Arnold Kling

Keynesians and Monetarists

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I turn out to be more Keynesian than Brad DeLong, at least in an old-fashioned sense. In a long and interesting post, Brad DeLong finds little difference between new Keynesians and monetarists. The former he describes as believing in five propositions.


--The key to understanding real fluctuations in employment and output is to understand the process by which business cycle-frequency shocks to nominal income and spending are divided into changes in real spending and changes in the price level.

-- Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy.

--Business cycle fluctuations in production are best analyzed from a starting point that sees them as fluctuations around the sustainable long-run trend (rather than as declines below some sustainable potential output level).

--The right way to analyze macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyze each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.

-- Any sound approach to stabilization policy must recognize the limits of stabilization policy—the long lags and low multipliers associated with fiscal policy; the long and variable lags and uncertain magnitude of the effects of monetary policy.


I don't much care for the third proposition, that business cycles are fluctuations around trend. It says that sometimes we have excess capacity, and sometimes we overtax capacity, but on average we get it right. I do not believe that. I believe the contrary proposition, which is that the economy is either at or near capacity, or below capacity.

If you really believe that the fluctuations around the long-term trend are roughly symmetric, then why should government bother about them? Recession? Don't worry, be happy. We'll be fluctuating to boom soon enough. Sorry, if that's what new Keynesians believe, then call me an old Keynesian.

It's the belief in symmetric fluctuations that drives the focus on policy rules rather than policy events. So I'm not a new Keynesian on that issue either. I am just fine with thinking about recessions as individual episodes requiring idiosyncratic policy responses.

I'm also not buying that monetary policy is clearly more useful than fiscal policy for stabilization. I would have to see a much stronger link between monetary policy and long-term interest rates to join that chorus.

I do believe that as the economy has become more complex, its ability to cope with recessions depends relatively more on private sector behavior, and traditional fiscal and monetary policy are less reliably effective. See Would Keynes Change His Mind?

For Discussion.

Why is the framework of fluctuations around a sustainable trend now in vogue, compared with a framework of shortfalls relative to capacity? Did I miss some major empirical proof?


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CATEGORIES: Macroeconomics



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COMMENTS (8 to date)
Eric Krieg writes:

>>I do believe that as the economy has become more complex, its ability to cope with recessions depends relatively more on private sector behavior, and traditional fiscal and monetary policy are less reliably effective.

Doesn't this statement in and of itself support the idea that there is a sustainable long run trend? What would happen if it was taken to its logical conclusion? The economy becomes SO complex that fiscal and monetary policy don't work at all.

Steve writes:
If you really believe that the fluctuations around the long-term trend are roughly symmetric, then why should government bother about them? Recession? Don't worry, be happy. We'll be fluctuating to boom soon enough. Sorry, if that's what new Keynesians believe, then call me an old Keynesian.

Aren't you reading "symmetric" into what Brad wrote? Even a quick glance at the historical data would show that the business cycle is not like a sine wave or something.

Couldn't the idea also be that the President has imprecise control over the economy at best so blaming him or crediting him for the economy's performance is strained at best. Of course, it'd be hard to say that Brad subscribes to this view given some of his posts knocking Bush.

Monte writes:

"Aren't you reading "symmetric" into what Brad wrote? Even a quick glance at the historical data would show that the business cycle is not like a sine wave or something."

You must not be familiar with the Kondratieff wave.

Arnold Kling writes:
Aren't you reading "symmetric" into what Brad wrote? Even a quick glance at the historical data would show that the business cycle is not like a sine wave or something.
I think that there may be more symmetry if you look at GDP growth relative to a trend line rather than relative to zero. That is, although there are many more quarters with positive economic growth than with negative economic growth, there is less disparity between the number of quarters with above-trend economic growth and below-trend economic growth.
PEmberton writes:

First up, Steve above misunderstands the symmetry. The long-run trend itself can be stochastic, with cycles around that.
It would be an interesting task in historiography to see how the professional mainstream came to the conclusion of symmetric fluctuations.
Part of the story is the Friedman-Phelps natural rate hypothesis: the economy can be shocked away from its natural rate but only temporarily.
Time series econometrics reinforced it - "draw a line through the data" representing trend, so the deviations must be cycle. But as JR Hicks long ago pointed out, we should not necessarily believe our statistical decomposition actually describes reality. Hicks entertained the notion of endogenous cycles, so maybe the time is ripe for a reaction to Friedman-Lucas-Frisch exogenous shock theories.

Boonton writes:
Doesn't this statement in and of itself support the idea that there is a sustainable long run trend? What would happen if it was taken to its logical conclusion? The economy becomes SO complex that fiscal and monetary policy don't work at all.

I believe this would be the rational expectations school. If the gov't tried to counter a recession by increasing money supply, this school held that the market would assume the increase would be inflationary and respond by immediately raising prices rather than increasing output.

Lawrance George Lux writes:
Why is the framework of fluctuations around a sustainable trend now in vogue, compared with a framework of shortfalls relative to capacity? Did I miss some major empirical proof?

Because Monetarist theory would not work within the latter context, Money flow would simply direct to the shortages of capacity, and control of Money Demand lacks effect. I am of the latter belief where a framework of shortfalls incite adverse economic conditions.

I personally do not believe either the Keynesians or Monetarists. I also do not believe in the conceptinalism of structural unemployment. I do believe Tax policy to be more effective than fiscal or monetary policy. Stable Tax policy will lead to stable Money Supply ratios. Deficit spending does not spur productivity, it actually contracts it by artificial inflation in Resource pricing. Easing Business taxation may be as harmful as it is helpful, through allowing Businesses to shift the Supply curve downward without loss of Profitability. lgl

Edgardo writes:

I stop teaching macro 20 years ago. Thanks for let me know that nothing has been learned over the past 20 years (the conversion of Keynesians into monetarists is at best similar to the conversion of socialists into liberals--late and still suspicious). I hope young economists become interested in the "wealth of nations" rather than "stabilization" (Samuel Bowles summarizes very well the main arguments for returning to the founders in the prologue of his new book "Microeconomics: Behavior, Institutions, and Evolution").

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