Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 27 November 2014

Understanding Anti-Keynesians

Paul Krugman says Keynes is slowly winning. Tyler Cowen says no, there is lots of evidence Keynes is still losing. If this strikes you as slightly juvenile, I don’t blame you. Squabbling over the relevance of some guy who died nearly 70 years ago does make the academic discipline of macroeconomics seem rather pathetic.

Now, as you probably know, I’m not a neutral bystander in this debate. However I have always thought it important to try and understand where the other side is coming from. Leaving aside the debating points, what deep down is the core of the other side’s beliefs? But before addressing that, we need to be clear what we are arguing about. Let me single out three Keynesian propositions.

1)    Aggregate demand matters, at least in the short term and in some circumstances (see 2) maybe longer.
2)    There is such a thing as a liquidity trap, or equivalently the fact that there is a zero lower bound to nominal interest rates matters
3)    At least some forms of fiscal policy changes will impact on aggregate demand, and therefore (given 1), on output and employment. Because the liquidity trap matters, when interest rates are at their zero lower bound we should use fiscal policy as a stimulus tool, and we should not embark on fiscal austerity unless we have no other choice.

If propositions (1) and (2) strike you as self evidently correct, you might accuse me of drawing the lines in this debate in a biased way. I would of course agree that they are correct, but I would also note that there are large numbers of academic macroeconomists (don’t ask me how many) who dispute one or both of these ideas. Tyler Cowen in the post cited above talks about a ‘so-called’ liquidity trap in the context of the UK.

Many macroeconomists - particularly those involved in analysing monetary policy - did think as recently as ten years ago that there was a broad academic consensus behind both (1) and (2). I was one of them. There was talk of the new neoclassical synthesis (pdf). This idea that there was such a consensus fell apart when a number of prominent academics objected to governments using fiscal stimulus in 2009.

This suggests (3) is at the heart of the dispute. However my reason for including (1) and (2) is that if you accept these two points, point (3) follows pretty automatically. I was careful in formulating (3) not to claim that fiscal policy should become the only or main stimulus tool: exactly what role it should play alongside Quantitative Easing or other forms of ‘unconventional’ monetary policy - including those analysed by Keynesian macroeconomists - remains unclear and can be reasonably debated. As I have noted before, the two sides are not symmetrical on this point: while most Keynesians are happy for central banks to undertake various forms of unconventional monetary policy, the aversion on the other side to using fiscal policy seems more absolute.

It is here that I have a difficulty. It seems to me in a mature, ideology free science we would be discussing - when in a liquidity trap - the relative merits of alternative forms of monetary and fiscal stimulus. It would also be generally agreed that, given the uncertainties involved with all forms of unconventional monetary policy, now was not the time to undertake austerity. But that is not the discussion we are having. Why not?

An easy answer is that it is all political or ideological. Just as politicians can use fears about debt as a means of reducing the size of the state, so antagonism against fiscal stimulus comes from the same source, or an ideological aversion to state intervention. That in my view would be a sad conclusion to draw, but it may be naive to pretend otherwise. As Mark Thoma often says, the problem is with macroeconomists rather than macroeconomics.

I can think of two alternative explanations that might at least apply to some anti-Keynesians. The first comes from thinking about the importance of money to macroeconomics. Money is very important, and indeed you could reasonably argue that the existence of money is critical to point (1) above. The mistake - in my view - is to therefore feel that monetary policy has to be the right way to stabilise the economy. It makes you want to believe that (2) is not true. This seems to me to have nothing to do with ideology.

The second is historical. I suspect we would not even think of questioning the central role of Keynesian ideas for macroeconomics today if it had not been for the New Classical revolution in the 1970/80s. This revolution was successful in the sense that it did change the way academic macroeconomics was done (microfoundations and DSGE models). Most academic macroeconomists - for better or worse - are deeply committed to that change. But the revolution was opposed by many in the Keynesian consensus of that time, and so Keynesian economics became associated with the old fashioned way of doing things. This association was encouraged by many of the key revolutionaries themselves. We now know, as a result of the development of New Keynesian economics, that there is no necessary incompatibility between the microfoundations approach and Keynesian ideas. However I suspect that, at least for some, the association of fiscal policy with old-fashioned Keynesian ideas set down deep roots. It certainly seems that some notable academics were surprised that New Keynesian models actually provided strong support for the use of countercyclical fiscal policy in a liquidity trap.

