New vs. old Keynesian macroeconomics

by on September 14, 2011 at 6:37 am in Economics | Permalink

Paul Krugman compares the two and calls for a pragmatic methodological pluralism.  Most of his discussion is about expectations, but when this topic first came up I had a few other issues in mind:

1. For how long — in today’s America — can an AD-driven recession last?  At what point do even the Keynesians toss in the towel and say “By now it is a growth and structural problem, not mainly AD”?  After all, the private sector had a chance to create more M2 and it failed.  How sharp is the distinction between the short run and long run?  At what point do long-run problems twist their neck back and screw up the present day?

2. How much do we heed the concrete results of new Keynesian models on the extent and duration of wage and price stickiness?  Many of these models suggest stickiness is not quite the bugaboo it is often made out to be, especially not in the longer run, or not with unemployed workers.  It is no longer the Great Depression and it seems at least possible that 2-3 percent of the workforce could lower their reservation wages without setting off a downward deflationary spiral.

3. How much should we integrate Keynesian results with search models of the labor market, a’la Mortensen and Pissarides?  That’s actually not easy to do, yet the search models are built on some fairly basic and general microeconomic intuitions.  I see little interest in these ideas from the old Keynesians.

4. What to make of the liquidity trap?  One of Krugman’s models (with Eggertsson) suggests that a very low rate on T-Bills implies an upward-sloping AD curve, and other counterintuitive results, but most new Keynesian models would not bring you to this conclusion.  This is a big difference with important practical policy conclusions.

5. IS-LM has a quite primitive or indeed non-existent treatment of the banking sector; Stephen Williamson stresses this point.

I interpret the old Keynesians as holding an attitude something like: “We know from the Great Depression that an AD problem can be very bad for a very long time.  Maybe there are mysteries in how that happened but we need to double down on traditional Keynes, Hicks, and IS-LM.”

The old Keynesian approach has a major presence in the blogosphere but much less influence in current academic macroeconomics.  Whether Econ 101 sides with the Old Keynesians I am not sure (it depends who teaches the class), but Econ 2011 in many cases does not.

There are enough AD-denialist arguments running around that the new and old Keynesian perspectives can forge an alliance on some major issues.  But as the downturn continues, this intellectual alliance will grow increasingly fragile, mostly over the question of whether long-run or short-run models are relevant.

Not long ago I tweeted this:

Confused by the Right on macro, you’re a New Old Keynesian; confused by the Left, you’re an Old New Keynesian.

I also see old Keynesians as believing that the IS-LM framework follows directly from the quantity theory of money, while new Keynesians are not committed to such a view and may even oppose it.  I may write a post devoted to this topic.

1 david September 14, 2011 at 7:40 am

Please do write such a post.

2 srb September 14, 2011 at 7:54 am

Why are “influence in current academic macroeconomics” and “influence in the blogosphere” the only measures? Surely there is a free market out there that we can consult for what works. What kind of models do those who make their living predicting the macroeconomy use? [I think you know the answer]
As for influence in academic macroeconomics, Krugman and DeLong would be the first to agree with you.

3 Andrew' September 14, 2011 at 10:50 am

Are you being coy? Just because people make their living doing something that people have to try to do it doesn’t make them right. By analogy, everyone playing professional sports makes their living doing it even though only one team wins the championship.

When I have heard Mark Zandi asked why he believes his models now when they were wrong before, he basically chuckles and admits that, to paraphrase, “because they are the models I have.”

This is basically what Krugman says, but he seems to confuse that with “no other models exist” when he has said that one other competing model (which he actually doesn’t realize he has in fact been using) isn’t worth investigating.

4 srb September 14, 2011 at 11:06 am

Just because people have influence in academia doesn’t make them right either.
Think about the implications of “they are the only models we have.” If “Keynesian” (old, new, bastard, hybrid, whatever) analysis is so horribly wrong, why haven’t better models been developed and driven them out of the market?

5 Pragmaticon September 14, 2011 at 11:48 am

Are we really going to have a redo on the debate over large-scale macroeconometric models? Really?

6 Andrew' September 14, 2011 at 12:51 pm

If there were an efficient market in economics that would be a very good question. My point is simply that actual practitioners don’t rely solely on academic models, and academic models don’t rely on practitioners to buy them, so the process would take time in any event. I suspect model failure is one of the first steps in the driving out process.

