Remember when . . .

. . . the new Keynesians believed that Congress should focus of long run fiscal balance, and central bankers should target inflation (and by implication, aggregate demand?)  It seems a long time ago.  Here’s Ben Bernanke testifying to Congress in 2006:

Well, in our short-term monetary policymaking, we are able to adjust for the conditions of fiscal policy, however they may be. I think fiscal issues are more important in the long-term sense because of the long-term obligations we have, for example, for entitlements. We have not found the fiscal situation to be a major impediment to our short-term management of monetary policy.  (emphasis added.)

New Keynesianism reigned supreme in 2006.

In the UK the Labour government dramatically increased the budget deficit over the past decade, partly for anti-recession reasons, partly out of desire to increase the share of GDP going to the government (without raising taxes.)  The new coalition government that took office in May was faced with an appalling fiscal mess, in some ways even worse than the US.  They adopted a very responsible policy of gradually cutting the budget deficit, by half over 4 years (to a level that would still be unacceptably high) and simultaneously encouraging the Bank of England to maintain adequate growth in nominal spending.  It’s hard to think of a more mainstream new Keynesian policy.  New Keynesianism seems alive in the UK.

[Update:  A commenter pointed out I was in error in my description of deficit reduction, they plan to eliminate the deficit by 2015.  That’s certainly good to hear. (This always happens when I rely on memory.)  Update#2, not quite eliminate it, Left Outside sent me the data]

And yet back in August 2010, when Paul Krugman had to find a name to identify with mainstream new Keynesianism, here’s the only economist that came to mind:

And I don’t understand at all [Koo’s] argument that monetary expansion is positively harmful. He seems to be making up arguments on the fly here; he’s so determined to defend the primacy of fiscal policy that he has to insist that anything else is a very bad thing. (In that sense, I guess, he’s the anti-Scott Sumner).

That’s right, the “primacy of monetary policy,” once a central tenet of New Keynesianism, is now reduced to a stump group headed by yours truly.  When I ask other economists what happened to mainstream new Keynesianism, the only answer I get is that we are in a new world because interest rates are zero, and monetary policy is out of ammunition.  But does situation in the UK look like a liquidity trap?  Like a central banks that is trying to inflate, but is out of ammunition?

Consumer price inflation surged to a two-year high of 4.0 percent from 3.7 percent in December, providing an awkward backdrop for the central bank’s updated quarterly growth and inflation forecasts on Wednesday.

Sterling hit a four-week high against the euro after the data and interest rate futures fell as investors bet on a series of rate rises over the coming year, starting in May.

In an obligatory letter to the government to explain why inflation remained so high, Bank Governor King highlighted differences of views on the monetary policy committee, raising speculation the hawkish minority was gaining ground.

“While Mervyn King would undoubtedly prefer to avoid increasing rates for now, he conveyed the impression that he has moved onto the back foot,” said Philip Shaw, an economist at Investec.

Rather than stress the one-off and temporary nature of upward price pressures, King admitted inflation was as likely to be above target as below it in two to three years’ time assuming interest rates rose as markets expected.

Analysts interpreted these comments as effectively endorsing market expectations of a May rate rise. Most economists until now have stuck with forecasts that rates would not rise until later in the year.

“We now expect the next move from the Bank of England to be a 25 basis point rate hike in May,” said Nomura economist Philip Rush who had previously expected an August move.

I feel like I am in some sort of Alice in Wonderland reality, where all the laws of economics are turned upside down.  Paul Krugman seems to like Ed Balls views on stimulus (he’s a prominent Labour Party critic of austerity), but I doubt he would buy into his views on inflation:

Shadow Chancellor Ed Balls noted the government was not only suffering higher inflation than its main trading partners but also slower growth, and blamed the government’s austerity drive for putting the Bank in such a dilemma.

“It’s the worst of all worlds and I think the Bank is in a very difficult position,” Balls said. “The government is not supporting growth in the economy and at the same time they are pushing inflation up.”