I should really stop there, but having started with Tyler Cowen’s post, I really should say something about his comments on the UK. The basic facts are very simple. We had significant fiscal contraction in financial years 2010/11 and 2011/12, which then stopped or at least slowed significantly. The UK recovery was erratic from 2010 to 2012, and only reached a steady pace in 2013. That is entirely consistent with the importance of fiscal policy in a liquidity trap. (The OBR calculate that austerity reduced GDP growth by 1% in 2010/11, and by 1% in 2011/12, with little impact thereafter.) Quite why the obvious fact that other things besides fiscal policy are important in explaining growth in any year is thought to be an anti-Keynesian point I cannot see. And if the case against Keynesian ideas rests on the incorrect forecast once made by a prominent Keynesian then this is really scraping the barrel. 

60 comments:

  1. How much of past academic papers would be rendered void if a Keynesian stimulus would be tried in a liquidity trapped country today and succeeded? Would it do serious damage to some academic economists of long standing?

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    1. 0; we had a Keynesian stim in China and the US; and see how terribly those two countries are doing in comparison with those bastions of rectitude the PIIGS.

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    2. @rob sol. What you had in the US was fracking, which came from nearly nothing in 2007 to making soon the US energy independent.

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    3. I think Obama-care had a much bigger impact than fracking. Those medical insurance subsidies sure add up, and there are a lot more people paying for health care these days.

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    4. i do not deny that fracking was valuable, but the us economy very quickly went from recession to growth; i do not doubt that fracking helped, but the change was very quick; too quick, i think to be explained by one year's change in fracking.

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    5. deniers will always come up with some single-word excuse, yesterday it was called hyperinflation, today it's called fracking, tomorrow it will be called something else, what a sad bunch.

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    6. to be fair; there is no such thing as a perfect expriement in economics.

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  2. Keynes is shorthand for the fundamental debates about macroeconomics and government policy. Overall I agree with Krugman and Wren-Lewis and strongly disagree with Cowen.

    However I think about aggregate demand management slightly differently than how it is traditionally presented. The liquidity trap is more of a political line than an economic one. Government spending and fiscal policy works and should be used above the zero lower bound. A reliance on monetary policy only above the ZLB makes the economy more unequal, volatile and prone to crisis.

    However, if fiscal policy is being blocked as it is in the U.S. by a Republican Congress, monetary policy becomes very important and the only game in town (besides currency policy). Even at the zero lower bound, the central bank can resort to QE and target longer term rates and mortgage rates. Japan is doing this now and the EU appears about to take the plunge.

    So in that sense the liquidity trap doesn't matter. Economically, fiscal policy becomes more effective and politically QE is harder to do than conventional policy. The Federal Reserve was tentative in approach to QE and ended it as soon as possible given that it was controversial. It has arbitrarily been decided that monetary policy should only be done by short term rates and that fiscal policy shouldn't be used above the zero lower bound. Those are politically motivated conventions. And we saw what those conventions led to: the housing bubble and financial panic.

    It could be that austerity in the U.S. didn't bite as hard because QE was more successful than widely considered or the private economy was stronger than expected. Likewise it could be that the original Obama stimulus wasn't as successful as hoped because it wasn't large enough or maybe it was big enough in that it allowed the economy to overcome the later austerity. Cowen is dishonest in that he doesn't consider these possibilities. As Thoma says, the problem is with the macroeconomists.

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  3. Aren't anti-Keynesians also arguing against what it said in the Bible, where I believe it was Daniel who advised Pharoah to keep one seventh of his crop in storage for each year of plenty so there would still be some in times of need? Sounds pretty Keynesian to me... and ironic that so many of today's anti-Keynesians are Bible bashing Tea Party supporters with a visceral fear of paying tax.

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    1. Ironically, tax cuts can be Keynesian. The Obama stimulus contained many tax cuts, like the payroll tax cuts.