7 jrs September 15, 2011 at 4:48 am

The basic Hicks Liquidity trap model has worked pretty well at understanding the recent crisis, much better in its qualitative predictions than the New Classical views that government borrowing in the US would cause soaring interest rates, the Fed’s monetary expansion would cause hyperinflation (Austrian view QTM, assuming money velocity is constant), and austerity will actually be expansionary because a dollar spent by government is a dollar that can’t be spent by the private sector (old Treasury view which Fama and Cochrane claimed) which is more efficient (plus confidence!). These are pretty important issues to understand in advising policy, and most of the Keynesian bashers have gotten them horribly, horribly wrong.

8 NAME REDACTED September 14, 2011 at 8:13 am

I’m not even sure that AD has a non-self-contradictory meaning.
If we aggregate over AD we are implicitly assuming that suppliers can change their production fast enough so that changes in preference bundles don’t necessarily change AD. This is itself incompatible with the idea of price stickiness.

Once we have price stickiness, the idea of AD no longer makes sense to me.

9 NAME REDACTED September 14, 2011 at 8:18 am

I should clarify. Its possible to fix this problem if we treat preference bundle changes that don’t change the overall price of the bundle as if they were supply shocks.

10 Theodore September 14, 2011 at 8:22 am

“It is no longer the Great Depression and it seems at least possible that 2-3 percent of the workforce could lower their reservation wages without setting off a downward deflationary spiral.”

OK, so why don’t they? Presumably this should mean that there would, at a minimum, be an inconsequential number of 99ers in search of work.

Conversely, it seems like firms have healthy enough profit margins at the moment that they can afford to pay that 2-3 percent even if they don’t lower their reservation wages. Assuming demand isn’t an issue.

11 NAME REDACTED September 14, 2011 at 8:39 am

@Theodore
Easy answers:
because
1) Due to the new health care bill, the marginal benefit of a worker must be many thousands of dollars more in a year than it was before.

2) The marginal benefit of a worker in a modern economy is highly uncertain.

3) The wealth loss from the crash has reduced the number of high productivity older workers that are retiring.

4) Minimum wage has gone up tremendously.

5) unemployment benefits have been extended so long that those coming off of unemployment benefits have serious skill loss.

12 Theodore September 14, 2011 at 9:43 am

(1) I’m uncertain of, and it seems as though potential workers would be able to lower their reservation wages to compensate. (2) is undoubtedly true, and very consistent with a demand story. (3) is indeterminate, since those older workers also have high wages, and again, in this story the younger workers can lower their reservation wages to make themselves more attractive. And I’m not sure how many of them were so much higher productivity in the construction industry. (4) is certainly an issue at the margin, though looking at the data, I wouldn’t say “tremendously” in real terms. (5) is true, but could again be compensated by lower reservation wages. Assuming reservation wages don’t fall below the minimum wage, which seems unlikely for jobs that require skills in the first place.

In general, the corporate profits picture seems inconsistent with a story of just a marginal cost curve hopping sharply leftward.

13 Mike September 14, 2011 at 9:27 am

They already have.

The new jobs added in the past year have lower wages than the jobs that were lost in the past year, and lower than those lost at the peak of job losses.

14 Nemi September 14, 2011 at 10:06 am

Good. So the recovery is going strong then I assume? Just hope the labor supply, through workforce participation, adjust quickly enough so that we won´t get soaring inflation from the upcoming boom.

15 Mike September 14, 2011 at 10:54 am

I didn’t say the recovery was going strong, only that there is more wage flexibility than people claim. I agree with Tyler (if I understand Tyler’s opinion) that search frictions are the major source of labor unemployment. Among these frictions, being anchored to underwater houses seems substantial to me.

I’m job searching now with a fresh MBA, and I’ve discovered I need to be willing to do a nationwide search to have any chance of finding a job.

16 Matt Waters September 15, 2011 at 2:13 am

From the standpoint of the employer, it does not matter what they can “afford.” It matters what they need.

Let me make up three classes of occupations with three different type of wage flexibility.

1. The farmer-type self-employed. For farmers and other self-employed, their labor clears like oil in tankers or food on store shelves. Farmers are in control of whether or not they work. If the demand for wheat declines, they won’t be out of a job and their hours won’t go down. They make the same amount of wheat for less money.

