Arnold Kling  

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I mention Scott Sumner a lot on this blog. Why? Because I see him as sticking up for mainstream macroeconomics. I myself have been pushing a non-mainstream idea, sort of a muddle between Leijonhufvud and Hayek that I call the Recalculation Story. But in the press and in the left-wing blogosphere, mainstream macro is nowhere to be found. It has gone into hiding.

Instead, we have had a "stimulus" and a "jobs summit" that are filled with what I once called Folk Keynesianism. In 2006, I complained

The idea that the economy needs consumer profligacy is not nearly as entrenched among scholars as it is among journalists, politicians, and other citizens. In fact, there is a strong case to be made that we would be better off if we had less consumer spending and more saving.

The scholarly consensus (SC) at that time was that monetary policy was the best tool for stabilizing the economy. The SC has been a no-show in the public discussions of macroeconomics. It was not defeated in debate. There was no confrontation in which folk Keynesians stood up, denounced SC, and demonstrated the superiority of their views. Instead, the SC simply disintegrated.

The SC would say that the Fed has the tools to fight the recession. It would say we do not need and never have needed a "jobs summit." We simply needed a more expansionary monetary policy.

The only argument that I have seen in favor of the shift from the SC to folk Keynesianism is the "liquidity trap" argument. That is, monetary expansion becomes ineffective when nominal interest rates are zero. However, that argument is quite weak. Years ago, Ben Bernanke pointed out that if the interest rate falls to zero in the Federal Funds market, the Fed can expand the money supply by purchasing assets in other markets, such as long-term bonds or mortgage securities. If nothing else, subsequent events have shown that what he proposed in theory can be put into practice.

Sumner's recent post points to a paper by Robert Hetzel that directly compares the SC to what might be called the folk-Minsky model of the recession.

The two contenders matched here are the credit-cycle view and the quantity-theory view of cyclical fluctuations. The credit-cycle view explains cyclical movements in output as a consequence of speculative booms leading to unsustainable levels of asset prices and leveraged levels of asset holdings followed by credit busts that depress economic activity through the impairment caused to the functioning of financial intermediation from insolvencies and deleveraging. The quantity-theory view explains significant cyclical movements in output as a consequence of monetary disorder deriving from the introduction by central banks of inertia in adjustment of the interest rate to shocks.

I myself have been pushing the credit cycle view--the folk-Minsky model. Hetzel, like Sumner, argues instead that the problem was a monetary contraction.

the absence of a funds rate reduction between April 30, 2008, and October 8, 2008 (or only a quarter-percentage-point reduction between March 18, 2008, and October 8, 2008), despite deterioration in economic activity, represented a contractionary departure from the policy of LAW [lean against the wind] with credibility. From mid-March 2008 through mid-September 2008, M2 barely rose while bank credit fell somewhat (Board of Governors 2009a). Moreover, the FOMC effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members. In May 2008, federal funds futures had been predicting a basically unchanged funds rate at 2 percent for the remainder of 2008. However, by June 18, futures markets predicted a funds rate of 2.5 percent for November 2008.

I am prepared to offer pushback against the Sumner-Hetzel viewpoint. However, it really deserves the status of the "null hypothesis." In a more reasonable world, everyone would be starting from the presumption that Sumner and Hetzel are correct. Those of us arguing folk-Minskyism and telling the Recalculation Story should be the ones fighting an uphill battle to bring our ideas into the policy debates. That this is not the case, and that SC is now on the fringe, is one of the most remarkable stories of this whole macroeconomic episode.

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COMMENTS (11 to date)
Daniel Kuehn writes:

Wow - six paragraphs to get to the liquidity trap. No wonder you think people have abandoned the scholarly consensus!

I don't think people have abandoned the scholarly consensus, we just haven't been in a serious liquidity trap situation in a very long time (I suppose we flirted with it in 2000/2001). Every scholarly consensus I've ever heard builds in these exceptional liquidity trap situations, they just aren't usually relevant because we aren't usually in one. So when one does pop up, a lot of people change their tune very quickly - but not because they've abandoned the scholarly consensus.