Um, I thought “pushing inflation up” was precisely how governments were supposed to “support growth.”  Wasn’t that new Keynesian orthodoxy?  I am seeing more and more commenters arguing that fiscal policy raises RGDP and monetary policy raises inflation, even though the standard Keynesian model says they both raise RGDP when output is low, and they both raises prices when output is high.  I don’t even know the name of this new model.  Over the next few months it will be interesting to watch Paul Krugman’s reaction to this development on the left.  Will he try to maintain his distinguished new Keynesian credentials, or wander off with the Ed Balls of the world into Wonderland?

I hope we all can agree that a BOE that is getting ready to raise rates in May is not stuck in some sort of “liquidity trap.”  But then what is the rationale for the bizarre policy debate in the UK?  And why has new Keynesianism circa 2006 also disappeared in the US?  Don’t believe it has?  Arnold Kling has noticed the same phenomenon:

I  am prepared to offer pushback against the Sumner-Hetzel viewpoint [that excessively tight money explains the severe recession.]  However, it really deserves the status of the “null hypothesis.” In a more reasonable world, everyone would be starting from the presumption that Sumner and Hetzel are correct. Those of us arguing folk-Minskyism and telling the Recalculation Story should be the ones fighting an uphill battle to bring our ideas into the policy debates. That this is not the case, and that SC [the scholarly consensus] is now on the fringe, is one of the most remarkable stories of this whole macroeconomic episode.

Even more remarkable, very few new Keynesians even seem aware of the fact that their model is gone, it’s disappeared.  Curiouser and curiouser . . .  

PS.   Help me name this new bastard Keynesianism.  The view that only fiscal stimulus raises RGDP.  It’s not Post Keynesianism, as they don’t even think the central bank can cause inflation.  Paul Krugman mentions Koo as a leader.  No, I won’t go there . . .

PPS.  I actually read the entire Bernanke testimony from 2006.  All I remember is a bunch of Dems demanding more housing loans on ever easier terms, and several Republicans warning about Fannie and Freddie getting overextended.  It made me revise my views on the housing crisis. I used to think both parties were equally to blame, now I think the Dems were slightly worse.  Oh, and there’s also Barney Frank not understanding the distinction between real and nominal wages.

HT:  Thanks to W. Peden for the tip about Ed Balls, and Daniel Carpenter for the Bernanke testimony quote.


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39 Responses to “Remember when . . .”

  1. Gravatar of Left Outside Left Outside
    20. February 2011 at 08:33

    They adopted a very responsible policy of gradually cutting the budget deficit, by half over 4 years (to a level that would still be unacceptably high) and simultaneously encouraging the Bank of England to maintain adequate growth in nominal spending.

    Hello from Britain!

    That quote actually describes Labour’s deficit reduction plan, now endorsed by Ed Balls (although before being installed as Shadow Chancellor, he publicly endorsed a slower fiscal tightening).

    The Tories (and Lib Dems) plan to eliminate the deficit over the course of the Parliament (by 2015).

  2. Gravatar of OneEyedMan OneEyedMan
    20. February 2011 at 08:53

    “PS. Help me name this new bastard Keynesianism. The view that only fiscal stimulus raises RGDP. It’s not Post Keynesianism, as they don’t even think the central bank can cause inflation. ”

    How about “Fiscalism” in the spirit of Monetarism

  3. Gravatar of TGGP TGGP
    20. February 2011 at 09:00

    Link to Arnold Kling’s quote here.

  4. Gravatar of Scott Sumner Scott Sumner
    20. February 2011 at 09:02

    Thanks Left Outside. I made the correction. And I’m relieved. BTW, is that total deficit or primary balance?

    OneEyedMan, Yes, fiscalism is good.

  5. Gravatar of Morgan Warstler Morgan Warstler
    20. February 2011 at 09:02

    “Um, I thought “pushing inflation up” was precisely how governments were supposed to “support growth.” Wasn’t that new Keynesian orthodoxy? I am seeing more and more commenters arguing that fiscal policy raises RGDP and monetary policy raises inflation, even though the standard Keynesian model says they both raise RGDP when output is low, and they both raises prices when output is high. I don’t even know the name of this new model. Over the next few months it will be interesting to watch Paul Krugman’s reaction to this development on the left. Will he try to maintain his distinguished new Keynesian credentials, or wander off with the Ed Balls of the world into Wonderland?”