2. Collectively-bargained and public-sector workers. The other extreme. If demand or tax revenue declines, then the employer is almost certain to do layoffs or cutting hours/furloughs instead of across-the-board wage cuts. So far, unions have been fine with cutting hours but then go crazy if employers try to cut their nominal wages, either directly or asking employees to pay more for their benefits. These wage cuts happen extremely slowly or painfully if they happen at all and for this class of workers, lower AD or lower tax revenue IS higher unemployment or higher underemployment, ie less hours or furloughs.

3. Nonunion private workers for companies. In between the other two in wage stickiness, the private companies have pretty much nothing legally stopping them from doing nominal wage cuts. According to many classical economists, such wage stickiness would not last very long for this reason.

So, AD shouldn’t matter for #1’s employment. AD should REALLY matter for #2’s employment, where wage cuts are just about impossible. The only way to save their employment during declining AD is for them to somehow become much more productive. More productivity means the same AD equals more products and thus more employment.

#3 is where it gets interesting. Wage flexibility here depends on many factors but the empirical evidence points to them being closer to #2 than #1, at least for workers for decent-sized businesses. The reason why is that decent-sized businesses very rarely cut nominal wages in practice. And when ALL employers do not cut wages, then the reservation wages of the unemployed DO NOT MATTER.

In a certain sector, if a worker makes 20 widgets/hr. and makes 20 dollars/hr., then the employer cannot price widgets for under one dollar an hour without reducing the worker’s nominal wage. So if demand drops for widgets where widgets should be priced less than a dollar, the employer has to either cut nominal wages or cut hours/employment for widget makers. And if ALL widget makers don’t cut nominal wages, then no widget goes to below one dollar in price and no widget maker is hiring because they do not have the widget demand to justify a new employee. Either a new widget maker needs to start up paying 10 dollars/hr. to unemployed widget makers or the current widget makers have to somehow cut nominal wages for the currently employed to decrease widget prices enough to raise widget demand enough to keep widget makers at full employment.

And like #2, a real productivity gain gets around the sticky wage issue. A productivity boom could drop widget prices substantially and increase widget demand more than the productivity increase. That means the unemployed widget makers find work.

But I have seen ZERO evidence that a central bank properly committed is unable to raise AD and also get around the sticky wage issue. While a real productivity boom might get around sticky wages for #2 and #3 above, why the hell would we depend on a productivity boom which may or may not happen instead of central bank action which is sure to reduce AD-driven unemployment?

17 Kevin Donoghue September 14, 2011 at 8:57 am

“IS-LM has a quite primitive or indeed non-existent treatment of the banking sector; Stephen Williamson stresses this point.”

Whereas NK models do? Come off it. Modelling the banking sector may fascinate Stephen Williamson and good luck to him, but it’s hardly a mainstream concern. I recently bought Benassy’s new textbook, which comes with a glowing blurb from Bob Lucas: “An encyclopedic achievement.” But no mention of the banking sector at all.

There’s a note of desperation in your posts on Keynesian economics these days.

18 Andrew' September 14, 2011 at 10:52 am

Banking not a mainstream concern? Someone inform the Ben Bernank.

19 Kevin Donoghue September 14, 2011 at 11:43 am

Didn’t Ben tell you? “Whether or not they use the name, most macroeconomists use something like IS/LM to organize their thinking about how various events affect aggregate demand.”

20 Kevin P. September 14, 2011 at 9:09 am

At the risk of appearing out of touch. Please define “AD driven recession” What does AD stand for. Thank you

21 Norman Pfyster September 14, 2011 at 9:20 am

Aggregate demand.

22 Kevin P. September 14, 2011 at 9:20 am

Thanks Norman

23 Andrew' September 14, 2011 at 9:49 am

Attention Deficit…what were we just talking about?

24 B.B. September 14, 2011 at 9:26 am

On point three, Roger Farmer at UCLA and Robert Hall at Stanford have tried to combine labor search models with old style Keynesianism and neo-Keynesianism respectively.

Farmer recommends that the Fed do QE with the stock market instead of Treasurys (using ETFs presumably). HIgher stock prices, lower risk premium, higher Tobin’s Q, more investment. Well, it is not like anything else is working well.

25 Tim S September 14, 2011 at 10:10 am

This, and then some. If macro is to emerge from its oubliette, it will be based on the work of folks like Farmer.

