What is a Keynesian? My definition is any economist who recognizes that an insufficiency of aggregate demand can lead to what
Paul Krugman dubbed PLOGs – prolonged large output gaps. In the late 1970’s a certain class of macroeconomics called the New Classical school decided we Keynesians were witch doctors practicing junk science. This view dominated certain aspects of academia for 30 years. Krugman’s
latest drew a lot of comments from the left but there was one odd one that defended what
Robert Lucas wrote back in early 2009. This defense got me to re-read those comments, which included this admission from the dean of the New Classical school:
At the end of 2008, U.S. GDP was about 5 percent below trend. People measure trends in different ways, but 2007 wasn't a great year either. The consensus forecast predicts something like 8 percent below trend by the end of this year.
Lucas’s use of “trend” was a bit odd but it is true that the CBO estimate of the output gap at the end of 2008 was 5% and things did get worse in 2009. Some of us are convinced that neither trends nor the CBO is the final word on potential output and I have suggested that 8 years into the Great Recession we still have a 5% output gap. Now that is a PLOG! But let’s give Professor Lucas a little credit for not arguing we never deviate from full employment. His discussion continued by going all Friedman-Schwartz on us as if monetary policy alone could quickly end the output gap. In fact the Bernanke FED did go all Friedman-Schwartz on us with a huge monetary stimulus. Some of us think they should have done more but a lot of the right wing complained it was excessive stimulus. Lucas, however, noted:
I've already said I think what the Fed is now doing is going to be enough to get a reasonably quick recovery committed.
OK – this prediction turned out to be quite wrong. But hindsight is 20/20. Lucas slammed Christina Romer for recommending massive fiscal stimulus. There were two parts of this critique:
But, could we do even better with fiscal stimulus? I just don't see this at all. If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that's just a monetary policy. We don't need the bridge to do that. We can print up the same amount of money and buy anything with it. So, the only part of the stimulus package that's stimulating is the monetary part. But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash. It has no first-starter effect. There's no reason to expect any stimulation. And, in some sense, there's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn't going to help, we know that.
I’m not sure why this right wing crowd laughed but one would have hoped Robert Barro might have whispered to Professor Lucas that he just misrepresented the Barro-Ricardian equivalence proposition.
Krugman certainly jumped on this nonsense from Lucas:
think about what happens when a family buys a house with a 30-year mortgage. Suppose that the family takes out a $100,000 home loan (I know, it’s hard to find houses that cheap, but I just want a round number). If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt. But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase. Now notice that this family is very much like the representative household in a Ricardian equivalence economy, reacting to a deficit financed infrastructure project like Lucas’s bridge; in this case the household really does know that today’s spending will reduce its future disposable income. And even so, its reaction involves very little offset to the initial spending.
We needed more fiscal stimulus back in 2009 and we needed to sustain it for longer. We still need a lot of infrastructure investment. In New York City, the good news is that we have decided to spend $4 billion on LaGuardia Airport and another $3 billion on Penn Station. And what we need to spend on our subway system is staggering. But I don’t want to be a selfish New Yorkers here. If there is any concern about deficit spending, let those very rich Republicans on the Upper East Side pay more in taxes to extend the new Second Avenue line to south Manhattan. But let’s get to the part the latest right wing critic of Krugman was noting. Someone asked Lucas the following:
In the last session, we had quite an animated discussion which spilled over into the lunch about models on fiscal multipliers, what they are. On the one extreme, we have models by people like Mark Zandi at Moody's who say that the fiscal multiplier for the spending initiatives we're discussing are on the order of 1.5. On the other hand, we have people like Robert Barro at Harvard who say there's zero or negative. How would you go about applying the Lucas critique to these types of models to sort of educate us in how we should think about the validity of these models?
Lucas replied:
It's her first day on the job and somebody says, you've got to come up with a solution to this -- in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning. So she scrambled and came up with these multipliers and now they're kind of -- I don't know. So I don't think anyone really believes. These models have never been discussed or debated in a way that that say -- Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics. Maybe there is some multiplier out there that we could measure well but that's not what that paper does.
Mark Zandi was McCain’s economic adviser in 2008 who had the good sense to tell the Senator we had a Keynesian problem. Of course the Senator failed to listen to his own economic adviser. Lucas was criticizing Dr. Romer for using Zandi’s model. Now we see criticism from the left for her use of this same model. Go figure! But to be fair – his model is probably best tossed into the waste bin given what we know now. Did I say hindsight is 20/20?
