. (But the IS curve isn’t really a demand curve).

    “If the slope were upward, then if Y were to exogenously increase (tech bonanza?), how does this play out? Savings increases, causing rate to increase, causing people to invest less… ?? Savings decreases causing people to invest more… ?? I’m struggling.”

    I prefer to think of I=S in terms of the goods market, not financial markets, which is wrong (many texts screw this up). But anyhow:

    It is not a tech bonanza. That’s an AS phenomenon. Y just increases. (We *can* reason from a Q change, if it’s just one curve.) If Y increases because Yd increases (do *not* ask why), then Id increases because it is easier for firms to sell more output. If an increase in Y causes Id to increase more than Sd increases, then r would need to rise to reduce Id and increase Sd enough to make Id=Sd at that higher level of Y.

    I explain it a bit more here:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/08/the-macroeconomics-of-double-pole-dancing.html

    earlier version here:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/07/an-upward-sloping-is-curve.html

    Gotta go.

  49. Gravatar of Cahal Cahal
    11. September 2011 at 06:02

    ‘You are misrepresenting both Keynes and Hicks quite badly.’

    I disagree. It completely ignores expectations, which were fundamental to Keynes’ analysis. It’s not that the model has ‘limitations’ it’s that it is baseless, or at least its base lies with the neoclassical economics of Robertson & others rather than Keynes.

    Keynes’ 1937 paper ‘The General Theory of Employment’ is best interpreted as an attack on the IS/LM model.

    As for Hicks, well, maybe he was less dismissive, but he said its use extended to little more than a ‘classroom gadget’ which seems closer to rejecting it than you imply.

    Economists always say models have ‘limitations’ then stick an epicycle onto them to try and make them resemble reality. It’s simply not good enough – they need to be swept away.

  50. Gravatar of edeast edeast
    11. September 2011 at 06:48

    For Nick:

    Here is a paper that uses the same (mpc + mpi) > 1, to derive the positive IS, gated so I can’t read it.
    http://www.jstor.org/pss/2978773

  51. Gravatar of Kevin Donoghue Kevin Donoghue
    11. September 2011 at 07:28

    Cahal: [IS-LM] completely ignores expectations….

    No model which takes future cash flows into consideration ignores expectations.

  52. Gravatar of Cahal Cahal
    11. September 2011 at 08:31

    Sorry that should have been changing expectations.

  53. Gravatar of Kevin Donoghue Kevin Donoghue
    11. September 2011 at 10:28

    Fair enough, there are obvious drawbacks to using comparative statics to study the effect of a change in expectations. But there are drawbacks to other approaches too. Economists won’t be giving up comparative statics any time soon.

  54. Gravatar of Nick Rowe Nick Rowe
    11. September 2011 at 11:32

    edeast: thanks. good find. (In my view, stability under interest rate targeting depends on whether the central bank adjusts (and is expected to adjust) interest rate faster than the multiplier process.)

    Cahal: if there were an infinite number of hours in my day, I would read everything that anyone suggested I read right through to the end. There are only 24. I’m not going to sit through 45 minutes watching that that whole video, just on the off-chance it improves later on. Opportunity costs, and all that. I would much rather be “challenged” by spending that same time reading Brad DeLong or Paul Krugman, for example.

  55. Gravatar of Cahal Cahal
    11. September 2011 at 11:56

    Nick I appreciate your stance to a certain extent – it’s the reason I won’t spend too much time on Rothbard or Ayn Rand. But I think economists in general need to be more open minded to critiques by the likes of Keen, Smith, Hudson, Orrell and others given the fields abject failures wrt the current crisis.

    Delong and Krugman might be perceived as left but tbh they are no more left than Republicans in the 60s; I would place them firmly in the centre. What’s more, they certainly aren’t going to challenge economics on the same level as others are.

  56. Gravatar of MikeDC MikeDC
    11. September 2011 at 12:51

    Delong and Krugman might be perceived as left but tbh they are no more left than Republicans in the 60s

    Perhaps that’s because since the 60s we have 50 years of evidence that economics of “the left” wrought a whole series of monstrous disasters upon the world.

  57. Gravatar of Kevin Donoghue Kevin Donoghue
    11. September 2011 at 14:15

    Cahal: [Delong and Krugman] certainly aren’t going to challenge economics on the same level as others are.

    Don’t be too sure. In their day, Keynes and Hicks were “in the centre” in the sense you seem to have in mind. Keynes was very much at home in Whitehall and the City. His economic writings prior to the GT were basically mainstream quantity-theory. Hicks was an authority on Walrasian GET and Austrian theory. That’s what made them so hard to ignore. (Well, that and the great-depression-thingy.) They couldn’t be dismissed as cranks. The same goes for Krugman, despite the worst efforts of his begrudgers.