26 Ram September 14, 2011 at 9:48 am

Tyler, what do you make of this:

http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=GDP&scale=Left&range=10yrs&cosd=2001-04-01&coed=2011-04-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=a&fq=Quarterly&fam=avg&fgst=lin&transformation=lin&vintage_date=2011-09-14&revision_date=2011-09-14

Aggregate demand fell way below trend precisely when the unemployment rate began to spike, real growth began to slow, disinflation bordering on deflation commenced, etc. This drop was the biggest (in relative terms) in the postwar period. It is rising again, but we’re still well below the pre-crisis trend level. What would you expect the US economy to look like today under these circumstances if you were a New Keynesian? Wouldn’t you expect various indicators to behave much as they have been behaving? And even to the extent that there are problems on the supply side (which there surely are), wouldn’t you expect that to be one medium-term outcome of a severely under-treated aggregate demand shortfall?

And what do you make of David Glasner’s observation that stock prices and inflation expectations have been unusually highly correlated throughout this crisis? If variation in inflation expectations is explained by variation in aggregate supply expectations, then we would expect stocks to fall on higher expectations, not rise. And yet we’ve been seeing just the opposite. It looks like stock traders care a lot about aggregate demand, not so much about aggregate supply. I know you’ve said that you believe there is an aggregate demand shortfall, but when you try to grapple with how huge that shortfall really is, and how generally consistent events have been with a New Keynesian story of what the consequences of that should be, it’s hard to think that the structural stuff is playing a big role here, or that more aggregate demand wouldn’t help address those issues as well.

27 josh September 14, 2011 at 10:01 am

“calls for a pragmatic methodological pluralism” = “calls for whatever sophistry justifies my political apetite.”

Tyler, could you please address when pseudo-libertarian status-whores will admit “By now it is a growth and structural problem, not mainly AD and these structural problems are greatly exacerbated by the infinite supply of low wage labor streaming across the border.”

28 NAME REDACTED September 15, 2011 at 6:55 am

No actually, people running across the border is actually good for US AD.

29 Donald Pretari September 14, 2011 at 10:17 am

At what point do we admit we’re waiting for the Next Bubble and the continued growth of Financial Services?

30 David R September 14, 2011 at 10:42 am

It may be that both views are correct. An AD deficiency which causes a long term recession may turn into a “structural” recession as the low income groups, the long term unemployed and the imbalance between employer needs and employee skills becomes large and permanent.

Those who believe that the longer a recession or slow recovery takes, the less effective an AD solution will be may have the right model. Policy in 2009-10 that was insufficient and has the wrong composition may have been the only chance to have averted a long term stagnation. Applying the correct policy for 2009 in 2012 won’t work.

Economics is dynamic and evolving, not static

31 o. nate September 14, 2011 at 2:26 pm

Another factor that could contribute to an initially AD-driven recession turning structural: the loss of geographic mobility caused by underwater mortgages. We already see a wide dispersion in unemployment rates, with North Dakota at 3% and Nevada at 12%. If underwater mortgages are dampening the usual geographic mobility of the workforce, that could be a structural change that raises the natural rate of unemployment, at least until the housing market recovers.

32 george September 14, 2011 at 10:59 am

Economics = alchemy. Ah, Keynesians and their beloved, monolithic aggregates and magestic math. So elegant and so pointless. All of it, a fancy way of saying, “Yeah, yeah, yeah, more G, brah…trust me. Animal spirts, charts, equations, velocity; look, it’s all very technical, but, I’m telling you, more G. That’s the ticket.”

“Oh, it didnt work? Clearly there wasn’t enough G, brah. Pfft, everyone knows that.”

33 Guy in the Veal Calf Office September 14, 2011 at 2:13 pm

So, you’re saying macro is kind of like: “how do two masses exert force on each other?… my derivative math model says ‘by exchanging particles in a gravitational field’…But we don’t see any particles…c’mon, postulate a graviton virtualparticle with zero mass and you’ve got elegant, majestic gravitational field theory….but your gravitational field can’t predict a lick at Planck….Yah brah, check out my 14 dimensional string theory…etc”?

Like that? Why does Caplan want these guys running things?

34 Michael September 14, 2011 at 2:51 pm

Keynesians using an IS-LM model aren’t the ones basing things on “magestic math.” That comes from the RBC side of Macro with their DSGE models (based on the early work of guys like Ed Prescott). The New Keynesians basically use those same DSGE models, just with prices (and price stickiness) tacked on (this is what guys like Greg Mankiw got famous for doing).