    He, he.

    Dude, he is not an economist. Jesus, DeKrugman calls what he does “The Conscience of the Liberal.”

    Each morning he looks in the mirror and thinks, “I’ve got to get more government money spent on the poor.”

    That’s something, but at its core, it is not being an economist – no matter how many charts and graphs you hang on it.

    —-

    Frankly, I think your mask is now ripped off, “holy shit it’s Uncle Milty!”

    They are screwed and they know it. If you get them to admit it, you win $1M.

  6. Gravatar of Scott Sumner Scott Sumner
    20. February 2011 at 09:06

    TGGP, Thanks, I added it. I’m sick today, that’s my excuse for all this sloppiness.

    Morgan, I’d deserve a million if I got Paul Krugman to admit a mistake. 🙂

  7. Gravatar of david david
    20. February 2011 at 09:10

    The intuition, I think, is the tradeoff between inflation-RGDP tradeoff in the short run, plus a fiscal-RGDP tradeoff in the short run, so the logic is that cutting RGDP via austerity whilst in a recession obliges a very high inflation rate.

    Which would be entirely true, wouldn’t it, if one were targeting NGDP. The inflation rate would indeed be much higher (but you wouldn’t care, because your mandate is to target NGDP). The BoE’s mandate is inflation, though…

  8. Gravatar of Indy Indy
    20. February 2011 at 09:12

    It should be “assymetric fiscalism” it only works it one direction.

  9. Gravatar of david david
    20. February 2011 at 09:13

    (another way to put it, I figure, is to realize that most people (monetarists and NK included) do believe in the Long and Variable Lags, and thus both tradeoffs will apply at the same time, rather than the surge in expected inflation making prices adjust to austerity rapidly.

    Also, inserted “expected inflation” for “inflation” in my previous comment… ;p)

  10. Gravatar of Scott Sumner Scott Sumner
    20. February 2011 at 09:21

    Indy, I suppose, I don’t know how they think. Which direction do they see fiscal stimulus working?

    David, But I’ve never seen a model that has that implication.

    Because the fiscal austerity is being phased in very gradually, I don’t see the lags issue as being important.

  11. Gravatar of Richard W Richard W
    20. February 2011 at 09:26

    I doubt whether he actually believes that the coalition government are causing inflation. Raising the price level through increasing VAT is probably what he means. Maybe he should take some advice from his brother.
    http://europe.pimco.com/LeftNav/Bios/Andrew+Balls.htm

    This Bloomberg speech gets to the heart of what Ed. Balls believes.
    http://edballs.3cdn.net/4666f3d18ae6fdd279_x0m6bn4d2.pdf

  12. Gravatar of david david
    20. February 2011 at 09:26

    @Indy

    Well, no, it applies both ways, doesn’t it. Let’s say that inflation is very high and burnt-in, and for whatever reason your bank is reluctant to raise rates (say, because your country is dependent on low unemployment for political stability), but would prefer not to let inflation go even higher. Your government proposes a fiscal expansion, perhaps because Egypt is on fire and we need to hand out goodies lest we burn too. That would put your bank in a difficult position as well, wouldn’t it? The high inflation doesn’t automagically make prices adjust to fiscal expansion.

  13. Gravatar of Left Outside Left Outside
    20. February 2011 at 10:03

    http://www.guardian.co.uk/uk/2010/jun/22/budget-2010-key-points

    A summary of last years budget there for you.

    The Tories plan to reduce the deficit to around 1% by 2015/16, although budgeting 5 years ahead is always a little bit like Extispicy.

  14. Gravatar of Jeff Jeff
    20. February 2011 at 10:04

    Help me name this new bastard Keynesianism. The view that only fiscal stimulus raises RGDP. It’s not Post Keynesianism, as they don’t even think the central bank can cause inflation.

    Ersatz socialism? Really, do you not detect a whiff of intellectual dishonesty? It seems that Krugman is more interested in growing the government and redistributing wealth and income than in growing the economy.

