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.