IS-LM is a far cry from that mathematically. As Krugman says, “you’re going from simple diagrams to 60-plus-equation derivations.” IS-LM is really just simple diagrams. Here the “60-plus-equation derivatives” refers to New Keynesian models, but those are just RBC models with an extra equation or two, so the 60-plus-equation critique is equally valid for the RBC guys as it is the NK people.

The “simple diagram” nature of IS-LM is why Krugman works with it first. You can do it in minutes! It’s also why he then moves on to a “stripped down NK” model….to avoid all that math. That “magestic math” (I prefer the term “stochastic calculus porn”*) is not the product of Keynesians at all, and is only an aspect of New Keynesian modeling due to the influence of the anti-Keynesians who made fun of IS-LM for not having that “magestic math.”

And, it is probably due to the lack of that “magestic math” is the reason that, “The old Keynesian approach has a major presence in the blogosphere but much less influence in current academic macroeconomics.” You can’t impress your colleagues or get published doing macro work without doing all that “magestic math” and since IS-LM doesn’t have that, it doesn’t get much attention.

Point being, if anyone is basing results on “magestic math” it sure as heck ain’t the Old Keynesians.

* from this great post by Arnold Kling:

“Graduate macro is even worse. Have the courses that use representative-agent models solving Euler equations been abolished? Have the professors teaching those courses been fired? Why not?…the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men’s urge for mathematical masturbation.” Here, Kling is deriding the DSGE models of the RBC school, and likely also the New Keynesian modelers who adopted that very “stochastic calculus porn” technique, and implicitly is calling for a return to the much simpler IS-LM approach that Krugman reveres.

35 Jean September 14, 2011 at 11:00 am

AD is back folks, and at higher levels than pre-recession. Mark Perry at Carpe Diem has the charts.

36 spencer September 14, 2011 at 3:49 pm

Personal consumption expenditures is back to pre-recession levels, but that is only part of AD.
A better measure of AD is final sales to domestic customers or final sales of domestic product and both of those measures of AD — that include PCE — are still far below pre-recession levels.

37 zatarra September 14, 2011 at 11:28 am

Aren’t you worried about being called the dumbest person on the planet by Brad Dewrong because this post?

38 Jim September 14, 2011 at 11:58 am

Sorry, Keynesians: the science is settled.

39 E. Barandiaran September 14, 2011 at 12:27 pm

For all Keynesians –Old, New, Reborn, Recycled– a simple lesson from Public Choice:

The goal is to save one job, his own.

40 E. Barandiaran September 14, 2011 at 12:44 pm

Angry? Please direct your anger toward people like Tim Geithner, a servant to the fraudulent-clown-in chief, who has just said:

“You have this terribly damaging political dysfunction here and in Europe that leaves the world wondering whether the political system has the capacity to do the right thing,” he said. “That is very damaging to confidence.”

41 Lord September 14, 2011 at 1:33 pm

The filp side of AD is unused capacity which is why it takes long to adjust, more of the same can be produced from productivity improvements alone and more investment is unnecessary. This means high profits for encumbants that are not competed away because everyone knows the encumbant can always undercut them if they had to. The combination of low inflation and productivity growth result in little to no progress in price adjustment. The entirety of growth must be borne by innovation which is small and slow, especially now. The wealth loss means debt liquidation will proceed for an extended period of time, doubly long since collateral values aren’t there to lower rates and risk premiums are greatly enhanced. Those are structural but ones that could be fixed monetarily with a sufficient money drop but probably not otherwise with conventional policy since there is little reason to borrow by anyone with the capacity to do so and little capacity to borrow by those with reason to. Game over.

42 Chris R September 14, 2011 at 1:38 pm

There’s actually been quite a bit of (3) going on; the main reference here is Gertler and Trigari, “Unemployment Fluctuations with Staggered Nash Wage Bargaining,” JPE, 2009. Variants on that are getting a lot of play on the conference circuit. My own take is that yes, nominal wages are sticky, and their model fits both the micro and macro facts on real wages (or labor’s share). I’m a bit more skeptical of the propagation mechanism; the staggered bargaining model over nominal wages has very strange predictions regarding the long run relationship between inflation and employment. There’s more work to be done as to how relevant sticky wages really are, and the really convincing evidence will come from the micro literature.