  15. Gravatar of Benjamin Cole Benjamin Cole
    20. February 2011 at 10:17

    Let me not play analyst, but strategist here.
    We should talk about Japan.
    The ruin that is Japan. A nation that has seen 75 percent declines in its equity and property markets in the last 20 years, and no end in sight. Where another eight years of deflation is predicted. Where young people do not have families anymore.
    Sure, from time to time, this or that nation will blip in some unexpected way. But the long road shows what overly tight money will accomplish, and that is Japan.
    Stay on topic, stay on Japan.

    BTW, I was in Thailand recently, and buried in the Thai newspapers was a story that Japan has advised Thailand that it will need 700,000 skilled Thai workers for Japan enterprises in Thailand in the next 10 years. Thailand has a pop of about 67 million.

    Evidently, Japan businesses have had enough of the Bank of Japan monetary noose around their necks, and will migrate manufacturing to Thailand. They can buy a lot of factory in Thailand with overpriced yen.

    Then, they can export from Thailand, thanks to the cheap Thai baht.

    The China story may hit a pothole–a Thai-Japan alliance may be a formidable competitor. Actually, I expect booms all across Asia, but especially Thailand, with its balanced federal budget, trade surpluses, okay government, ready workforce, and abundant agriculture. China will likely go up the ladder in manufacturing.

  16. Gravatar of Shane Shane
    20. February 2011 at 10:59

    I like fiscalism. I think you might also call it “Real Keynesianism,” by analogue with RBC theory. The thinking seems to be as follows:

    1. The economic collapse represents a major moral failure of capitalism.

    2. The private sectors has not changed their ways, and are still as corrupt and degenerate as ever.

    3. In ordinary times fiscal and monetary stimulus may be interchangeable, but right now the private sector is inherently untrustworthy. They will simply take the money and use it to speculate or to invest where interest rates are higher.

    If you think this is an exaggeration, I would point you to the following two interviews, which serve as virtual manifestos for this brand of Keynesianism.

    Joe Stiglitz on “Democracy Now!”: http://www.democracynow.org/2010/10/20/nobel_laureate_joseph_stiglitz_on_how

    Michael Hudson on “Democracy Now!”: http://www.democracynow.org/2010/11/5/new_600b_fed_stimulus_fuels_fears

    It was an honor to serve as your whipping boy in an actual post for once, Prof. Sumner, as opposed to just the comments section!

  17. Gravatar of Ashwin Ashwin
    20. February 2011 at 11:20

    Scott – great post. My acid test of the coherence of an economist’s macroeconomic views is their opinion on the current situation in the UK and so far you’re the only mainstream economist who passes this test. I may not always agree with you but atleast you make sense! 🙂

    No sensible economist can deny the ability of the BoE to generate inflation. Therefore, if you complain about the fiscal contraction, you need something more than an NK-view of the world to do so. Fiscalism is not a bad word to describe it but it’s probably close enough to a post-Keynesian/MMT worldview. I know they don’t usually think a central bank can generate inflation or impact AD but the UK does have some unique institutional features that negate this argument. Most UK mortgages are floating-rate mortgages which means that small changes in interest rates have a big impact on household balance sheets and spending (Yes I know we need to take the savers into account and their reduced income but historically, interest rate changes feed very quickly into household spending).

  18. Gravatar of Scott Sumner Scott Sumner
    20. February 2011 at 11:33

    Richard, Read the first few pages of that Balls essay from August 27, 2010. Then think about the fact that the S&P closed at 1047 on the day before, and is now around 1340. It puts his musing on the possible market response to QE2 in a whole different perspective.

    I probably shouldn’t have been so hard on Balls. What else can a politicians say? They can’t say they hope inflation rises even higher. My post is actually directed at my fellow economists.

    Left Outside, Thanks. Perhaps I was thinking of the decline from 149 billion in 2009-10 to 60 billion in 2013-14. But even so I was wrong; that’s well over half.

    Jeff, But be careful, he hasn’t yet made the argument that monetary stimulus only raises prices . . . yet. 🙂

    Benjamin, Glad to hear Thailand is doing well, I really like that country.

    Shane, Thanks. BTW, I wasn’t thinking of you in a whipping boy sense, I was thinking of people like Stiglitz and Robert Reich. But I was too lazy to dig up links.