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  4. Economics is not as precise as the natural sciences. Hence, results are never 100% clear. You can always find some far-fetched reason why XYZ might be true in this case, but not in the other. I think that makes economists very sure of themselves, more so than natural scientists. For physicists or mathematicians, self-esteem does not help in supporting their results, it's either right or wrong. But economists often add their personal convictions to their research. After all, that's why there are economic schools. There are no schools in physics or mathematics. And there is another problem: the close relation of economics to politics, another area where personal convictions play a huge role.
    That's why economics is infused with tribalism. Admitting that there might be something to Keynesianism is like acknowledging defeat of the own team, and of oneself.
    Unfortunately, Conservatism is very much all or nothing, probably because the rejection of change that is the defintion of conservatism, leads to an idealization of a certain time, either the present or a 'Golden Age', the Empire, the Thatcher years, the Reagan years, Eisenhower's 50s or something like that. Then there's the manichean world-view that goes along with strong religious beliefs. That leads to the bunker mentality of conservatism, any deviation from the ideal, even compromise, is heresy. I think it wasn't always this way. But since the conservative revival of Thatcher/Reagan, conservatism as a political ideology thinks itself ready for a complete takeover again. It's no coincidence that this conservative revival happened both in politics and economics. To some degree, the same people are responsible. Anyway, there will be no economic consensus for quite a while.

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    1. I suppose some might say you should have added balance with a hippie punch or two. But IMHO this is exactly right.

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    2. In fact, theoretical models in physics or biology are by no means truer than those found in economics. In both cases, theories are working hypotheses -- you can, given appropriate data, refute an hypothesis, but you can't accept it because it's a fallacy called claiming the consequent.

      In truth, you never know how the world really works. I can wear a coat because it's cold, but also because it rains and that simple faft explains the above. Proponents of austerity made clear predictions and they failed to hold: their model is wrong. There is no discussion to have on this, it follows from a logical law. However, so far, neokeynesian economists got things right. I can't say their model is the true model of reality, but I can say evidence so far support something very similar to their model. People like Wren-Lewis have what we could say is our best knowledge. If we don't use that knowledge, we're stupid.

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  5. OK, 1 and 2 are positive, while 3 is normative. Some of us think that matters. As to 3's normative claim, why should, and should not, we? Does everyone benefit? In all circumstances in all countries? Is it based on a utilitarian calculus? etc. etc.

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    1. It is based on normative propositions that appear trivially true. Like its a good idea to try and reduce the extent of a demand deficient recession. Like increasing public spending of some kind - even if its simply bringing forward public investment - can make a contribution to that. Can you give me an example where that will not be true?

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    2. In the Eurozone context, the question is whether states that have very big public debts/deficits (France and Italy) should continue to make them bigger, ie use fiscal policy as stimulus. That countries like Germany who has got maneuver margins should do fiscal stimulus is approximately obvious. But is it true for France?

      In other words, you write "we should not embark on fiscal austerity unless we have no other choice." Has France another choice? (As an aside, do you describe French budget as austere?)

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    3. The problem, and the argument against 3, is that it's not easy to "simply bring forward public investment". Yes, here in the US there are a lot of roads and bridges that could be repaired and refurbished. But there are only so many construction workers available at any one time, and the requisite civil engineering, planning, etc., cannot magically happen over night. On top of that you have to factor in time for environmental and other regulatory reviews. Plus, what's to stop political forces from steering all the money to some districts leaving other districts with nothing (and no stimulus)? I guess my point is that it's just very naive to think that government spending can (effectively) be increased overnight or even in a matter of months or quarters. The government is good at wasting money, but spending it on valuable projects with net-positive rates of social return is much more dicey.

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    4. Anonymous@9:49 is really citing a problem of political will, as all of the issues mentioned have legislative solutions that have been solved before, and indeed were solved repeatedly in the past when political will was .

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    5. lfig, your characterization of the tradeoffs is a little too simple, IMHO. After years of stagnation, the downturn found Germany in a relatively favourable situation, with therefore much less of a need for government intervention (if at all), the case for Germany to go for fiscal stimulus is not based on a defense of German interest, but based on a defense of the interests of the rest of the eurozone, esp. Greece, Spain, Portugal, Ireland, Italy. Much of the benefits of a German fiscal stimulus will spill over, so from a purely German point of view, there is no slam-dunk case in favour of it. However, as the rest of eurozone will sink into fascism and islamism, Germany will eventually discover that that spillover could have bought it political stability and that its narrow-mindedness gave it a blowup of the eurozone (hypothetical situation I give a 30% odds, if I were in charge I'd break up the eurozone into two parts, with France leading the south and Germany the north, and bribe super Mario into joining the south). Lastly, the case for a fiscal stimulus in countries like France is that there is no tradeoff: damned if you do, damned if you don't: fiscal austerity leads to deficits and debt anyway, arguably to a similar degree as fiscal stimulus (or so says a report of the IMF). If you disagree leave it there, I'm only expressing my views not trying to convert anyone to them. Cheers.