What these models really lack is an interesting source of shocks. Everybody’s all hung up on productivity shocks or shocks to inflation (or worse, Taylor rule shocks). Old Keynesians got away with simply saying things like, “Consumers (or investors) simply freaked out.” New Keynesians can’t get away with saying such things. Maybe the “New Old Keynesians” like Farmer are on to something after all.

43 E. Barandiaran September 14, 2011 at 1:55 pm

Since you are familiar with this new research, I’d appreciate greatly any reference to research dealing with Tyler’s point (3) in the context of an open economy. Thanks.

44 Chris R September 14, 2011 at 5:51 pm

That part of the literature seems to be pretty open as far as I can tell.

45 Dan H. September 14, 2011 at 1:47 pm

I don’t think you can understand Krugman without acknowledging that he has a very strong, personal bias towards interventionism. He has even admitted in interviews that he chose economics as his profession because he was enthralled by Hari Seldon, Isaac Asimov’s ‘psychohistorian’ who used his vast knowledge of economics and human behavior to scientifically control the economy and lead it to better outcomes for all people. Krugman sees himself as an Olympian savior, using his giant intellect to push and pull on the levers of the economy to make the world a better place.

With that mindset, he is going to be strongly disposed to believe in Keynesianism and other interventionist theories, almost regardless of the evidence against them. You could drop a mountain of evidence on him that what the economy needs most is to be freed from the shackles of control and manipulation and it will fix itself, and he would simply find a way to denounce it.

A key rule in critical thinking is to always be more wary of accepting ideas that would lead you to action that you would prefer to take even if you were ignorant of the idea. Keynesianism is a powerful theory to someone who already believes that economists should be the stewards of the macroeconomy. It gives them the justification and the tools to do what they already want to do.

46 sam September 15, 2011 at 6:51 am

You say, “…You could drop a mountain of evidence on him” in reference to Krugman. So i turn the question on you: At what point do you stop believing that free markets don’t work as described by the models? Would you like another dose of 2008? Another bubble? Did I hear Great Moderation? The problem, as I see it, is there IS NO MOUNTAIN OF EVIDENCE that deregulation will save the economy. Instead, there seems to be a plethora of evidence going the other way.

It’s so easy to throw your hands up and walk away from the problem if you’re an economist who believes in structural unemployment(or just tell people to major in nursing and engineering). It’s second nature for someone who is blind to the outside world and relies heavily on mathematics for his satisfaction. A lot of economists fool themselves into thinking that the nature of the problems they deal with are similar to the problems of the natural sciences. They forget that the economy’s problems are man made problems and that man made problems can in fact be solved at least partially. If you don’t believe in interventionism, but still believe that economics is a science then don’t go to the doctor. Maybe your brain will return to equilibrium after being shocked by an aneurysm. Perhaps an invisible hand will magically remove that clot and save your day.

47 kevin quinn September 14, 2011 at 2:27 pm

Tyler gives us a false alternative: either sticky prices explain an increasingly lengthy recession (implausible, I agree) OR we need an RBC explanation – potential output is lower. The exclude alternative is coordination failure. Look at what Farmer is doing – and he is using DMP search models. Coordination failure (multiple real Pareto-rankable equilibria) can explain, uniquely, long periods of suboptimal real output and employment.

48 Chris R September 15, 2011 at 4:44 am

That’s exactly it.

49 mulp September 14, 2011 at 2:44 pm

Which version of Keynesian theory describes actual success in stimulating job creation: hike taxes on the people with too much money not being invested and use that tax revenue to build things everyone needs like roads, bridges, water,sewer, power grids, telco, schools, universities, R&D?

In the 30s, taxes were hiked and hiked and hiked, and while that was deemed a failure, if jobs were created at the same rate as FDR’s first two terms, employment today would be 30 million higher.

And lots of taxes were levied on consumption of luxury goods because that was seen as money to be invested in productive assets like roads and bridges.

Reagan cut taxes in 1981 to stimulate the economy but drove unemployment to the highest rate since the 30s, but then Reagan agreed to hike taxes, including a doubling of the gas tax to pay for investment in transportation, and the economy turned around.

The economy of the past fifteen years has been rather hollow with “investment” meaning pouring money into a ponzi scheme called the NASDAQ tech bubble or real estate.

The only thing that propped up the economy while Bush was president was the government spending in roads and bridges and the disaster response to the Katrina et al broken windows, plus the cost of breaking windows and building cities in Iraq using US workers to house US personnel.