  19. Gravatar of Philo Philo
    20. February 2011 at 11:35

    @ Benjamin Cole:

    “We should talk about Japan. The ruin that is Japan.” I don’t think you’re going to be able to convince people that Japan’s twenty-one-year doldrums are due to tight money. An unexpected monetary tightening can cause a recession, but the economy should eventually adjust to a consistent monetary policy, whatever it is. The BOJ has been aiming consistently at zero percent inflation (or perhaps minus one-half percent) for a couple of decades; it’s long past the time when this should be harming the economy.

  20. Gravatar of Scott Sumner Scott Sumner
    20. February 2011 at 11:42

    Ashwin, Good point about the institutional differences in the UK. What’s worrisome is that they haven’t even raised rates yet. I suppose that monetary tightening in the UK raises headline inflation, (although not actual inflation of goods prices.)

    Philo, I have to agree. They’ve had three bouts of deflation, which isn’t good, but over the longer term their problems are heavily supply-side.

  21. Gravatar of Shane Shane
    20. February 2011 at 13:24

    Hahaha, I know I wasn’t your real target. I was just imagining (projecting?) that I might have played an ever so small roll as an extra in “more and more commenters” after yesterday’s exchange. And it would be this anonymous rabble who, I guess, take turns as whipping boys for the big guys like Stiglitz and Reich.

    In any case, I think the post really speaks to a tendency for the left–which I would count myself part of–to want to have our own “anti-stimulus” line. It’s partly fueled by political opportunity, in that it gives us a way to be against giving more money to THE BANKS while being for “good stimulus.”

    On a certain level, however, this really does fit in rather well with New Keynesianism in that it just takes the idea that monetary policy can have effects even at the zero bound one step further, this time adding the twist that these are unpredictable and may range from real growth through creating inflation expectations (Krugman, Delong) to speculation and “beggar-thy-neighbor” currency wars (Stiglitz, Reich) to economic imperialism (Hudson). Perhaps all along it’s been the case that there’s a much broader range of novel beliefs that have taken over for the old “pushing on a string” common wisdom than people realized.

  22. Gravatar of W. Peden W. Peden
    20. February 2011 at 14:14

    I couldn’t find the Balls-Boulton interview, but here’s some Balls-

    http://www.youtube.com/watch?v=x1PoLhiElzA

    – where he attributes all growth to Labour’s fiscal stimulus, the contraction to the fiscal tightening (even, as he admits, before its happened e.g. before the VAT rise) and this is causing high inflation to depress the economy.

    2:38 – 3:20 is about as concise an expression of “fiscalism” as you’ll find, bearing in mind that the implication is that high inflation and falling unemployment are both concomitants of fiscal austerity.

  23. Gravatar of W. Peden W. Peden
    20. February 2011 at 14:28

    That said, since Balls gets sweaty even when trying to agree with himself, it’s hard to construct a rational macroeconomic standpoint based on what he’s saying-

    http://www.youtube.com/watch?v=Yb6jY6BPfeY

    Balls-Osborne is a far, far cry from Howe-Healey, Clarke-Brown or Jenkins-MacLeod.

    More fiscalism-

    http://www.youtube.com/watch?v=i3pZdaQL1M8

    Here he gets outwitted by the immense economic learnedness of breakfast television presenters-

    http://www.youtube.com/watch?v=6LEOisXq_es&feature=related

    (In a world of independent monetary policy, what is a “plan for growth”? A plan to raise output as a proportion of NGDP? Great, there’s plenty that governments can do- and even more that they could stop doing- in order to do that. But, as Scott Sumner has pointed out, there is no model where governments can demand- pump-up RGDP when NGDP is given.)

    But it’s a bit hard to call out Ed Balls as the paradigmatic fiscalist, because this is the kind of nonsense that many, many politicians have been peddling for decades, if not centuries: we are responsible for growth, we are not responsible for inflation. They were also responsible for employment until they found out that they couldn’t control it.

  24. Gravatar of JPIrving JPIrving
    20. February 2011 at 15:09

    Professor Sumner,

    The name for this “new” model is Vulgar Keynesianism. That is, using the language and prestige of Keynesianism as cover for political goals. Or, Not quite having a model of the economy, but just knowing deep down that *spending must be good*. Bob Higgs may have coined the term.

