Robert Lucas on Non-Standard Monetary Policy
The Treasury View, Raw

More "Treasury View" Blogging

From PGL:

PGL: EconoSpeak: Heritage and the National Review Adopt the Treasury View: David Freddoso of the National Review interviews Brian Riedl of Heritage (not Cato - my apologies) in the The Case for No Stimulus:

The grand Keynesian myth is that you can spend money and thereby increase demand. And it’s a myth because Congress does not have a vault of money to distribute in the economy. Every dollar Congress injects into the economy must first be taxed or borrowed out of the economy. You’re not creating new demand, you’re just transferring it from one group of people to another. If Washington borrows the money from domestic lenders, then investment spending falls, dollar for dollar. If they borrow the money from foreigners, say from China, then net exports drop dollar for dollar, because the balance of payments must adjust. Therefore, again, there is no net increase in aggregate demand.... There is this notion that the redistribution of money from savers to spenders creates new spending. But that assumes that people store their savings in their mattresses. That may have been true in the 1930s, but today, people use their savings to pay down debts or invest. Or they put it into the bank, who in turn lends it to others to spend. Therefore, savings circulate through the investment side of the economy, which counts just as much in the GDP as the consumption side of the economy.... The government is going to have to raise interest rates in order to convince people to lend them the full amount they need. We’re already facing a deficit of $1.2 trillion this year, and 700 billion next year. We borrowed $700 billion for TARP, and now we’re going to borrow $800 billion for this stimulus package.

Hang on a second – Riedl notes that Keynesian insufficiency of aggregate demand may have existed in the 1930’s so that an increase in national savings does not automatically become investment demand but he argues for complete crowding-out ala the classical full employment model is the only relevant view for today’s economy. Has he been asleep for the past couple of years? Does he not know how far the employment-population ratio has declined or how low Treasury bill interest rates are? I know we should expect incredible stupidity from the National Review but this one really takes the cake!...

It does make one despair: crowding out is one-for-one only if (a) we are at full employment so that prices fully adjust completely so that greater nominal spending does not mean greater real spending, or (b) the velocity of money is constant and the money multiplier is constant and the monetary base is constant. Reidl is confused in a way that I thought had been cleared up in the 1930s by John Hicks (1937), "Mr. Keynes and the 'Classics': A Suggested Interpretation"--if not a decade earlier by Knut Wicksell. Olivier Blanchard once wrote an article called "What Do we Know About Macroeconomics that Fisher and Wicksell Did Not?" The answer, apparently, is that some of us may know a great deal more, but that collectively we know rather less.