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    6. Perhaps it is best to have a job guarantee program and keep infrastructure spending long term.

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  6. I would be quite suspicious of Cowen's views on anything as compared to, say, a Williamson. Cown's job at both JMU and the Mercatus center are tied closely to Koch funding. Hell, he heads the center. He is not a macroeconomist and basically trolls the Keynesianview by looking for papers and casual empirical relationships that appear to support his paid-for positions. Unlike Krugman and Williamson there is hardly any there there. He'll glom on to tbis or that paper as evidence regularly mischaracterizing the structure and results before moving on to his recommendations for the best restaurants in Fargo. It would all be in good fun until you step back and realize that he is the Koch's public intellectual point man and his agenda ain't finding the truth. He's worth every penny by the way.

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    1. Tyler Cowen is the academic equivalent of David Brooks.

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    2. Sorry I've just realised I'm talking absolute shite! Ignore me...

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    3. don't disagree with you, buts its GMU not JMU.

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  7. Japan just had another "surprise" recession after 25-years' Keynesian proactive fiscal policies with the nose bleeding level of public debts. EU is following Japan to have its first lost decade.

    That is all because there is a hidden ugly side of Keynesian proactive fiscal policies of "stealing money" from the future generation.

    Stealing is never good. Therefore, no generational theft should be the equilibrium (or optimal) government fiscal policy.

    http://ssrn.com/abstract=2519730
    Or http://mpra.ub.uni-muenchen.de/59712/
    Or http://econpapers.repec.org/paper/pramprapa/59712.htm

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    1. Except that "stealing" and Keynesian policy is what happened in the transition from the Great Depression into the social democratic Golden Age of capitalism. It was a boon for future generations. Once the rightwing got a hold of policy it's been downhill ever since.

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    2. Actually, Japan never had consistent Keynesian fiscal policy. Any demand to "balance" policy with increase in VAT is anti-Keynesian. Look at their new measures. They started a bit towards moving from liquidity trap, they rose VAT, they fell into depression.
      True Keynesian policy is this: run balanced budget. When recession starts, expand budget. When recovery is firm, run surplus, to reduce and eliminate debt. Run balanced budget until the next recession.

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    3. Strange sort of depression-

      http://www.tradingeconomics.com/japan/unemployment-rate

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    4. Unemployment is a trailing indicator and in any case doesn't define a recession; that would be GDP growth rate which for the last 2 quarters has been negative.

      http://www.tradingeconomics.com/japan/gdp-growth

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    5. Peter: even generational thefts sometimes do work out for both current voters and the future generation. We see that plays out often in our daily lives with regular thefts: both the theft and the victim do well financially afterwards. For example, if somebody steals a car from a billionaire, both the theft and the billionaire could still do well financially afterwards. However, it does not mean that stealing is a good thing. In order to justify the generational thefts, one has to prove that the generational thefts are good for both current voters and the future generations in most cases. Empirically, generational thefts in Japan and EU are very bad for the future generation.

      Running a balanced budget through a business cycle is an interesting idea only on paper. It is nearly impossible to implement in reality. It requires the steal-like determination and discipline of the current voters and the political leaders. Also it is highly unsymmetrical between consumption and saving: it is easy to spend the money for current consumptions, and it is extremely painful to cut back to save the same amount money. For example, an person can spend his or her own lifetime savings away easily, and nearly impossible to earn back the lifetime savings. These are two reasons why you rarely observed the balanced budget through a business cycle in the real world.

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  8. It's like driving a car. Monetary policy is the brake pedal. It allows you to increase or decrease friction. Fiscal policy is the accelerator pedal. It allows you to increase or decrease the energy input. In ordinary circumstances, you can speed up or slow down using either. Tap the brakes, release them. Tap the accelerator, let up on it. However, if you want to get the car rolling, it really helps to use the accelerator pedal, unless you are on top of a hill.