I don't think people are as unacknowledging of quantitative easing as an alternative to a liquidity trap as you and Scott suggest either. It's received a ton of attention lately. The problem is, when you dabble in quantitative easing you dabble in picking winners, and that's always dangerous. I think a lot of people think that if we're going to take the risk of picking winners, it's better to do it with a deliberative, representative body rather than an appointed committee. The argument is fundamentally philosophical, rather than economic.

I appreciate your recalculation perspective - I love reading your posts on it, and I agree with many of your insights. I just think that you're misdiagnosing what people are abandoning. They ARE moving past the "least common denominator". I don't think they're moving past the consensus.

Philo writes:

It turns out that most economists didn't really believe what they were teaching their students (namely, the SC). It's as if we discovered that most clergymen were closet atheists.

fundamentalist writes:

This just proves that politicians and the media never did care about what economists actually thought. Folk-Keynesian policy was popular long before Keynes was born. Many states went bankrupt in the US before the Civil War due to state stimuli and "investment." That's why many states have in the constitutions articles limiting state involvement in the economy.

From the days of Hamilton, people have thought the guv should control and direct the economy. All Keynes did was dress this ancient nonsense in academic garb and make it a respectable women instead of just a whore.

Politicians will always pick from the economic basket whatever supports their prejudices. The media just tags along and promotes whatever the politicians want because the media are the politicians whores.

Ryan Vann writes:

The liquidity trap is valid only if you still think the FED only uses interest rates to control money supply. Add in that government has pretty much guaranteed it won't let large businesses fail, and you can't make too much of a case for expected return being lower than current interest rates (from a strictly financial point of view).

Anyway, I don't see too much of a conflict between the credit-cycle or quantity-theory; they aren't really intended to do the same things. One is an explanatory story and the other is a policy suggested to deal with the realities. In other words, you could be a credit-cycle proponent and support the type of quantity theory policies that Sumner promotes.

Daniel Kuehn writes:

Ryan - Right, I generally agree with you. Except that the things the Fed has outside the interest rate are more troubling to some people. Like I said - it's a philosophical concern more than it is an economic disagreement. Not to mention I suppose one could argue that their other options are still somewhat untested and speculative. I agree with Arnold - I don't think that's true. I think we do know quite a bit about them. But I've heard some people make the argument, and I suppose it's at least a plausible concern.

pushmedia1 writes:

I can't wait to read Prof. Ben Bernanke's autobiography.

Mr. Econotarian writes:

"It's as if we discovered that most clergymen were closet atheists."

More like we've discovered that in war there are no atheists in a foxhole, even if they each believe in a different god, and none has any scientific support.

Ryan Vann writes:

Mr. Kuehn,

I wouldn't disagree with anything you've wrote. Some of the more unconventional monetary actions are definitely untested, which is probably why many credit-cycle folks are skeptical of the quantity-theory panacea, as you suggest.

Either way, both concepts are worthy of consideration, if not for the sake of challenging the brain a bit.

Dave writes:

Just my two cents - I have heard since 1984-85 - when I started getting interested in history and economics in High School that spending by FDR ala Keynes - deficits, the make work jobs , govt spending is "what got us out of the depression". If you try to refute this, people seem to take offense - its as if it has been repeated so many times over the years that it has become gospel. Also, I have always felt that politicians love any opportunity to justify spending.

Doc Merlin writes:

Um, the fed has been buying up assets like crazy and as a result the AMB increased 100% in the last few months of 2008. 2009 was still horrible though.

While I agree with his ideas about futures' convertibility. I don't believe that the fed should be expansionistic!

Doc Merlin writes:

@Ryan Vann

Um, well, no, now the fed just outright buys large chunks of the economy, since it has monopoly power on printing money it can at will nationalize whatever parts of the economy it wishes to, just buy buying them. Its rather frightening. The fed has become what the disestablishmentarianists feared it would.

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