Scott Sumner  

The last New Keynesian left alive

What Happened in Ukraine... Krugman's Priceless Economics...

I've done numerous posts pointing out that prior to 2008, New Keynesian economists believed the fiscal multiplier was roughly zero. Paul Krugman used to say that aggregate demand was essentially whatever Alan Greenspan wanted it to be. Jared Pincin sent me another great example from a 2006 textbook by Brad DeLong and Martha Olney:

As a rule, today's Federal Reserve does routinely neutralize the effects of changes in fiscal policy. Swings in the budget deficit produced by changes in tax laws and spending appropriations have little impact on real GDP unless the Federal Reserve wishes them to" (pg. 399). They also write on pg. 400: "The rule that prevails today and probably will prevail for the next generation is that the Federal Reserve offsets shifts in aggregate demand created by the changing government deficit.
At this point many Keynesians will respond that the zero lower bound (now the minus 0.75% lower bound) changes everything. But that certainly wasn't the view a recently as a decade ago. Here are some examples of mainstream economists pre-2008:

1. Frederic Mishkin said that monetary policy remained "highly effective" at the zero bound.

2. Ben Bernanke agreed, and suggested the BOJ do level targeting.

3. Lars Svensson said currency depreciation was a "foolproof" way of escaping a liquidity trap.

4. Paul Krugman spoke of the need to "promise to be irresponsible," i.e. a higher inflation target.

A decade ago I was right in this New Keynesian mainstream. I believed the central bank could and should keep NGDP growing at a fairly stable rate. I believed that the fiscal multiplier was roughly zero. Like Bernanke and Mishkin, I believed low interest rates to not imply money is easy. Etc., etc.

Some Keynesians cite Keynes's famous quote:

When the facts change, I change my mind. What do you do?
There are two problems with this argument.

1. I see no facts that would have led a sensible person to abandon the zero multiplier view.

2. Many Keynesian roll their eyes at zero multiplier claims, as if they are obviously absurd. How can an idea that was right in the New Keynesian mainstream in 2006, when the Japanese liquidity trap was already well understood, suddenly become a cranky heterodox view in 2009? Especially given the complete failure of the 2013 "test" of the anti-austerity theory. If nothing else, anti-austerian Keynesians are engaging in intellectual dishonesty any time they ridicule the arguments of the stimulus skeptics. After all, they believed those things just a few years ago.

If someone I hadn't seen since 2006 bumped into me, they might say to me; "I thought you were a centrist on macroeconomic policy. What made you decide to suddenly become an extremist?" My response would be that I am still a centrist; it's the rest of the New Keynesians that have migrated to the view that Krugman called "Vulgar Keynesianism" in 1997.

Which reminds me of one of the most unfortunate technological innovations in the history of art, the disastrous invention of the talking picture:

Screen Shot 2015-03-03 at 10.23.25 AM.png
PS. What picture is most diminished by the invention of sound (actually talking)? My vote is Titanic. Woulda been a great silent flick.

Comments and Sharing

COMMENTS (9 to date)
Capt. J Parker writes:

Yes but,
Saying monetary stimulus is still effective at the ZLB does not mean that monetary offset of fiscal stimulus will still happen if the monetary authority keeps rates at the ZLB. I think that's what advocates for fiscal stimulus at ZLB would argue.

Andrew_FL writes:

Seems like it's more like, when the politics change they change their minds.

SG writes:

@Capt. J. Parker

Scott does not claim that monetary offset of fiscal stimulus will always happen.

Rather, his critique is of those "vulgar Keynsians" who allege that once you hit the ZLB, up is down, black is white, and the central bank can no longer achieve its inflation target. But, as Scott has pointed out time and time again, recent experience, common sense, and the words and actions of central bankers all suggest that even after the worst economic slump in three generations, central banks still focus monomaniacally on inflation and, in the case of the ECB, are willing to push inflation below their stated target for any reason or no reason at all.

Regardless of whether or not monetary policy *precisely* offsets a given amount of fiscal stimulus or austerity, it is still true that most Keynsians simply assume away monetary policy. It's that unwarranted assumption that has been, and will continue to be, a fatal flaw in all their arguments.

Scott Sumner writes:

Captain Parker, That may be so (although I don't agree it is.) But note that this post isn't really about the correct estimate of the multiplier at the zero bound, it's about the way that certain ideas are dismissed as being out on the fringe, when they clearly are not.

guthrie writes:

Re: your movie question, most silent stars' careers ended at the advent of dialogue. Chaplin was a singular stand-out, but his career had enough momentum that he could dictate the terms of his transition to 'talkies'. I often wonder what might have been created if Keaton, Harold Lloyd, et. al., weren't forced to transition.

OTOH, without talkies there might never have been a Marx Brothers' series, or a Billy Wilder (so-author of the above quote), or a Kevin Smith.

Most films still use techniques developed during the silent era, so it's not hard to imagine most films without dialogue. Whether a film is 'improved' by the removal of speaking is subjective and probably harder to determine... :) If I were to vote it would likely be a film like The Ten Commandments (1956), great visuals but notoriously hammy dialogue/acting.

Steve J writes:

Krugman mentions the impact of zero interest rates even in the 1997 article you cite...

Ray Lopez writes:

Simple question: if monetary policy leads the economy, and the Fed can determine NGDP, do we have any empirical evidence this is true? Every chart I have seen shows the Fed working with the market, but not leading the market. This includes even the famous Volcker era where supposedly the Fed 'broke the back of inflation'. You'll notice the Fed jumped around, going down *and* up, in response to a volatile market. It had the tiger by the tail, not steering the tiger. I am not claiming that the Fed does not make mistakes (as it did in the Great Depression), but I am claiming these mistakes don't seem to matter much. Where is your EMPIRICAL evidence that the Fed leads the market? Not theoretical, as that horse has been beaten to death. If this is a stupid question then surely you can easily refute it. And if it's so stupid, then far more brilliant minds than mine have fallen for the proposition of the neutrality and super-neutrality of money (e.g., Fischer Black).

Scott Sumner writes:

Guthrie, Good observations.

Steve, Yes, and he still favored monetary stimulus in Japan, despite zero rates.

Ray, I don't understand your point. Are you saying that the Fed can't control NGDP, or that controlling NGDP will have no effect on RGDP (due to money neutrality)? Those are radically different questions.

Brendan riske writes:

Japan is the major test case. They were the first to indulge in all out easing. And when their policies fail, it will be a lesson in what happens when you follow keynes to far. It's beyond the zero bound now, europe is in negative interest rate territory and america will be soon as well. People hold bonds just to sell them at a higher price, even though they are losing money. it's insane.

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