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  9. I would say that it is not like driving a car. With a car, people are generally sure that some acceleration can lead to the car moving by itself if the car is just about to reach the top of a hill.

    With economics, the existence of any snowball effect is far from clear, as shown by the troubled history of countries which have tried stimulus. In mathematics, the lack of evidence for a proposition is reason enough to doubt it. In economics, however, it seems that the same rule does not apply.

    I would want economists to make real testable predictions about the future before concluding in favour of Keynes

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    1. Which countries have tried stimulus and failed?

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  10. As someone supportive of the market monetarist line, I will add a few more reasons why we follow this approach.

    The first is that interest rates are epiphenomenal, really useful (if uneven) indicators of policy but not actually involved in the demand transmission mechanism. Even when raising or lowering interest rates dring normalcy, central banks are actually announcing an intention to raise or lower interests, which they then achieve by adjusting the money supply. This means that there isn't a fundamental difference between QE and normal monetary policy. Its the same mechanism Its just looks a bit weird in periods of low growth and low real interest rates. The zero-lower bound is scary but doesn't have any real effect on policy.

    The second, related to this point is that (broadly rational) expectations matter. In fact, expectations are the main mechanism through which the central bank can influence the real economy. This means that fiscal stimulus (to be paid out of taxes or higher borrowing in the future) is, all other things equal, less effective than increasing the money supply.

    I acknowledge that in extreme circumstances, monetary and fiscal policy tend to blend together. Is a helicopter drop monetary or fiscal, for example? But the important thing is increasing the money supply which you can achieve directly without that much fancy fiscal footwork. Now perhaps it would be 'nicer' if market monetarists were a bit more ambivalent on fiscal vs monetary stimulus, more willing to split the difference.

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  11. "The first comes from thinking about the importance of money to macroeconomics. Money is very important, and indeed you could reasonably argue that the existence of money is critical to point (1) above. The mistake - in my view - is to therefore feel that monetary policy has to be the right way to stabilise the economy. It makes you want to believe that (2) is not true. This seems to me to have nothing to do with ideology."

    Yep. Good post, because that's me to a T. An excess demand for the medium of exchange is at the root of all recessions, and problems should be solved at their roots.

    It took me some time to get my head around "Quantitative Easing". Until I realised that it is not "unconventional" monetary policy at all. It is just good old-fashioned Open Market Operations, under a silly new name. Central banks have (almost?) always had government bonds on the asset side of their balance sheets. How did they get there? They bought them, which is Open Market Operations!

    And if a central bank is expected to have a much smaller balance sheet in future than it has at present, that will cause nominal interest rates on government bonds to fall to 0%. So you can always change monetary policy to change those expectations.

    But I agree with you that cutting G and/or increasing T in a recession is usually bad policy, and increasing G (in particular government investments) is *usually* good policy. But it isn't needed. And the whole question would be moot if monetary policy were done right, because there wouldn't be any recessions!

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    1. "And the whole question would be moot if monetary policy were done right, because there wouldn't be any recessions!"

      By which Nick Rowe obviously doesn't mean problems due to supply-side shocks like oil price spikes/rapid falls.

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    2. W Peden: well, for example a drought in an agricultural economy would cause a drop in output, but I wouldn't call it a "recession" unless we also saw excess supplies of goods/labour etc all over the place. Which shouldn't happen, if monetary policy responds correctly.

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    3. Nick, you and Scott Sumner have convinced me that monetary policy can be effective at the zero lower bound. I no longer disagree on this point. If monetary policy were done right, there wouldn't be any recessions. That has finally gotten through my thick skull. However, the problem is, it doesn't seem to be done right very often. Recessions do exist and they exist all around the world right now.

      Focusing just on the U.S. case (I am a Merikan after all), should we just sit around waiting for the Fed to figure it out, or should we take advantage of the low rates and go out and rebuild the bridges falling down all over the place?
      Scott has replied to that question with a resounding, no, because the Fed will just offset it. I think, so what if they do, we end up right where we started but with bridges that are no longer falling down, and that were built with loans as cheap as we could ever hope to get. If they don't (or can't completely) offset it, then we are better off for doing it.

