« When are there NO gains from trade? | Main | The peanut theory of recessions »


Feed You can follow this conversation by subscribing to the comment feed for this post.

Yes, I've been making the same argument, albeit not using the IS-LM model (which I don't understand.) Perhaps the reason I never understood the model was it seemed to imply tight money raised real interest rates, and it clearly didn't in the 1930s, or today.

Nick, You keep stealing my comments. You said:

"Now lets just add one twist to the standard story. Suppose the monetary shock is not about today's money supply and/or demand, but is news about future money supply and/or demand."

I was about to pounce, to say "that would be the only type of monetary policy that really matters."

And then at the end you said:

"And current monetary policy is not something that can be separated from expected future monetary policy. By far the most important part of current monetary policy is expected future monetary policy. An expected future monetary tightening is a current monetary tightening. Monetary policy consists largely of managing people's expectations about the Aggregate Demand curve."

Your perfection is making it hard to find comments.

King showed in 1993 that in a dynamic forward-looking IS-LM model with ratex, tight money can reduce real rates. I'm horrified that most new Keynesians still don't seem to understand this.

Scott: yes, you were standing at my shoulder when I wrote this. Translating you into ISLM. (I have a certain fondness for the ISLM model. It is very flexible, and able to portray a number of different views).

"I'm horrified that most new Keynesians still don't seem to understand this."

I'm not sure if they understand it or not.

How does all of this relate to the point Krugman made in "Japan's Trap"?

Monetary policy: It may seem strange to return to monetary policy as an option. After all, haven't we just seen that it is ineffective? But it is important to realize that the monetary thought experiments we have performed have a special characteristic: they all involve only temporary changes in the money supply.

. . . A permanent as opposed to temporary monetary expansion would . . . be effective - because it would cause expectations of inflation.

Tom: it's related, but a bit different.

In Paul Krugman's model, the original problem (the "shock") was an increased supply of saving that caused the IS curve to shift left and forced the natural real rate of interest down to zero. In my post, the (very short run) IS curve shifts left because expected future monetary policy is tightened.

Plus, I would add to what Paul said as follows: ". . . A permanent as opposed to temporary monetary expansion would . . . be effective - because it would cause expectations of inflation. *and it would increase expected future real income also*"

I'm not sure how many don't understand either, but it seems like a lot. I frequently confronted Keynesian arguments that 1929-30 couldn't have been tight money, because interest rates fell. And of course that seemed to be the standard Keynesian view of 2008. I seem to recall a certain NYT columnist frequently saying "This wasn't like 1982, a recession caused by tight money by the Fed." But why not?

BTW, what's wrong with you other commenters--this is a important post! Where are you?

Scott: they are all over at your place, fully employed commenting on your massive quantity of good quality posts this last few days!

Nick: It just shows that people prefer sensationalism over substance. Anyway, I'm going back to one a day.

Future monetary tightening causes desired investment and consumption to decline in anticipation of a decline in future income, sales, etc. Gotcha.

Wouldn't the expectation of a future upward LM shift cause the demand for liquidity to increase in the current period, shifting interest rates today?

This is fun. The central bank of IS/LMylvania must have outstanding credibility - the citizens do its work for it. It's barely even necessary. All the government needs to control inflation is a spokesman who will occasionally say, "If you don't do this, we're going to make a central bank."

The comments to this entry are closed.

Search this site

  • Google

Blog powered by Typepad