Take that, old-style Keynesians!
A few months ago I got into a series of arguments with some old-style Keynesians who kept insisting that monetary policy is ineffective once nominal rates hit zero. “Period. End of story.” I kept trying to explain that unconventional monetary policy could still be highly effective; the problem was that we needed to be much more aggressive. I pointed to FDR’s currency devaluation in1933 as an example of how an aggressive monetary policy could boost NGDP rapidly, even with interest rates near zero and much of the banking system shut down for months.
Finally my views are getting some respect, and from some unlikely quarters. First the NYT does a piece on my blog, and now there is this post from the Time’s Nobel Prize winning columnist:
Two months ago I wrote that there were hints of a relatively quick economic turnaround in Britain. Now those hints have gotten much stronger. Basically, aggressive monetary policy and the depreciation of the pound are giving Britain a boost relative to other advanced countries.
If only the US had followed a similar course, instead of relying almost completely on costly fiscal expansion, which has only a modest impact on the path of NGDP over time. Still, it’s not too late for US to learn some lessons from the Brits.
Ideas have consequences. Because so few people understood that monetary policy could be highly effective at zero rates, and because the only person on the left who did understand this mostly kept his mouth shut, a monetary alternative to fiscal stimulus was never seriously considered. On the right, lots of economists understood that monetary policy can be very effective at raising NGDP sharply when interest rates are zero. As far as I can tell, most of them failed to loudly condemn Fed policy because they thought that no further stimulus was needed. Thus when the Congressional debate over fiscal stimulus took place last winter, the right never used their most powerful argument. They deserved to lose the debate.
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7. August 2009 at 10:39
This is a little bit of a side note, but I think what the problem is also is that most common people do not understand monetary policy and that it is faster and usually more effective than fiscal policy.
What I really think needs to happen is that economics (and finance possibly also) needs to be a required class in high schools.
Elected officials are not going to support monetary policy if their constituents do not ask for it. And they are not going to ask for it, if they do not understand it.
I still remember when the Fed cut rates a full point instead of a half (or a half instead of a quarter, cant remember exactly) near the very beginning of all this: All I heard was people screaming madly about inflation; and people like Jim Cramer were making big scenes about how idiotic the FED is because they were going to cause huge inflation which would weaken the stock market.
7. August 2009 at 11:03
Could we get a link to something about the unconventional monetary policy being talked about?
7. August 2009 at 11:16
Krugman, Jan 26th: my definition of a liquidity trap is, purely and simply, a situation in which conventional monetary policy “” open-market purchases of short-term government debt “” has lost effectiveness. Period. End of story.
The man agrees with you. That’s not new. He’s agreed with you all along. Of course he isn’t looking for “a monetary alternative to fiscal stimulus” but a monetary policy which augments fiscal policy.
It’s the Chicago crowd you have a problem with. This post should be headed “Take that, Lucasians!”
7. August 2009 at 11:46
I think what the problem is also is that most common people do not understand monetary policy and that it is faster and usually more effective than fiscal policy.
Fiscal stimulus is a simple story. That, plus it gives politicians money to spend, gives it a lot of political power as a policy response.
7. August 2009 at 11:54
And no-one down here in Oz who has been paying attention is likely to deny the value of falling exchange rate as a response to a negative economic shock.
7. August 2009 at 12:02
If you look at the recent talk Dr. Christina Romer gave (link to pdf: http://blog.prospect.org/blog/weblog/DCEconClubprint.pdf), you’d find that at least the CEA feels fiscal stimulus is the way to go.
7. August 2009 at 12:05
The link I gave about might not work because the commenting system mistakenly includes the close bracket at the end as a part of the URL. Try this:
http://blog.prospect.org/blog/weblog/DCEconClubprint.pdf
7. August 2009 at 13:18
“If only the US had followed a similar course, instead of relying almost completely on costly fiscal expansion, which has only a modest impact on the path of NGDP over time. Still, it’s not too late for US to learn some lessons from the Brits.”
Well, if you recall, Bernanke’s Fed waited until WELL after they saw that the BoE could deploy QE without blowing up the world before they timidly tried something similar (and not even close to on the same scale).
As to why? There’s a tremendous amount of anti-inflation ideology.
Also, I do feel compelled to defend a modest amount of fiscal stimulus (notably, cash payments to states/localities to defer excess expense cutting). Also, some of the stimulus money includes real investments (e.g. energy infrastructure, basic R&D).