  25. Gravatar of Britmouse Britmouse
    20. February 2011 at 15:10

    Thanks for your continued commentary of the UK. Apologies for the long comment again.

    Note that UK/EU CPI figures ignore housing costs (what’s the worst that could happen?!); interesting data to back up Ashwin’s comment here on feed through to other inflation measures:

    http://www.bondvigilantes.co.uk/blog/2011/02/18/1298047740000.html

    King: “Well, I’ve only ever said one thing about this, and I’m not going to comment any more on fiscal policy. There has to be a Plan A. Now you can clearly debate, you know, the timing and everything else; but that this country needs a fiscal consolidation starting from its largest peacetime budget deficit ever seems to be common to everyone.”

    http://www.bankofengland.co.uk/publications/inflationreport/conf110216.pdf

    There is King, explicitly not tying himself to the specifics of the “austerity plan”.

    So for Krugman is *any* comment on fiscal policy necessarily “political”? I don’t get it. Is he simply ignorant of the what King actually said? I find that hard to believe. Bernanke talks about fiscal policy all the time – is that not “political”?

    Balls is a smart political strategist, and one of the primary architects of our current malaise, as Brown’s economics guru since forever. He is misrepresenting King’s position… if not downright lying… so, what is he up to? Is he just pissed off because King won’t support endless fiscal expansion? It seems too petty. Is he trying to pull King into the populist anti-banker sentiment?

    I have the highest regard for King. He could have pointed out at any time that 1.7% of our 4% CPI inflation is due to the tax and duty changes, and shifted blame onto the government. The press would have lapped it up, but he does not even mention it – not a single word; instead he takes the bullet.

  26. Gravatar of Benjamin Cole Benjamin Cole
    20. February 2011 at 17:04

    Philo:

    Well, the results speak otherwise.

    Friedman said all inflations are monetary; ergo should not all deflations be monetary? Japan is in perma-deflation-recession. What else besides tight money could cause that? Well, a declining work ethic, but no one seems to say that. Declining output per worker? No, that is not happening.

    BTW, Friedman, Ben Bernanke and John Taylor all advised Japan to go hard into the QE route. They did for a few years in the mid2000s, and Taylor actually wrote a paper gushing about the positive effects of QE in Japan. It’s on his website.

    But the BoJ backed off, and went back to tight money. Japan continued sinking.

    I think there is a huge untold story here: The modern economy, and real estate, cannot withstand tight money. Sticky wages, declining investor expectations, leveraged property and banks and other impediments work against tight money not for years, not for decades, but we are coming on generations in Japan.

    When will you invest in the Japanese stock or property markets? Eight years from now—and if other investors concur, what are the results?

    Tight money is really bad idea. It may be the worst idea in play in modern economics. Japan has proven that in spades.

  27. Gravatar of Doc Merlin Doc Merlin
    20. February 2011 at 17:08

    Indy makes a good point. They never advocate drastic cuts to spending during booms, just increases during recessions. If anything its more creeping socialism than anything else. They keep expanding the state, but never strongly advocate contractions.

  28. Gravatar of Doc Merlin Doc Merlin
    20. February 2011 at 17:16

    WRT japan, I am reasonably certain their GDP is very understated due to the very high tax rate and the very vast, under-the-table cash economy.

    “Tight money is really bad idea. It may be the worst idea in play in modern economics. Japan has proven that in spades.”

    @Benjamin
    Japan didn’t have tight money, however they had very, very loose fiscal policy witch seriously damaged their economy. They pushed to 0 percent rates, and then began EQ, but that had little actual effect on their measured NGDP. They then began to do what was in their power to keep expanding, but nothing really happened. This is because any extra expansion went directly into their government and the zombie corps being propped up by their government. What I am saying is that excessively loose fiscal policy makes monetary policy ineffective.

  29. Gravatar of Benjamin Cole Benjamin Cole
    20. February 2011 at 17:57

    Doc-

    Japanese Wages Hit 20-Year Low. Chart Looks Like Cliff Dive
    10:56 am

    August 4, 2009

    by LAURA CONAWAY

    High Frequency Economics
    ‘This is what a depression looks like, eh?’
    Carl B. Weinberg of High Frequency Economics sends a bummer note this morning.”The global economic downturn is not taking any time off for summer vacation,” he writes. Global credit has stopped growing, he notes, and German retail spending is looking very 1990.