  58. Gravatar of MTD MTD
    11. September 2011 at 14:59

    CA – Waldmann, who seems strangely obsessed with Scott, really doesn’t put forward any convincing arguments against the quasi-monetarist view. Laughably, Waldmann seems to simply sit back and ‘pull rank’ about the fact that ‘highly ranked’ academic economists haven’t embraced Sumner’s view or that Sumner is not among the ‘highly ranked’ academicians. After comments like these, it is Waldmann who has proven himself to be unserious.

  59. Gravatar of StatsGuy StatsGuy
    11. September 2011 at 16:19

    Nick:

    “If Y increases because Yd increases (do *not* ask why), then Id increases because it is easier for firms to sell more output.”

    Err… Why? 🙂

    No, seriously. Firms think they can sell more when they expect _future_ demand to increase. If current Y increases because of debt spending (e.g. deficit spending that is not supported by money printing) then expectations of future Y could decrease. Firms would not invest, but merely temporarily increase output to convert unused capacity to cash balance.

    To accept an upward sloping IS line, we need to know why an increase in Y causes an increase in expected Y, and I suspect the answer is contingent on the state of the economy (and, in particular, debt vs. asset valuations). In other words, it seems the slope of the IS line can change over time. Otherwise, if we’re at the top of a boom, shouldn’t we just stay in a boom forever (unless we face a major exogenous shock)?

  60. Gravatar of Nick Rowe Nick Rowe
    11. September 2011 at 17:01

    StatsGuy: OK. Fair point. Let me answer it a bit obliquely:

    How long is the period?

    The traditional IS curve incorporates the traditional Keynesian multiplier through the consumption function. Current demand for consumption depends on current income.

    As we move to shorter and shorter periods, going to continuous time in the limit, this assumption becomes ridiculous. Does my consumption this instant depend on my income this instant? No. It depends on existing assets and expected future income. The longer we make the time period, the bigger this effect will be.

    Another way of thinking about it is that mpc depends on the expected length of the recession.

    And exactly the same sort of issues apply to the marginal propensity to invest.

    Look. I’m basically agreeing with you. The ISLM is a crude model. It doesn’t really specify when the present period ends and the future begins. If you have to put everything in 2 dimensions, you have to fudge this a bit.

    The basic question we want to ask is this; if monetary policy is loosened, so the Y expands and the economy escapes the recession, will r rise or fall? The slope of the IS curve is supposed to answer this question. If it slopes down, it says r falls. Which I think is the wrong answer.

    And “loosening monetary policy” doesn’t just mean what the central bank does this very instant; it includes expectations about future monetary policy. So the IS must do that too.

    Now, you *could* say that a loosening of monetary policy will increase expected future Y, and so cause the downward-sloping IS to shift right. But the whole point of having 2 curves (demand and supply; IS and LM) is that when you shift one curve the other curve normally doesn’t shift. So you have to build that effect right into the IS curve. Which means it slopes up.

    (I think I explained this more clearly in one of my 3 posts. My brain is tired.)

  61. Gravatar of Nick Rowe Nick Rowe
    11. September 2011 at 17:14

    Cahal: fair enough. And I do spend a lot of time reading a variety of people who disagree with my own particular perspective on economics. But there’s an awful lot of them. And they all disagree with each other, as well as with me. And they all think I am wrong, and tell me I would realise my mistakes if I spent a lot more time reading their stuff. Some of them may indeed be right. But which ones? So I try to read a little of each, but cut my losses quickly if I run into stuff that seems dead wrong, or I hit seriously diminishing returns.

  62. Gravatar of Scott Sumner, Verächter des alten Wissens « Redrockreason Scott Sumner, Verächter des alten Wissens « Redrockreason
    11. September 2011 at 22:42

    […] Sumner in seinem Blog: I so dislike IS-LM that I never learned it well enough to critique it […]

  63. Gravatar of Cahal Cahal
    12. September 2011 at 01:35

    Kevin,

    ‘Don’t be too sure. In their day, Keynes and Hicks were “in the centre” in the sense you seem to have in mind. Keynes was very much at home in Whitehall and the City. His economic writings prior to the GT were basically mainstream quantity-theory. Hicks was an authority on Walrasian GET and Austrian theory. That’s what made them so hard to ignore. (Well, that and the great-depression-thingy.) They couldn’t be dismissed as cranks. The same goes for Krugman, despite the worst efforts of his begrudgers.’

    Hicks came at things from a different angle to Keynes which is what I am highlighting here. IS/LM is more the culmination of:

    a) Hicks & others trying desperately to reconcile their theories, with little regard to theoretical rigour (they literally coordinated their notation and compromised. That’s not how good theories are born.)

    b) Various models that were arrived at almost entirely separately from Keynes’ analysis by Robertson, Hicks and others.

