Has the Keynesian IS-LM model made good predictions lately?

I’ll skip context and links and cut right to the chase.  Reinhart-Rogoff and nominal gdp perspectives and TGS views also have been predicting a slow recovery, so while IS-LM has done OK here it wins no special prizes.

What about the “no crowding out” prediction?  Since at least the early to mid 1980s, it has been well-known in macroeconomics that U.S. budget deficits do not forecast real interest rates very well and that includes under periods of full or near-full employment.  Here is a brief survey by Alan Reynolds on the topic (you can follow up on his references), and he is usually considered a villain by the Keynesians and so he is hardly a Keynesian himself.

There may be a few reasons for the general lack of a connection between deficits and real interest rates in the United States:

1. The supply of capital to the United States is fairly elastic, either domestically or internationally.

2. We don’t have good identifying restrictions on the empirics in the first place.  For one thing, controlling for monetary policy is tricky.

3. We haven’t yet seen budget deficits big enough to matter.

4. We are not measuring budget deficits correctly because what matters is the consolidated fiscal stance of the U.S. government, a’la Robert Eisner.

5. Ideas related to Barro’s Ricardian Equivalence hypothesis.

Anyone — Keynesian or otherwise — paying attention to the last thirty years of empirical macro never expected much crowding out of financial capital in the first place.  It simply has not been in the cards.

To put it more bluntly, the “no crowding out” result is not much of a predictive victory for Keynesian economics, IS-LM, the liquidity trap, and so on, even though I have read it claimed as such many times.  It is a strike against some predictors who were wrong in the first place, especially in the right-wing popular press circa 2009-2010, plus some Republicans who jumped ship on the issue, perhaps because they wanted to attack Obama.

What’s a unique prediction we might look at?  It is a common Old Keynesian claim these days, at least from Krugman, that the AD curve is upward-sloping because of a liquidity trap.  That would imply that harsh and binding minimum wage hikes, and other wage-propping mechanisms, should prove expansionary.  That claim, at least for the Great Depression, has been knocked down fairly conclusively by Scott Sumner.  If there is no comparable test on today’s data, it is because we have grown that much wiser.


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