      I guess I am just frustrated by market monetarists unwillingness to accept any role for fiscal policy at all. They act as if there are no public goods out there and that all government expenditures are wasteful, in spite of the fact that there are bridges all over the country (now i am focusing on bridges to make a point but there are many other examples) suggesting otherwise.

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    4. Student: I drove 3,000kms across Canada in June. It seemed like (I probably exaggerate) every second bridge was being repaired/replaced. It pleased me, simply on standard micro cost-benefit grounds, given the very low real interest rates. (Despite my having to do a 600kms detour when one bridge slipped and blocked the road). I don't think Scott would disagree in principle.

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    5. "should we just sit around waiting for the Fed to figure it out, or should we take advantage of the low rates and go out and rebuild the bridges falling down all over the place?
      Scott has replied to that question with a resounding, no, because the Fed will just offset it. I think, so what if they do, we end up right where we started but with bridges that are no longer falling down, and that were built with loans as cheap as we could ever hope to get."

      There's another things would be different from when we started: interest rates would be higher. That would be a good thing given our current situation. If enough fiscal stimulus was done and the fed offset it enough, we would not only be in a place where Scott Sumner and Nick Rowe argue and insist that monetary policy *could* work if only the Fed really did it right finally, we would be in a situation where monetary policy *has* worked in the past, and the Fed has proven politically capable of acting. That would be a better place to be as I see it.

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  12. Keynesian ideas were developed based upon the assumption of growth. To what extend do aging and shrinking populations, and changing consumer behavior, in some countries change economic theory?

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    1. It is all relative...
      Germany is thought to loose about 35 % of worforce 20-65 years over the next 50 years, the whole population reducing 25% - 80 millions to 60 millions.
      So, no growth possible?
      Wait: this is a 0,23% yearly reduction of the workforce in relative numbers. And technology brought us much more growth than that, at least the last centuries.
      So, growth per capita is to be awaited. In Germany.
      And it is what matters, correct?

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    2. Thanks for the reply. What about changing consumer behavior of aging population? Do they save more and spend less? That seems to be the case for Japan for example. You can lead a horse to water, but you can't make it drink.
      Doesn't this change economics?

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  13. "Tyler Cowen says no, there is lots of evidence Keynes is still losing. If this strikes you as slightly juvenile, I don’t blame you. Squabbling over the relevance of some guy who died nearly 70 years ago does make the academic discipline of macroeconomics seem rather pathetic."

    Your remark is even more juvenile. And it says a lot about education in economics. You clearly have not studied something like political philosophy, or political science or political philosophy.

    Many debates go back a long way and were framed by very key thinkers. That is one reason people must read the classics of their disciplines before they proceed any further.

    It is very likely they will be debating Keynes vs Smith vs Marx 70 years from now.

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    1. "It is very likely they will be debating Keynes vs Smith vs Marx 70 years from now.'

      And almost surely rational expectations, RBC and New Keynesianism would have been forgotten, only traceable to an historian investigating intellectual delusion during the target period.

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  14. I really appreciated the author’s bent as I selected this article from the blogosphere. Many of our “impenetrable” problems are due to the frailty of our egos which prevent us from yearning to understand the other point of view, thus preventing the quid pro quo between various interests needed for progress. Although I enjoyed the author’s selection and discussion of three foundations of Keynesianism, I was remiss that the core belief of my personal anti-Keynesian bias was not addressed.

    I do not disagree that under the right macro-economic circumstances that (1), (2), and (3) hold, my issue is with whether or not they hold given every set of economic circumstances. During the rapid growth period experienced during much of the twentieth century; when both population and productivity growth were probably unparalleled in human history, the economic model so eloquently put forth by Keynes had obvious merit. My reluctance to accept that model is quintessential given the world’s current circumstances lies in my belief that absent a productivity miracle equivalent to say, harnessing the human productivity equivalent contained within a gallon of gasoline and/or dramatic rates of increase in the number of “young adults” who demand the goods and services produced by our global economy, the end game of Keynesian economics will be only to further extend the current golden age of debt deeper and deeper into what would be future demand until as in the author’s (3); the game is no longer possible.