7. August 2009 at 13:36
Paul, First we need to educate economists, then we can work on changing textbooks that our students read. Right now I don’t see many economists calling for a more expansionary monetary policy. Why not?
Bedmondson, Almost my entire blog is on this topic, but here’s one post where I discuss options:
http://blogsandwikis.bentley.edu/themoneyillusion/?p=411
Kevin, You said:
“Krugman, Jan 26th: my definition of a liquidity trap is, purely and simply, a situation in which conventional monetary policy “” open-market purchases of short-term government debt “” has lost effectiveness. Period. End of story.
The man agrees with you. That’s not new. He’s agreed with you all along. Of course he isn’t looking for “a monetary alternative to fiscal stimulus” but a monetary policy which augments fiscal policy.
It’s the Chicago crowd you have a problem with. This post should be headed “Take that, Lucasians!”
Where do I start.
1. Your suggested title makes no sense. Lucas has said that he supports an expansionary monetary policy in a recession, and also that monetary policy is still effective in a recession. So what would be the “take that” from Krugman’s quotation?
2. Of course Krugman (sometimes) agrees with my view, I thought it was pretty obvious that the unnamed economist “on the left” who understood this all along was Krugman. Who else do you have in mind? Can you find me a single quotation from DeLong or any other old-style Keynesian saying that inflation targeting is still highly effective in a liquidity trap, and is a better stimulus that fiscal policy? I have listed several such quotations from Krugman in earlier posts, so I can hardly be accused of ignoring his earlier views.
3. As far as “The man agrees with you.” Did you happen to read his reply to my call for a more aggressive monetary stimulus?
4. There was no reason for me to take a gratuitous shot at Lucasians in a post attacking old-style Keynesians. But I did anyway. The final line was that they deserved to lose the debate over fiscal stimulus. And that still isn’t enough?
The bottom line is that you are right that Krugman has always held these views. And I would add that Krugman is worshiped by the old-style Keynesian community. DeLong once said something to the effect that Krugman is right about everything. And yet that community either doesn’t understand or ignores his argument that inflation targeting can be highly effective in a liquidity trap. They pretend it isn’t there, like that embarrassing uncle you hope the neighbor don’t see. I want to shove Krugman’s views right in their faces. And I’ll do it over and over again if necessary. I hope it won’t be necessary.
Regarding those on the right, I feel that I spend more time criticizing those who oppose stimulus in my comment section, than I do criticizing those on the left.
Thanks Lorenzo, I really need to do a post on Australia. Have they had any years of falling NGDP since 1992? I bet not, and I bet that’s why they haven’t have any severe recessions either.
Thanks Dilip, I’ll check it out. Of course when she was a private economist she wrote that it was monetary stimulus, not fiscal stimulus, that got us out of the Depression.
7. August 2009 at 13:41
Statsguy, I understand where you are coming from on fiscal policy, and think it’s a reasonable view. But you have to understand my role here. I don’t take anything as given. I feel my job is to open people’s eyes to the insanity of the Fed calling for fiscal stimulus, and simultaneously refusing monetary stimulus because of fear of inflation. There is simply no justification for that policy stance. If you want to take inept monetary policy as a given, and then argue for fiscal stimulus because monetary policy is obviously inadequate, then it’s hard for me to disagree with you. Note the final line of my post, that was me basically saying “I may not agree with Statsguy, but I acknowledge he won the argument.”
7. August 2009 at 14:53
Statsguy writes:
There has been no meaningful Quantity Easing. The Fed is currently obsessed with regulating the yields of particular assets. A policy which stems from a great deal of confusion as to what’s going on in the marketplace, what it takes to move the market, and more generally how it is that the Fed influences the economy.
7. August 2009 at 15:49
Scott,
What would you tell people on the right like me (although I don’t like the right left distinction… I would rather be on the sunny side of the street) that understand your point about the effectiveness of QE but believe that the only role for the FED was to avoid the depression but not the recession. On the positive side of your analysis I’m sold but on the normative side not so much. I’m no Austrian but I still get the gut feeling that whenever the government gets their hands too much into the economy bad things happen, I don’t care if it is fiscal or monetary policy, if the president is Bush, Obama or Castro or if the Fed Chairman is Greenspan, Bernake, Lucas or Friedman, too much government gives me a chill down my spine. The same applies to health care reform, stimulus plans and social security. You can come to me with an ideal policy but if it involves too much government intervention then I discard it by default. If someone one the shady side of the street (i.e. the left) disagrees then think about the war on Irak.
