People Claiming That Even John Maynard Keynes Is No True Keynesian!: April Fools Festival Day XVIII
Oh, this is going to be fun!
Let's start with J.W. Mason:
...One of Krugman’s bugaboos is the persistence of claims that expansionary monetary policy must lead to higher inflation.... As an empirical matter, of course, Krugman is right. But where could someone have gotten this idea that an increase in the money supply must always lead to higher inflation? Perhaps from an undergraduate economics class? Very possibly--if that class used Krugman’s textbook.
Here’s what Krugman's International Economics says about money and inflation:
A permanent increase in the money supply causes a proportional increase in the price level’s long-run value.... On average, years with higher money growth also tend to be years with higher inflation.... A permanent increase in the level of a country’s money supply ultimately results in a proportional rise in its price level but has no effect on the long-run values of the interest rate or real output...
Let me interrupt to say that a mildly generous--or even a not severely antipathetic--reader of Krugman's textbook would notice the phrases permanent increase and ultimately results and long run. Such a reader would recognize that they undermine Mason's claim that Krugman claims that:
an increase in the money supply must always lead to higher inflation...
Interrupting the "must always" are three factors: The increase must be permanent. Its permanence must be credible. And the association happens in some long run, which is not tied to any particular time on the clock. As John Maynard Keynes said in perhaps his most famous quote, and as Krugman stresses:
This long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again...
Mason goes on to write:
Let me anticipate a couple of objections.... Everything changes at the zero lower bound.... But... that's irrelevant here, since I am looking at the 9th Edition, published in 2011... [which] does talk about the liquidity trap... in a two-page section at the end... [and] the further reading suggested on policy at the zero lower bound is an article by Lars Svennson that calls a permanent expansion in the money supply “the foolproof way” to escape a liquidity trap...
I cannot help but wonder what fight J.W. Mason wants to pick with Lars E.O. Svennson. What block replaces the quantity theory of money in his visualization of what economic theory should be? What does J.W. Mason want to argue that the relationship between the long-run price level and the credible and permanent level of the money stock is? He doesn't say.
And there is more! Lars Syll:
...The mainstream... still says demand causes short-run fluctuations, but only supply factors... can affect [the] long-run.... Even Paul Krugman... writes... 'shocks to aggregate demand affect aggregate output in the short run but not in the long run’.... Krugman does point to one exception: If interest rates are nearly zero, as during the financial crisis.... But, Taylor asks, what’s the logic?... [Krugman] turns Keynes upside down...
Well,let's roll the videotape.
Does John Maynard Keynes believe that shocks to aggregate demand have permanent long-run affects on the level of output?
It appears that he does not:
...[is that] the forces propelling [the economy] upwards at first gather force and have a cumulative effect... but gradually lose their strength until at a certain point they tend to be replaced by forces operating in the opposite direction... until they too, having reached their maximum development, wane and give place to their opposite....
[A] typical, and often the predominant, explanation of the crisis is... a sudden collapse in the marginal efficiency of capital. The later stages of the boom are characterised by optimistic expectations as to the future yield of capital-goods sufficiently strong to offset their growing abundance and their rising costs of production and, probably, a rise in the rate of interest also.... Wen disillusion falls upon an over-optimistic and over-bought market, it should fall with sudden and even catastrophic force.... Liquidity-preference... does not increase until after the collapse in the marginal efficiency of capital. It is this, indeed, which renders the slump so intractable. Later on, a decline in the rate of interest will be a great aid to recovery and, probably, a necessary condition of it. But, for the moment, the collapse in the marginal efficiency of capital may be so complete that no practicable reduction in the rate of interest will be enough....
It is not so easy to revive the marginal efficiency of capital.... The explanation of the time-element in the trade cycle... is to be sought in the influences which govern the recovery of the marginal efficiency of capital.... The interval of time, which will have to elapse before the shortage of capital through use, decay and obsolescence causes a sufficiently obvious scarcity to increase the marginal efficiency, may be a somewhat stable function of the average durability of capital.... When once the recovery has been started, the manner in which it feeds on itself and cumulates is obvious....
It is quite clear what Keynes's theory of the "trade cycle" is:
A boom is produced by overoptimism about future profits, which, when those overoptimistic expectations are disappointed, causes a swing in expectations of future profits from overoptimism to overpessimism, and a slump, which in turn induces exaggerated liquidity preference.
Because of this exaggerated liquidity preference, the slump cannot be cured by any "practicable reduction in the rate of interest".
Rather, the slump continues until the existing capital stock has depreciated enough that capital is scarce enough that the rate of profit has risen high enough that, even with overpessimism and exaggerated liquidity preference higher investment is profitable again.
The recovery then, as investors notice that profits are running ahead of expectations, "feeds on itself and cumulates" in a "manner... which... is obvious".
This is not a theory that Lars Syll would like. This is not a theory in which shocks to aggregate demand cause permanent shifts in the level of output, is it?
A positive shock to aggregate demand would, in this framework, certainly reset the phase of the business-cycle clock to a later phase. But it would not produce a permanent rise in production. The extrapolative expectations-panic-reaction-elevated-liquidity-preference-depreciation-and-rising-marginal-product-of-capital driving engine of the business cycle is still operating. Keynes thinks that we should interrupt this driving engine, and aim for a permanent boom: he does think that there is another, sustainable equilibrium out there other than the one plagued by business cycles. But as long as this driving engine is operating, no single aggregate demand shock is going to have a permanent effect on the level of output
Is this, in Lance Taylor and Lars Syll's view, enough to disqualify one from being a Keynesian?
Then, like Paul Krugman, John Maynard Keynes, at least in the model he presents in chapter 22 of the General Theory, is no true Keynesian.