    But that’s nothing compared to the news out of Japan, where overall pay clocked in last month as the lowest in 20 years. Cash earnings are down 7.1 percent over June 2008, as companies cut summer bonuses by 17 percent. Wages were down 2.5 percent lower than May 2008. With less money in their pockets, Weinberg writes, Japanese families will be spending less for a long while. “This is what a depression looks like, eh?” he writes.

    Only tight money could ruin Japan the way it has been ruined. I agree that federal spending, here or in Japan, is largely wasteful, and perhaps not stimulative, less accommodated by monetary policy. However, do not conflate a good idea–that being less federal spending–with a really proven bad idea, that being tight money.

    Japan didn’t have tight money? Deflation and zero interest rates, as Friedman said, are a sign on tight money. You can’t have it the other way.

    Japan completely destroys any rational sentiments for tight money.

  30. Gravatar of Lorenzo from Oz Lorenzo from Oz
    20. February 2011 at 19:25

    Doc M: What I am saying is that excessively loose fiscal policy makes monetary policy ineffective. This seems massively implausible to me. Piling up debt and specific government spending is more important than the policy that profoundly affects every single market? I am betting one could find fiscal profligacy without tight money that did not have the same effect. By, for example, casting one’s eye down the list of high public debt countries.

  31. Gravatar of StatsGuy StatsGuy
    20. February 2011 at 21:42

    In agreement with many comments above, I have to respect Mervyn King for at least stating the truth – which is, living standards in the UK are going to drop for a bit. He blamed it on the banking crisis, but the real reason they needed to drop is because the developing world is growing at 7% and the UK is structurally unprepared to accept the loss in consumption as resources get redistributed.

    The raw truth of the matter is that distributional losses resulting from developing world growth, technological change, and competition for scarce resources are outweighing gains from trade and technological improvement in consumer surplus for a lot of people in the UK, at least for several years – all made worse because consumption was preserved for so long through debt, leaving the adjustment doubly painful. Mervyn King told truth to power, and power doesn’t like to hear truth.

    If you combine Alan Blinder’s recent message + Mervyn King’s message, you get: “yes, it sucks to be british and lower/middle class – but unemployment and debt suck even worse than diminished real wages.”

    [As an aside, I sympathize with Blinder – he foolishly mentioned the D word (distribution), which is not politically correct among the neoliberal consensus. Silly Blinder, everyone knows consumer surplus _always_ trumps distributional losses.]

  32. Gravatar of Doc Merlin Doc Merlin
    21. February 2011 at 02:23

    WRT japan, I am reasonably certain their GDP is very understated due to the very high tax rate and the very vast, under-the-table cash economy.

    “Tight money is really bad idea. It may be the worst idea in play in modern economics. Japan has proven that in spades.”

    @Benjamin
    Japan didn’t have tight money, however they had very, very loose fiscal policy witch seriously damaged their economy. They pushed to 0 percent rates, and then began EQ, but that had little actual effect on their measured NGDP. They then began to do what was in their power to keep expanding, but nothing really happened. This is because any extra expansion went directly into their government and the zombie corps being propped up by their government. What I am saying is that excessively loose fiscal policy makes monetary policy ineffective.

    @Lorenzo

    Your list doesn’t help your case, as I didn’t say that the bank would be unable to generate inflation by expanding the money supply. I said that it wouldn’t actually help the economy, where fiscal profligacy is practiced. If anything your list supports my position.

  33. Gravatar of Doc Merlin Doc Merlin
    21. February 2011 at 02:23

    Woops sorry, double post. The @Lorenzo part is what I meant to post.

  34. Gravatar of Lorenzo from Oz Lorenzo from Oz
    21. February 2011 at 04:01

    Doc M: Now I am really confused. I was not implying that the central bank could not cause inflation: that seemed to be the implication of your claim that fiscal policy which was sufficiently loose “makes monetary policy ineffective”. I was suggesting that we could find countries with periods of prolonged fiscal profligacy with quite different monetary policy outcomes — i.e. that monetary policy was still as effective as it chose to be despite regular high budget deficits.

