Weekend Reading: Paul Krugman (2011): Mr Keynes and the Moderns
Paul Krugman's distinction between Chapter 12er and Book 13 Keynesians is, I think, dead on:
Paul Krugman (2011): Mr Keynes and the Moderns: "I’d divide Keynes readers into two types: Chapter 12ers and Book 1ers. Chapter 12 is, of course, the wonderful, brilliant chapter on long-term expectations, with its acute observations on investor psychology.... Its essential message is that investment decisions must be made in the face of radical uncertainty to which there is no rational answer, and that the conventions men use to pretend that they know what they are doing are subject to occasional drastic revisions, giving rise to economic instability.... Chapter 12ers insist is that this is the real message of Keynes...
...Part 1ers, by contrast, see Keynesian economics as being essentially about the refutation of Say’s Law–the possibility of a general shortfall in demand. And they generally find it easiest to think about demand failures in terms of quasi-equilibrium models in which some things, including wages and the state of long-term expectations in Keynes’s sense, are held fixed while others adjust toward a conditional equilibrium of sorts.... So who’s right?... Keynes... in his 1937 QJE article (Keynes 1937)... declared himself a Chapter12er. But so what?... Our goal now is not to be faithful to his original intentions, but rather to enlist his help in dealing with the world.... For what it’s worth, I’m basically a Part 1er, with a lot of Chapters 13 and 14 in there too, of which more shortly....
What I’m always looking for in economics is ‘intuition pumps’–ways to think about an economic situation that let you get beyond wordplay and prejudice, that seem to grant some deeper insight. And quasi-equilibrium stories are powerful intuition pumps, in a way that deep thoughts about fundamental uncertainty are not. The trick, always, is not to take your equilibrium stories too seriously, to understand that they’re aids to insight, not Truths; given that, I don’t believe that there’s anything wrong with using equilibrium analysis. And as it turns out, Keynes-as-equilibrium-theorist... has a lot to teach us to this day. The struggle to liberate ourselves from Say’s Law, to refute the “Treasury view” and all that, may have seemed like ancient history not long ago, but now that we’re faced with an economic scene reminiscent of the 1930s and we’re having to fight those intellectual battles all over again....
Keynes’s critique of the classical economists was that they had failed to grasp how everything changes when you allow for the fact that output may be demand-constrained. They mistook accounting identities for causal relationships, believing in particular that because spending must equal income, supply creates its own demand and desired savings are automatically invested. And they had a theory of interest that thought solely in terms of the supply and demand for funds, failing to realise that savings in particular depend on the level of income, and that once you take this into account you need something else–liquidity preference–to complete the story.... There’s dispute about whether Keynes was fair in characterizing the classical economists in this way. But I’m inclined to believe that he was right. Why? Because you can see modern economists and economic commentators who don’t know their Keynes falling into the very same fallacies.
There’s no way for me to make this point without citing specific examples, which means naming names. So, on the first point, here’s Chicago’s John Cochrane (2009): “First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about 'crowding out'.” That’s precisely the position Keynes attributed to classical economists... All it takes to dispel this fallacy is the hoary old Samuelson cross.... The argument that deficit spending by the government cannot raise income also implies that a decision by a private business to spend more must crowd out an equal amount of spending elsewhere in the economy. Needless to say, in the political debate this point isn’t appreciated; conservatives tend to insist both that fiscal policy can’t work and that improving business confidence is crucial. But that’s politics....
Keynes’s discussion of interest rate determination in Chapter 13 and 14 of the General Theory is much more profound than, I think, most readers realise.... The proof of its profundity lies in the way so many people – including highly reputable economists–keep falling into the fallacies Keynes laid out, both in discussions of fiscal policy and in discussions of international capital flows.... Again, I need to name names to assure you that I’m not inventing straw men. So here’s Niall Ferguson (in Soros et al 2009): “Now we’re in the therapy phase. And what therapy are we using? Well, it’s very interesting because we’re using two quite contradictory courses of therapy. One is the prescription of Dr Friedman–Friedman, that is–which is being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the early 1930s. I’m fine with that. That’s the right thing to do. But there is another course of therapy that is simultaneously being administered, which is the therapy prescribed by Dr Keynes–John Maynard Keynes—and that therapy involves the running of massive fiscal deficits in excess of 12% of gross domestic product this year, and the issuance therefore of vast quantities of freshly minted bonds.... You can’t be a monetarist and a Keynesian simultaneously–at least I can’t see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up..."
What’s wrong with this line of reasoning?... As Hicks told us–and as Keynes himself says in Chapter 14–what the supply and demand for funds really give us is a schedule telling us what the level of income will be for a given rate of interest.... This tells us where the central bank must set the interest rate so as to achieve a given level of output and employment...
#weeekendreading #johnmaynardkeynes #macro #economicsgonewrong