About Bernanke’s support of the fiscal stimulus, I believe it was pure talk. It would have happened anyway so why pick a fight when you are trying to push your own agenda?
Alex.
7. August 2009 at 17:09
i still believe that krugman’s “are you talking to me?” response to you was meant to say that he agreed with you. but it is the talking out of two sides of his mouth – oh yeah, you did a post on that – that is hard to figure. i think he was playing dr. krugman not mr. keynes in his response to you.
7. August 2009 at 17:31
Well, according to the ABS, Australia has not had GDP (expenditure measure) at current price growth at less than 5%p.a. since 1991/92 and the quarter-to-quarter yearly increase has not been below 4% since September quarter 1992.
7. August 2009 at 17:47
sir, i appreciate your concern but i just have one query about this which is that what is if every country follows the approach of aggressive monetary policy as in by currency devaluation any country develops on cost of other`s. wont that create a impasse?
7. August 2009 at 20:05
Here’s an idea. Stop calling it a “stimulus”.
What you advocate isn’t a stimulus — it’s not Keynesian snake oil, at least if it is microeconomically operational it had better not.
If you want to sell what you have on offer to people who think of global economic order as a microeconomic and relative price coordination problem — which it is — best not package your wares in the language of Keynesian witchcraft.
8. August 2009 at 04:31
Statsguy: “As to why? There’s a tremendous amount of anti-inflation ideology.”
And rightly so.
I see people pointing out Britains supposed recovery. I’m a Brit, I live in Ireland but I’m currently back in Britain visiting. The first thing I notice is there is no sign of this supposed “deflation” of prices. Even going by Keynesian theory I see no evidence of a liquidity trap that must be tackled.
I think the state CPI statistics are lies. The UK statistics office have no real independence of government here and I think they have been told to make the indexes show deflation.
The government however are still pouring huge sums of money into quantative easing. As a result the rate of interest is very low. I invested some money yesterday, I could only get 3.5% on a one year bond. A rate which is probably about 1% or so after inflation.
This of course is the real purpose of inflationist policies. To disadvantage thrify members of society and to aid the feckless. The Labour party who current govern Britain are a left-wing party. Like other left-wing parties this is their purpose. It can only end of course in destruction of wealth, but why should they care about that?
8. August 2009 at 04:52
Jon, I agree. They did adopt what seemed like a QE program in March, but because much of their policy is passive, the reductions in the base from banks borrowing less from the Fed, basically offset the increases from the Fed buying T-bonds. Hence the base hasn’t increased this year.
Alex, You said:
“What would you tell people on the right like me (although I don’t like the right left distinction… I would rather be on the sunny side of the street) that understand your point about the effectiveness of QE but believe that the only role for the FED was to avoid the depression but not the recession. On the positive side of your analysis I’m sold but on the normative side not so much. I’m no Austrian but I still get the gut feeling that whenever the government gets their hands too much into the economy bad things happen, I don’t care if it is fiscal or monetary policy, if the president is Bush, Obama or Castro or if the Fed Chairman is Greenspan, Bernanke, Lucas or Friedman, too much government gives me a chill down my spine.”
Alex, don’t you see the contradiction there? First you say you don’t want the Fed to try to stop the recession, but then you say you are worried about big government. Let me repeat a point that I frequently make, but that people miss:
1. The way to small government: An effective monetary policy of stabilizing NGDP growth so that business cycles are mild and trend inflation is low. In addition, any debt crisis that occur would be much less severe than if accompanied by falling NGDP. Monetary policy does not make government one dollar bigger.
2. The way to big government: Follow the most regressive type of Austrian economics, those who view the recession as the solution to the previous binge. Unfortunately if we get in that bind, 90% of the public will blame the free market system. We will end up with massive fiscal stimulus and huge bailouts to banking, autos, etc.
It’s your choice. Which view do you think leads to more big government?
rob, You said,
“i still believe that krugman’s “are you talking to me?” response to you was meant to say that he agreed with you. but it is the talking out of two sides of his mouth – oh yeah, you did a post on that – that is hard to figure. i think he was playing dr. krugman not mr. keynes in his response to you.”