I can’t find any record of tax cuts creating jobs in the US because tax cuts prevents government from investing because you can’t borrow to invest if you can’t repay the debt. I remember when local and State governments very directly debated tax hikes tied to debt issue tied directly to building schools or building water systems. States and Federal debate on the gas taxes were tied directly to building roads and bridges using debt to be repaid with those taxes.

Keynes described policies already enacted in the US: hike taxes to take money from those refusing to invest and invest in public infrastructure immediately with borrowed money to be repaid by those tax revenues.

How it became distorted into cut taxes to put more money in the pockets of people who are refusing to invest is the puzzle to me.

Why does any economist still believe that cutting taxes to promote investing in ponzi schemes like real estate and stock market bubbles after we have seen that end disastrously three times in three decades?

50 Bernard Guerrero September 14, 2011 at 7:08 pm

“Reagan cut taxes in 1981 to stimulate the economy but drove unemployment to the highest rate since the 30s, but then Reagan agreed to hike taxes, including a doubling of the gas tax to pay for investment in transportation, and the economy turned around.”

Tendentious reading, at best. I’m pretty sure some dude named Volcker was doing something or other around that time that _might_ have had something to do with that recession….

51 NAME REDACTED September 15, 2011 at 6:58 am

No… forcing interest rates as high as 18% couldn’t have caused a recession /sarcasm.

52 David R September 14, 2011 at 2:55 pm

Actually Keynesian Economics died earlier, it’s demise has been announced and its death is chronicled in this post here

http://dismalpoliticaleconomist.blogspot.com/2011/09/rick-perry-announces-death-of-keynesian.html

53 nic September 14, 2011 at 3:42 pm

Tyler, I expect the longer that these economic issues continue the more credence Keynesian ideas will gain, as was the case after the great depression.

54 E. Barandiaran September 14, 2011 at 8:32 pm

Tyler, I have a question for you and all readers familiar with the Keynesian and non-Keynesian models that were used to assess Obama’s jobs program as announced on Thursday, September 8. At that time he didn’t say how he was going to pay for it but last Monday (September 12) he proposed to increase taxes. Assuming that you have reviewed the differences between the initial estimates of the program’s effects on employment and the new estimates taking into account the proposed tax increases, please identify the structural assumptions of the models that explain the differences between the two sets of estimates.

We can discuss forever how good or bad a particular model is, but since at best macroeconomists are engineers pretending to solve important social problems, it’s better to discuss particular “predictions” of the alternative models. I don’t agree with Friedman’s methodological position, but a comparison of “predictions” is useful to understand how the models work (if macroeconomists were scientists, they would be interested in understanding how the world economy works).

55 Lord September 14, 2011 at 11:20 pm

The big New Keynesian mistake is it assumes reduced prices will increase demand, but at times like these they will only go towards reducing debt, as demand elasticity negates. This will hold true as long as people are uncomfortable with their level of debt and insist on reducing it.

56 NAME REDACTED September 15, 2011 at 6:59 am

If that is the case, then there is no way to end the recession without digging away the debt first.

57 NAME REDACTED September 15, 2011 at 7:00 am

Or liquidating it.

58 Lord September 15, 2011 at 4:01 pm

Or filling it in with a money drop. I’m not holding my breath.

59 Andrew Luscombe September 19, 2011 at 2:19 am

You can pay individuals to take on more debt resulting in either an overall increase in debt or a slower overall reduction. There are a lot of individuals in different positions and some of those can be influenced. Schemes like Australia’s first home buyer grant and home builders grant encoraged enough young people to take on $400,000 debt for a cost of $7,000 each, and many of those to build a $400,000 home for $14,000 that the total debt and AD went up. The government has nothing to loose, because if there are no takers, there is no cost, and any taker will be adding many multiples of the grant to AD. I know that the US has a surplus of houses, so you wouldn’t tie the grant to loans for housing, but grants for loans to purchase cars, RVs, boats, or for other organisations to take out loans to build things like universities and schools to build new buildings, or whatever, even grants for having babies have been successful in encouraging people to buy stuff (as well as ameliorate population imbalances).

You can also take money from people who aren’t spending it and spend it for them.

60 JimV September 15, 2011 at 5:25 pm

In answer to question 1, when the economic policy being followed is “the beatings will continue until morale improves”, pretty much forever. See Depression. Great.

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