    Also, though Keynes might have been considered centrist in his time that is not equivalent to centrist now. His most prominent critics were those on the left who saw him as an evil capitalist. I wouldn’t say TGT was immensely disparate to his other books as they all incorporated Boolean uncertainty and came to low long term interest rates as a policy conclusion.

    MikeDC,

    ‘Perhaps that’s because since the 60s we have 50 years of evidence that economics of “the left” wrought a whole series of monstrous disasters upon the world.’

    Don’t be silly. I won’t debate whether you genuinely think we’ve had disastrous ‘left wing’ policies for the past 30 years because books have been written, but to say that the state of the overton window at any point in history is necessarily just and right is a combination of status quo bias and just world fallacy.

  64. Gravatar of Scott Sumner Scott Sumner
    12. September 2011 at 06:06

    W. Peden. Yes, I think that’s the name.

    Nick, Another problem I have with IS-LM is that monetary policy shocks sometimes make short and long term interest rates go in opposite directions. I don’t like the idea of any graph showing how monetary shocks affect “the” interest rate.

    Kevin, You said;

    “I suspect Brad DeLong is close to the truth when he says (quoting from memory) that every macro-model has an IS-LM representation. And that’s just the problem.”

    I agree, that’s the problem.

    Marcus, Thanks for the pep talk.

    Martin, I’ll grant you 1974 (in 1982 inflation had fallen sharply.) I should have been more specific, and talked about starting from a very low trend inflation, i.e. very low nominal wage increases. Core inflation was far higher in the 1970s. But good point correcting me–my statement was poorly worded.

    Are you saying monetary policy can’t boost euro NGDP? Or RGDP?

    Richard, Good observations.

    Nick, I’ll take your word for it, it makes my hair hurt just trying to think about shifting an upward-sloping IS.

    Statsguy, S and I do equate, it’s a tautology.

    CA, I look forward to reading DeLong. You said;

    “Also, Robert Waldmann comments in the comments section. That guy reeaallly doesn’t like you very much Scott.”

    He’s still mad the Economist picked me for “By Invitation.”

    Nick, Bank in 1993 Robert King pointed out that in a forward-looking IS-LM with ratex, an expansionary monetary policy may well raise interest rates, even real rates.

  65. Gravatar of MikeDC MikeDC
    12. September 2011 at 06:07

    Cahal – what do you mean “we’ve had”, and why are you limiting yourself to 30 years when we were originally discussing a 50 year window of time? If you want to discuss “the US since 1981” you’re going to get a very different picture than if you discuss “the world since 1961”. The latter rightly informs the thinking of economists studying the former.

  66. Gravatar of StatsGuy StatsGuy
    12. September 2011 at 09:47

    ssumner:

    “Statsguy, S and I do equate, it’s a tautology.”

    It’s only a tautology if you use certain definitions.

    Does the definition of S&I match in time period? Does the time period in which S&I match correspond to the time period in which r is modelled to equillibrate with Y? Depending on the time period, how do you model inventory buildup and depletion? (If inventory builds, does that count as “investment” even though it’s actually _depreciating_ in value? This is not a trivial question. Inventory accumulation/depletion are central to RBC)

    But most importantly, even subject to many definitional specificities, S&I only match in the real goods sense (even if they do, which they don’t), but r is primarily determined by the financial economy (unless, of course, you NGDP target – when you NGDP target, r truly IS determined by the real economy; tell Brad DeLong to go smoke that).

  67. Gravatar of Martin Martin
    12. September 2011 at 10:59

    Scott

    “Are you saying monetary policy can’t boost euro NGDP? Or RGDP?”

    I have no doubt about NGDP. I have my doubts when it comes to RGDP. I think the boost in NGDP will be mostly – if not all – inflation.

    Sure high inflation will free up real resources for consumers to consume, but I doubt there will be much of a lid on wages in those circumstances. Moderate inflation will probably keep a lid on wages but I do not know whether that will be sufficient to reduce debt to free up real resources.

    The question in my mind is what inflation would (now) be optimal for RGDP and that would be the NGDP-target. I just don’t think that would be a very high number.

    On a side-note: if you’ve seen Trichet, I doubt the ECB is now capable of committing credibly to a higher target: http://www.youtube.com/watch?v=k7EeYQ_MbOM

  68. Gravatar of ssumner ssumner
    13. September 2011 at 18:06

    statsguy, You said;

    “It’s only a tautology if you use certain definitions.’

    It’s a tautology if you use correct defintions. Savings are defined as the funds put into investment.

    Martin, That’s certain a defensible view, but I don’t agree. There’s lots of unemployment in Europe. Perhaps that’s true for Germany.

  69. Gravatar of Unlearning Econ Points out Sumner's Ignorance on Keynes | Last Men and OverMen Unlearning Econ Points out Sumner's Ignorance on Keynes | Last Men and OverMen
    27. March 2017 at 02:34

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