    Keynes put forth what proved to be a useful economic model during a strong global growth phase. Is it equally valid during a period characterized by demographic and technological circumstances especially in the west which serve to stagnate employment and wage growth while the threat of unfunded retirement liabilities looms? Will QE and significant government deficit spending, were it to be reapplied in the US for example, spark the long term growth in global GDP for which we all yearn today? My fear is that QE and stimulative government spending in today’s economic backdrop are likely to lead primarily to further misallocation of capital by both companies and governments.

    Is it better to postpone inevitable pain as long as possible through generous application of Keynesian economic tenets, or to unleash the market forces effectively dampened by the strong hand applied by governments attempting to “manage” their economies through every downturn so as to minimize any pain to the entities that represent the biggest threat to the political class? And finally, is the pain that would result from a rebuke of Keynes a necessary prerequisite to the next wave of real economic progress? These are the questions I hoped would be discussed in this otherwise useful and very well written article.

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    1. It seems then that the biggest difference between Keynesians and Anti-Keynesians is about whether the degree of pain is inevitable or not. Keynesians seek not to put off the pain, but to reduce it as much as possible. Anti-Keynesians seem to think that because it is inevitable that there is going to be pain, that we should just accept it as it comes, regardless of the human impact, and despite the fact that we have plenty of tools that can blunt the pain.

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  15. Nick, I don't understand. If people don't want to borrow from the banks at2% interest, the government can use monetary policy to induce the banks to lend at 1%. But if people don't want to borrow at 0% interest, how does swapping bank holdings of debt for bank holdings of cash change the situation? What induces people to borrow is surely their expectations of the future state of the economy based on their current experience of the economy. What is going to kick start the cycle of optimism among borrowers? Something - like fiscal policy, or a literal helicopter drop - surely has to increase their incomes?

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    1. How does swapping debt for cash change the situation? Debt holders have been induced by overpayment to part with an asset they were happy to hold at pre-QE prices. They go out and rejig their portfolios, which may involve spending on consumption and assets, "exciting" as Hume put it, a bit of extra economic activity. To the extent that they leave some of their increased wealth on deposit, banks also rejig their portfolios, which may involve some additional lending. Trouble is, that this is a sugar rush only. It fades when the rejigging is done. As has been known for centuries, monetary stimulus can only boost economic activity for months. And that is without allowing for some Ricardian equivalence effect, in which the fact that the state over-paid for some assets is going to impose costs on the public.

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  16. that there is no necessary incompatibility between the microfoundations approach and Keynesian ideas. "

    Wrong. Keynes opposed classical micro-foundations and "submission to market idols". This is not a trivial matter. It involves fundamental assumptions about human behaviour and social interaction. New Keynesian economics might get Keynesian results, but it is not the view of the world that Keynes had. Very likely it is also not the view of the world many in a civilised society have.

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  17. Do we ever get to stop pretending that Tyler Cowen is a serious person and not an ideologue?

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  18. "The UK recovery was erratic from 2010 to 2012"

    Erratic, perhaps, but in nominal terms it was not particularly slow on average. If we think in the AD/AS paradigm, there was a problem with AS, and perhaps a problem with the regularity of AD, but not a big problem with the general level of AD. Now you can argue that that is the wrong paradigm, or that there were obvious temporary AS problems that policy should have offset with stronger AD and weren't because of the fiscal tightening. But in any case it isn't straightforward that the fiscal tightening weakened AD.

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  19. "There is such a thing as a liquidity trap, or equivalently the fact that there is a zero lower bound to nominal interest rates matters" - but pace the EU central bank, which is offering negative interest rates, at least between central banks. But negative interest rates could be offered to retail accounts too, and most savers would accept them, since it is inconvenient to keep money in a safe deposit box or under a mattress. - Ray Lopez (a loyal reader of Marginal Revolution!)

