Arnold Kling  

Consensus Macroeconomics?

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Milton Friedman describes the consensus in macroeconomics as having moved in his direction.

That Keynesian vision was thoroughly discredited by experience in the '70s and '80s. It has since been replaced by what has become known as New Keynesian Economics, which incorporates some key quantity theory (monetarist) propositions: that inflation is always and everywhere a monetary phenomenon; that monetary policy has important effects on real magnitudes in the short run but no important effects in the long run (the long run Phillips curve is vertical), the crucial function of a central bank is to produce price stability, interpreted as a low and relatively steady recorded rate of inflation.

By the same token, Friedman is willing to concede that the velocity of money is not constant.

The improvement in [policy] performance is all the more remarkable because velocity behaved atypically, rising sharply from 1990 to 1997 and then declining sharply -- a veritable bubble in velocity. Chart 2 shows what happened. Velocity peaked in 1997 at nearly 20% above its trend value and then fell sharply, returning to its trend value in the second quarter of 2003.
...During the rise in velocity from 1988 to 1997, the Fed kept monetary growth down to 3.2% a year; during the subsequent decline in velocity, it boosted monetary growth to 7.5% a year.

This note by Paul Krugman seems to reinforce Friedman's characterization of the macroeconomic consensus. See also this earlier piece.

For Discussion. Krugman and Friedman would agree that monetary and fiscal policy do not permanently affect output and employment. They would agree that the inflation rate is an important indicator for monetary policy, and that velocity may be unstable. But when Friedman says that "the crucial function of a central bank is to produce price stability," would New Keynesians like Krugman agree?

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CATEGORIES: Monetary Policy

COMMENTS (2 to date)
Barry Ritholtz writes:

Of course not -- Keynesians (both new and old alike) recognize that while full employment is not possible, the closer an economy comes to it the better, and that government policies can help move it in that direction.

Hence, deficit spending thus morphed from a sin to a sacrement in Keynes' (and Krugman's) World during economic downturns.

Based upon this, the K's would not agree (not by any remote stretch of the imagination) that the "crucial function of a central bank is to produce price stability;"

Rather, they would argue that the crucial function of central banks is to smooth out and soften the hardship of the business cycle, increasing consumption when the economy gets too weak. That is why Keynes so strongly advocated public works programs during the Depression, and why later Keynesians opposed a balanced budget amendment for the national government -- the budget runs a deficit at exactly when extra stimulus is most needed.

The more interesting question to me is this: Has the Fed done a good job, by either Keynesian or Monetarist measures? The short answer is no -- despite AG being knighted, they've made a botch of it. That's an entirely different discussion which requires much more space and time . . .

Eric Krieg writes:

FYI, National Review magazine has an article in the latest issue concerning Freidman and his mea culpa concerning a steady expansion of the money supply.

Alls I know is that the definition of "money" these days is so vaugue that controlling it is almost impossible. To me, Greenspan's job seems impossible.

Add to the fact that he is supposed to control both inflation AND the unemployment rate, and it seems doubly impossible. It would seem to simplify things a bit to target a certain inflation rate, say 2% per year, and let unemployment take care of itself.

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