9 comments:
"What is a Keynesian? My definition is any economist who recognizes that an insufficiency of aggregate demand can lead to what Paul Krugman dubbed PLOGs – prolonged large output gaps."
"ce qu'il y a de certain c'est que moi, je ne suis pas Marxiste” -- Karl Marx
Robert Skidelsky:
"My purpose in this paper has not been to enter into an argument with Keynes. It has been to show that his thought, from whatever period of his life one chooses to take it, is richer, more suggestive, and more unexpected than the textbook Keynesianism that still flourishes, or the administrative Keynesianism that ruled policy in the 1950s and 1960s. His views on the minimum sustainable rate of unemployment and his fiscal philosophy still have a great deal to offer governments. His reminder that economics needs to retain its connection with the non-economic ends of life as these have been conceived by moralists and ethical philosophers remains a necessary warning against blind worship of the golden calf, and against marketization carried to extreme lengths. So I say: Down with Keynesianism, and up with Keynes!"
Further on the Marx/Marxisme quote, it is Engels quoting Marx:
"Now what is known as ‘Marxism’ in France is, indeed, an altogether peculiar product — so much so that Marx once said to Lafargue: ‘Ce qu'il y a de certain c'est que moi, je ne suis pas Marxiste.’"
- Letter to Bernstein, 1882.
In a further remark on the distinction between Marx and "Marxisme," Engels offered the criticism that the latter used "the materialist conception of history... as an excuse for not studying history."
Similarly, the notion that Keynesianism consists of "recogniz[ing] that an insufficiency of aggregate demand can lead to... prolonged large output gaps" is used by the so-called Keynesians as an excuse for not studying history or, for that matter, Keynes's writings on economic theory.
It would be very interesting to hear what Lord Keynes would say of the current macroeconomic debates - not just in the US but also in the UK and Europe. James Tobin in the 1970's used to scoff at the New Classicals claim that Keynes is dead but noting the actual man died way too young in 1946 but his influence lives on.
Two comments:
It is an old observation, but Milton Friedman was much more of a Keynesian than Lucas. He never bought into the nonsense of ratex that lies at the base of all DSGE models.
The other is that indeed Lucas went at least partly Keynesian at the worst moment of the crisis. Which says to me that just as they say "there are not atheists in foxholes" (which may not be true), there also may be no non-Keynesians in the foxholes when a full-blown global economic crisis hits (which also may not be true).
"If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that's just a monetary policy. We don't need the bridge to do that. We can print up the same amount of money and buy anything with it. So, the only part of the stimulus package that's stimulating is the monetary part. But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash"
Yes if you discount the future economic value of the bridge to zero. I suppose we could have had the same short term impact recreating the Colossus of Rhodes over the Golden Gate in 1937, pouring cement and steel to make an even better 400' statue with sword and shield warning the Asiatic Horde to "NOT EVEN TRY IT!" Instead they built a Bridge. Along with another one connecting SF to Oakland. Whatever you think of the car and truck culture that grew up after WWII and largely displacing rail as the primary method of transportation you can't readily dismiss the economic multipliers provided by the bridge building of the 30s and the highway building of the 50s and 60s.
Keynesianism isn't all about digging holes, putting money in them, filing them up, and paying people to dig up the money. Sometimes it is about digging holes, putting in rebar, pouring foundations and building stuff. Like Hoover Dam. And the SF-Oakland Bay Bridge. The tendency of people to equate investments in infrastructure with Helicopter Drops from Uncle Ben Bernanke drives me crazy. Perhaps it is a hangover from Hayek whose central assumption was that planning always amounted to negative value. As if the Market would magically have delivered us Rural Electrification and Interstate Highways. Or for that matter the Transcontinental Railroad of the 1860s and the Canals of the 1820s to 1840s.
"Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000;"
This is why ordinary folks don't understand economics. Where were these people living before they bought that house? Under a highway overpass? In mom's basement? Odds are they were paying rent or another mortgage.
Ordinary folks understand economics just fine. It's that economists don't study economics, but rather "Economics".
True, but the wrong turn that led us into the current coal pit was made well before the choice to follow Keynes or "Keynes", Marx or "Marx".
Brad DeLong covered Lucas on C. Romer, most recently here (2009) and here (2012).
The thing that makes me happiest about Lucas's Nobelish Prize is that he got it just in time to have to share it with his ex-wife. (Amazingly, he still pretends continuity dominates.)
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