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    1. You are still pushing on a string when there is no effective demand for money to invest because the enterprise requires sufficient C,I , G or X-M demand

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  20. Just thought I'd point out that much of this goes back to the over-simple concepts that the classical economists had about markets. In the first place, they mostly worried about micro-economics feeling, somewhat correctly for that time, that if markets were allowed more freedom and trade was also freed that nations would benefit as a whole. Of course the history of the social aspects of laissez-faire should be damning enough but apparently some purists don't want to modify their views. So basically, the idea that governments can do anything positive in economics is antithetical to that mindset. If you are forced to concede that monetary policy must be conducted then the least is the best and heaven forbid that a government would use fiscal policy. I was dragooned into reading Capitalism and Freedom as a summer reading assignment in college. The ideas are often terribly naive, incorrectly formulated and ridiculous against modern reality. However, they are loved by those that like very clean and basic ideas. It's sort of like not wanting to concede Newtonian Physics is the end of all progress, but with the very serious failure that economies are social constructs and what might have been true for a special case in the Eighteen Century is not true now.

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  21. As we can see in a variety of disciplines (CO2, evolution, economics), for one side, evidence and reason does not matter; faith is all important.

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  22. This doesn’t much respond to Cowen. But I like the effort to clarify the dispute. That’s hard to do, since whereas Keynesians all accept Keynesian theory and policy prescriptions for more or less the same reasons, anti-Keynesians reject them for a wide variety of reasons.

    This post’s argument, for fiscal stimulus when rates are near zero, is a very particular argument, and yet still I think a confusingly broad one, as so much is unspecified: the unemployment rate, the trend in the unemployment rate, the economic growth rate, the population growth rate.

    Currently most advanced economies have interest rates near zero, but other parameters vary widely. Japan has low economic growth, negative population growth and stable, full employment. The Euro Area has near-zero economic and population growth and high unemployment that’s coming down very slowly. The US and UK have moderate economic growth and population growth and moderate unemployment that’s approaching full.

    For each of these cases the debate is different. In Japan and the UK the debate is over whether consolidation is needed. In the Euro Area the argument is over whether the stronger economies need stimulus, and whether it’s economically or politically desirable for stronger economies to fund stimulus elsewhere. In the US the debate is coulda woulda shoulda – the time for stimulus has passed, but Keynesians still chide us with claims that recovery and long-term growth would have been better had more stimulus been applied.

    The point is, the world is complicated, and the simple case for fiscal stimulus laid out above rarely applies. Why stimulate if there’s no obvious slack, or if slack is disappearing at an acceptable pace, or if growth-per-capita rates are not obviously below potential? Near zero rates and inflation appear to me to be an inevitable feature of advanced economies with low working-age population growth. I think it’s just a matter of time before society accepts that. That doesn’t have anything to do with my opinions about the use of fiscal stimulus during recessions.

    But let’s clear off the complications of the real world and address the simplest, most ideal case where the three tenets laid out in this post would obviously point towards a need for stimulus. Take a country with high unemployment, near zero to mediocre growth rates, and moderate population growth. What could anti-Keynesians have against stimulus then?

    Many things:

    Aggregate demand is just aggregate supply, plus or minus inventories and the current account balance. To say the economy has deficient demand is to say that it has deficient supply.

    To say that demand and supply are deficient in the aggregate is not helpful. You need to say what exactly is deficient. Were demand for and the newly produced supply of homes deficient in Spain in the wake of its property bubble collapse? If you were forced to try to seriously think through what exactly is deficiently demanded and supplied, you might become skeptical about the government’s capacity for making such decisions.

    What makes investments worthwhile is that they produce long-term value. Making a lot of ad-hoc public investment decisions every time the cycle turns down is not likely to improve the soundness of those investments.

    Regardless of the current level of slack, it is never true that 12x investment is inherently better than 10x investment. It always depends on whether that extra 2x is invested well.

    For the same reason that we prefer capitalism to socialism, we should prefer private investment over public investment wherever private investment is workable. The debate over which investments should be public should be undertaken with a long-term perspective and should not be hijacked by the cycle.

    I’ll leave it at that since I have no objection to using deficit-spending to smooth consumption spending, which I think should be mainly done through a strong safety net, including providing retraining and temporary employment geared towards sustaining and improving people’s employability.

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    1. Agreed. We need long term infrastructure spending.

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  23. I think expansionary austerity is possible if we replace taxes that have high dead weight loss with a Land Value Tax and do things like legalise drugs that reduce the deficit and help the economy, combine with cuts to spending with low fiscal multipliers.
    Combine this with agressive helicopter drops targeted at paying down household debt and import substitution policies.
    This is what the coalition government should have done in 2010.
    What do you think Simon?

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