Month: March 2009

I hadn't known that Keynes had a brief protectionist period:

Keynes's 1933 writing on "National Self-Sufficiency" marked the furthest point of his departure from the idea that free trade promotes peace…"National Self-Sufficiency" argued against free international mobility of goods and capital on the grounds that such mobility could endanger peace; that gains from the international division of labour had diminished; and that such mobility placed individual economies 'at the mercy of world forces.'  Keynes proposed a gradual move towards greater 'economic isolation' and 'national self-sufficiency.' in goods and finance.  His motivations included his desire for Britain to fight unemployment with expansionism, which required free from 'interference from economic changes elsewhere'; and his new belief that 'economic internationalism' was inimical to peace.

That is from Donald Markwell's generally quite interesting John Maynard Keynes and International Relations: Economic Paths to War and Peace.  And you will find the essay here.  Keynes, of course, did snap out of that phase.  One thing I learned from this book is that international relations is the key topic for tracing the evolution of Keynes's thought over his entire career.

Much of the debate over fiscal policy has occurred in Keynesian terms but its worth pointing out that it's perfectly reasonable to discuss fiscal policy in a monetarist framework.  Start with the quantity theory of money MV=PY, money times velocity equals prices times real output.

In the long run we know that real GDP is pinned down by real factors (labor, capital, technology, institutions and so forth) so increases in M will increase P proportionally.  But in the short run there are plenty of reasons to think that increases in M can increase Y – this is accepted by monetarists, Austrians, rational expectation theorists (ala Lucas) for unexpected changes in money, Keynesians and new Keynesians (only originalist RBC type theorists would object.)  But M and V enter the equation in an identical fashion and thus logically must have the same effects for the same change.  Thus if you think money is potent then V must be potent as well and V is fiscal policy.

To be precise, V is how fast money turns over and we can think about shocks to V as spending shocks.  Spending shocks can be driven by consumers or by the government – this is what Brad DeLong means when he says "the government, in this respect, is just like any other group of starry-eyed optimists whose eagerness to spend pulls the economy into a high-employment, high-pressure boom."

One way of understanding the current recession is that V has fallen by a lot and it is dragging down Y (just as would a sharp fall in M).  We can counter with an increase in M (monetary policy) or by an increase in V (fiscal policy).

Now we might think that V driven by government is too slow or too wasteful (ala Kevin Murphy (pdf)) to work well or we might think that neither increases in V nor increases in M would be as effective as Keynesians imagine since there is also reverse causality (falls in Y and expectations of slower growth in Y are reducing M and V).  We could pursue the last point to its fullest and abandon the quantity theory altogether (making V an endogenous function of Y, for example, and removing it as an independent variable).  But if we hew to the basic ideas of the quantity theory–and remember, it's not a true model only a way of looking at the world!–then fiscal policy is not impossible.

Here are some slides from Michael Mandel, he says yes it was an illusion.  Matt Yglesias has a good summary of his argument.  Median wages were stagnant, the stock market was down, and health care costs were rising, without necessarily translating into better outcomes.  Mandel argues that the current collapse in part stems from the revelation that productivity growth (and no, he doesn't trust the reported numbers) was low all those years.  On top of all that perhaps productivity growth in finance was overstated as well.

My take is this: there was some productivity growth but much of it fell outside of the usual cash and revenue-generating nexus.  Maybe you will live until 83 rather than 81.5 and your pain reliever will work better.  In the meantime you will read blogs and gaze upon beautiful people using your Facebook account.  Those are gains to consumer surplus, but they don't prop until the revenue-generating sectors of the economy as one might have expected.  Given that, the rest of Mandel's argument can still work, whether or not you think the productivity gains were a mirage in some absolute sense.

The worry is that if the government cannot or will not extricate itself
from Fannie and Freddie, it will face similar problems should it
eventually nationalize some large banks.

Here is more, interesting throughout.

He has written on inflation (ha-ha), so why not Arrow-Hahn-Debreu?  The most interesting part of the paper starts here (p.29):

We can now turn finally to the role of gauge invariance in economics. The proposal that gauge theory is essential for making progress in economics was made by Malaney and Weinstein[8]. I would now like to argue that there are deep and compelling reasons why the extension of economic theory to incorporate out of equilibrium behavior should centrally involve the kinds of gauge invariances they proposed.

Here is a short essay on gauge invariance.  He also endorses agent-based modeling.  I didn’t “get” where this paper is headed (OK, you put in gauge invariance but comparative statics are still hard to predict a priori), but I’m always interested to see how top minds approach the foibles of the economic method.

I thank Michael F. Martin for the pointer.

Better than nothing:

A new internet-only exchange, the so-called Deposit Exchange, has
opened in Ukraine. It enables people whose bank deposits have been
frozen in banks of questionable solvency to sell the money in those
deposits at a discount. The buyers of the frozen deposits, although
they cannot withdraw the money, can use the full value of the deposits
to cover the value of loans issued by the banks for home, car and land
purchases on which customers have defaulted, and thereby take
possession of the repossessed property. Currently the discounts on
buying a frozen deposit are in the range 10-34% (Lenta.ru, in Russian).

I thank Matthew Bown for the pointer.

The post is here, excerpt:

My view, which I thought was pretty clear, is that the liquidity trap
is real: no matter how much the Fed increases the monetary base, it has
no effect, because it just substitutes one zero-interest asset for
another. If the Fed could credibly commit to inflation at rates higher
than the 2-ish percent target it’s already believed to have, that would
be effective. But right now I don’t see that as a realistic option,
hence the emphasis on fiscal policy and bank recapitalization.

Sumner outlines in detail a number of ways the Fed might increase aggregate demand, through monetary operations, without simply substituting one zero-interest asset for another.  So I don't yet see how Krugman has responded to or even recognized Sumner's points.  It also seems that the Fed can announce an inflation target of, say, four percent a year.  That may not be one hundred percent credible, but if presented as an alternative to the trillions of dollars of bailouts, I believe it could be reasonably credible (and indeed popular) and of course it would become more credible all the time as the Fed's monetary policy was observed.  Bennett McCallum has written persuasively on how to establish central bank credibility when such a course is welfare-improving.  Sumner himself wrote:

One key to making the policy credible (as many have already argued) is
to set an explicit nominal target, and commit to make up for any
shortfall this year with even faster nominal growth in the future (and
vice versa.)  I know that your [Krugman] expectations trap argument raises
questions about credibility.  But explicit targets tend to be more
credible because it is embarrassing for policymakers to go back on
their word–they don’t like to lose credibility (for good reasons.)  And
Bernanke, et al, already have reputations very different from the
members of the BOJ.

I don't myself agree with all of Sumner's points (especially his causal account of what happened), but again I don't see that Krugman has responded to the substance of the letter.

I should add that I don't think anyone (I'm not talking about Krugman here) has responded to the claim that quantitative easing, and other monetary reforms, could substitute for a very expensive fiscal stimulus.  (It's much more common to bash "the Treasury view.")  Usually there is simply a brush-off to the effect that we already are trying some monetary innovations.

Addendum: Arnold Kling offers comment.  Sumner responds too.