When I hear people discuss the long run I am sometimes reminded of
students who mistakenly assume the term ‘long run’ means ‘the distant
future’ and ‘short run’ means ‘the present or near future.’ But that
is not at all what these terms mean. The present, right now, is the
“long run” for policies instituted years ago. So if Keynes believed
that in the long run nominal income is determined by monetary factors,
then he should have explained current movements in nominal income in
terms of past movements in monetary policy. Of course that is not what
the GT does.
Krugman recognized that Keynes’ liquidity trap rested on a
foundation of sand and attempted to build a model of “expectations
traps” that was consistent with rational expectations. I have doubts
about this model, but even if one accepts Krugman’s argument it doesn’t
really help the GT very much. Krugman argued that temporary increases
in the money supply will be hoarded, leaving AD almost unchanged. But
this would apply even more strongly to budget deficits, which unlike
money supply increases, must be temporary.
If a transitory budget deficit will have no long run impact on
nominal spending (holding money constant) then its effect on current
spending will be even weaker than otherwise. There is a reason why
modern graduate macro texts place so little emphasis on the ideas that
Keynes developed in the GT, they are very hard to justify in a model
with rational expectations. What puzzles me is why concepts such as
the MPC, the multiplier, the paradox of thrift, and fiscal stimulus
have recently become so widely debated among economists. Do these
concepts help us understand movements in nominal spending? And if so,
what is the model that justifies that view?
It is worth reading every single one of his (twenty-two, so far) posts, even though you must click to get under the fold.