Scott Sumner is now blogging

He is a very smart monetary economist at Bentley.  The blog is here.  Here is a very good post on Keynes's General Theory; excerpt:

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.

And this:

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.


Is clicking under the fold such an issue? The blog works for me.

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Bentley College

Bentley University

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The point about the long run seems idiotic too me. It only is true if there were no shocks to the economy in the recent past. There is no reason to believe we are in some steady state equilibrium today as the result of past policies.
Not that the other comment you quote makes more sense. That confuses temporary tax cuts with all fiscal policies.

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Re: “Krugman argued that temporary increases in the money supply will be hoarded, leaving AD almost unchanged.†

It appears to be high powered money that is being hoarded, as the banking system’s excess reserves have soared to $.8tn & growing. (Bernanke’s $1tn TALF will swell these yet more.) The AD impacts are comparable in the absence/shortage (relative to reserves) of credit-worthy and credit-desiring customers for the expansion of credit and thus also of money by the commercial banking system.

Elucidation on what I’m missing? Thanks.

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Interesting blog, as an econ grad student you don't get to see much of old-school Friedman-type monetary thought (I guess Keynesians would be the old old school, and Swedes/Austrians would be the really old school...) But I still don't see that this approach is obviously more relevant to today. Today's problems are a result of credit overexpansion, debt, leverage, illusory wealth... how do those things fit into his framework?

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Why is economics so married to its rational expectations theory?
Is there any other non-rational expectation theory making better prediction?

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One way to view rational expectations is as a formalization of the famous Lincoln quote "You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time." Or you can view it as a kind of internal consistency requirement. Why should anyone believe your model's predictions when one of the assumptions of the model is that people don't believe it?

Prior to the RE revolution, economists had known and incorporated in their models the idea that monetary policy could have a real effect only to the extent that it was not anticipated. It was common to bow in that direction by using some sort of adaptive expectations. Everyone but the far-left crazies had to acknowledge the force of Friedman's argument that the long-run Phillips curve is vertical, because people would eventually figure out the Fed's game.

Rational expectations just takes that insight a step further. If a policymaker exploits agents incorrect expectations to further his own ends to their detriment, it simply makes sense that those agents will try to figure out the policymaker's game and respond accordingly. That's the important idea in RE, and how anyone can object to it is beyond me. Sure, it may be that few people habitually solve Euler equations in their heads, but Friedman's Positivist Economics addressed that a long time ago.

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I do think it is useful to understand how it is that financial problems may have caused a drop in velocity and aggregate expenditure. However, it should not be assumed that the economy can only recover if those problems are fixed. Or, even, that they should be fixed in order to prevent a repeat.

For example, it is easy to come up with arguments that stock market speculation can result in fluctuations of aggregate expenditures given some kinds of monetary institutions. But I think the solution is to develop better monetary institutions that maintain total expenditure in the face of fluctuations in the stock market rather than attempt to stablize the stock market. I think it is interesting to understand how stock prices could have that effect. But, I would not accept a notion that one must allow aggregate expenditures to remain depressed (or excessive) until stock prices are somehow corrected because that is the "real" cause of the problem. Nor do I think it is necesary to understand exactly how it happens to correct the problem.

Why is it that past patterns of federal funds targetting are not resulting in the usual response of nominal income? Interesting question. But, the fact that the target for federal funds is near zero and past practice would suggest it needs further lowering, and zero appears to be a lower bound doesn't mean that we must understake a massive, debt financed government spending program or else leave the economy in recession. Federal funds rate targetting needs to go.

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He said that all Ratex really means is that if you build a model of the economy assuming the world works one way, it makes no sense to assume that people in the world believe it works another way.

It makes no sense to assume that people can be wrong about the way the world works? Am I misreading that sentence? People being wrong about the way the world works is the historically normal condition. If your model assumes that people expect housing prices to rise indefinitely, it must also assume that housing prices actually will rise indefinitely? That view might have made you popular circa 2005, but you can expect to get laughed at trying to advance it today.

If you want the model to represent reality, the model's assumptions about people's expectations should track the way people actually form expectations. If this turns out to be different from the way the model actually works, that's not an inconsistency, it's an instance of the sentence "people are fallible".

It really seems like you're building models of human behavior with practically no knowledge of human psychology. How can this possibly produce a useful model of human economies? (An interesting theoretical point falls out of this question: nonhuman economies could, and probably would, be systematically different than human economies because of the different behavior of the agents that make them up. Since we don't have any nonhuman societies to compare to, though, xenoeconomics can't presently advance beyond the speculative stage. Similar remarks apply to politics and sociology.)

In a world where people uniformly form rational expectations that accurately reflect the way that world actually works, how could there be a book called Extraordinary Popular Delusions and the Madness of Crowds, except as fiction? How can Ratex explain each of the actual historical sequences of events described therein?

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The definitions of long-run and short-run are way off. I always remember long-run being defined as however long it takes for material resources to be 100% flexible. The time that the "long-run" takes ranges from several seconds as in stocks and bonds to years as in oil production.

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