No, He repeated his argument that monetary policy is ineffective at zero rates. He clearly did not agree with me. You need to read his entire reply. There is no ambiguity. He even denied ever making the argument that monetary policy could be effective at zero rates.
Lorenzo, Thanks. Notice that Australia’s unemployment rate is 5.8%, which is where we’d be if we had followed NGDP targeting. I may do a short post on this. The first half of 2008 saw excessively fast NGDP growth, and 2009:Q1 was too slow, but otherwise very good.
Mehul, No, every country can depreciate their currency at the same time, and in fact should do so. Many people assume the right way to measure a currency’s value is against some other currency. But an exchange rate is just a single price. Rather what matters is the value of a currency in terms of all output prices, or all input prices. If you have all countries target inflation at 2%, then all currencies will be simultaneously depreciating against goods and services at a rate of 2% per year.
But you do raise a good question, as the sort of “depreciation” than Krugman was referring to was exchange rate depreciation. And you are right that all countries cannot do that at once.
Greg, How about “stable monetary policy” or “predictable monetary policy?”
8. August 2009 at 07:23
Scott:
Do you know why many economists call anything other than open market operations in T-bills as being “really” a sort of fiscal policy?
Also, you need to be careful to distinguish between committing to the current inflation target (2%,) switching to some really high inflation target (say, 10%) to level targetting (inflation next year should be sufficient to get the price level to where it would have been if we had maintained 2% inflation,) and finally, to targetting the growth path of nominal income–which is what we really should do!!!
I think Krugman has in mind changing the target for the inflation rate. Say, 15% per year for the next two years. That would work, Krugman might say. But it is politically impossible.
Krugman would say, that libertarian Sumner’s notion that the Fed can do any good by saying that “we will” get the price level to rise two percent next year. WE WILL. WE PROMISE. That isn’t what he has in mind at all. That would do no good.
8. August 2009 at 10:46
Alex: Scott’s response is important (bad times lead to big gov’t) but I have a simpler point to make. Given that we have a Fed, their job should be a neutral one: meet the public’s demand for money. That lets the economy sort out how to allocate among various sectors. In the past, Bernanke favored an explicit inflation target, reportedly about 2%. That would be a reasonable approach — if the Fed targets the best FORECAST for inflation, and does WHATEVER IT TAKES (open market purchases or sales) so that current expectations are in line with the forecast. Last summer and fall, they seemed to forget that they have the power to stop inflation as needed in the future. They should have TAKEN ACTION to prevent economic growth (and their moderate inflation target) from falling below the forecast.
Of course Scott would recast all of the above with NGDP instead of inflation, and that’s almost certainly a better policy. But the above would suffice, and would NOT have been a radical step for the Fed to take. It’s not an extreme counter-factual at all; it’s grounded in things that Bernanke and other members of the FOMC should know and believe.
One more point: I think the biggest hurdle for the Fed may be the dreaded “long and variable lags”. If they believed (as Scott does) that they have the power to nip inflation in the bud in the future, then they are are free to aggressively increase demand in the present. Bernanke’s “exit strategy” article in the NYT would have been perfect — if it was the prelude to aggressive new actions. As is, it’s a sad reminder that the Fed is largely sitting on its hands, leaving millions out of work.
9. August 2009 at 05:22
Bill, You need to distinguish between what sort of inflation expectations Krugman thinks the Fed is capable of getting, and the completely separate issue of what would happen if they succeeded in getting those inflation expectations.
1. Krugman seemed to say that high inflation expectations were needed for a recovery. That is false. If he wants to say “If the Fed tried for 2% inflation expectations we’d end up with only 1%” then we could debate that issue. I still think he’d be wrong, but we could have a debate. As far as I can see though he is not making that argument, rather he is making the statement that high inflation expectations are needed. One reason I am pretty sure about this is that when he does say this, he often cites “Taylor rule” studies that clearly claim that a high expected inflation rate is needed to get the required real interest rates.
As for whether the Fed would be believed, I think with price level targeting they would. I don’t recall any examples in all of world history of a central bank promising inflation and not being believed. Why does Krugman assume they wouldn’t be believed? (If he is in fact making that assumption, and I have no evidence he is.)
Yes, NGDP is the right way to look at this issue, but let’s be honest here. Inflation expectations over the next couple years are near 0%. To get up to 2% you’d need very fast expected NGDP growth. So one implies the other in the current environment of 9.4% unemployment.
TTF, Thanks, I agree.