  35. Gravatar of W. Peden W. Peden
    21. February 2011 at 07:59

    Doc Merlin,

    “Japan didn’t have tight money, however they had very, very loose fiscal policy witch seriously damaged their economy”

    They did what they had to do in order to get to 0% inflation and then stopped. In that respect, Japanese monetary policy was perfectly effective and tight; it was just that it was also bone-headed.

    However, it’s true that Japan has had a very loose fiscal policy, which has given it the worst of both worlds: tight money plus loose fiscal policy, which is one situation in which the Treasury View holds, since the loose fiscal policy is eating into the money that would otherwise be available to the private sector. So, insofar as you are saying that (with NGDP given) loose fiscal policy negatively affects the private sector and therefore RGDP as a proportion of NGDP, I quite agree with what you’re saying.

  36. Gravatar of OGT OGT
    21. February 2011 at 10:36

    Statsguy- I agree with you that the larger crisis has to be viewed to a large degree as a failure of Western economies and institutions to adpat to and accomodate the rise of developing countries. Ben Bernanke appears to a agree too, judging by his latest ‘Savings Glut’ paper.

  37. Gravatar of Scott Sumner Scott Sumner
    21. February 2011 at 17:27

    Shane, One of the things that really stunned me in 2008 was when I found out that other people really believed the zero rate bound was such a problem. I think it’s fair to say that the economics profession had a very low opinion of the BOJ, and it’s claim that it had done all it could to create inflation. (And I think that low opinion was justified.) And then to see mainstream economists suddenly claiming there was nothing more the Fed could do—it seemed to go against almost everything that had been published in recent decades. And this continued after Bernanke insisted the Fed was not at all out of ammunition. The whole episode was very strange–which I guess shows out of touch I was.

    W. Peden, Thanks, those clips always remind me how much more intelligent British political discourse is as compared to American debate. We really should adopt your parliamentary system. Even Ed Balls was slightly less bad than I expected.

    JPIrving, Thanks for that info. I do vaguely recall that term. Bastard Keynesianism is another term I recall.

    Britmouse, I agree, it is normal for central bankers to call for deficit reduction. And it is their job to offset any effects on AD.

    Benjamin, You are right about the middle 2000s in Japan. Things were gradually getting better in Japan, and then in 2006 they again slammed on the brakes. It was an inexplicable error–unless you assume they don’t want any inflation.

    Doc Merlin, Yes, the Labour party increased the share of GDP going to government during 2001-08, when it should have been falling (because the economy was expanding.)
    The share should go up in recessions and down in booms.

    Statsguy, King told the truth, but I’d blame Labour’s “big government” policies more than globalization. Blair did a fine job for about 5 years, then it all went downhill.

    I think Blinder’s problem was talking about the “problem” of outsourcing. Outsourcing is a solution, not a problem. This happens almost every recession, people confuse cyclical problems and secular trends. Outsourcing occurred at a rapid rate between 2002-07, and unemployment fell sharply.

  38. Gravatar of Old Whig Old Whig
    25. February 2011 at 04:09

    Why not call it “Vulgar Keynesianism” or “Political Keynsianism” since it’s objective is to protect a ever larger and larger government sector as well as higher and higher taxes regardless of facts on the ground.

    Sweden 1993 and now UK 2010 is doing what the US aught to do. Hard core austerity programs. Nor because it’s theoretically correct but because it’s morally correct and sets the tone for the future. There must be harsh pain for all but in particular for formerly protected areas such as the poor, military spending and entitlements.

    Why do you think Sweden post hard core austerity 1993-1997 are now 2008-2010 according to Scott Sumner having the fastest recovery?

    In Sweden we have the following saying, my rough translation:

    “When your freezing to death you can urinate in your pants, at first it will feel very, very good but in the long run it will kill you faster when the urine freezes over.”

    It’s in my opinion what Vulgar/Political Keynsianism is about.

  39. Gravatar of Scott Sumner Scott Sumner
    26. February 2011 at 11:23

    Old Whig, Good comment.

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