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Aren't you assuming that government spending has never has any effect on the velocity of money?

But what of Post-Keynesians who reject both IS-LM of Old Keynesians and microfoundations of New Keynesians?

Wealthy individuals and Executives tend to have a low MPC. Provincial gvmt spending on teachers and nurses, is to the middle class which has a higher MPC. I look at it as top-tier income/corporate tax rates vs conditional transfers to the provinces. A bank or oil company is more than 10x less efficient in creating labour. There are multiplier but still, in Canada, examining the employment intensity of sectors results in policy guidance that dwarves analysis of these IS curves. We are really trying to estimate the balance sheet of human capital. For sure in a recession, we should be adding nurses and teachers (including B-2-B training), and taxing oil and finance, at present tax levels, regardless of what old Keynes says. I suspect the truth is between the theories as permanent income doesn't make much sense; sure rich people have permanent minimum incomes as their low risk portfolios.
It is as easy as looking at the google finance # of employees and looking at educator and health care labour force, and demanding best practises as you grow their workforces.

What about the actual experience of the last five years which shows that austerity in a liquidity trap is not expansionary? The Fed has a study out on this.

John Cochrane is really good on this stuff.

But then the question is which do we care about more, the old Keynesian intuition or the New Keynesian model?

Nick, as I read it your point is that the NK model doesn't stack up on its own terms regardless of what we think of liquidity traps, Post-Keynesianism etc. But just a mathematical quibble (I read this quite quickly and didn't actually write out the maths, so this might be a bit dumb). Isn't the implication of lowering the growth rate of spending to raise the natural real rate equivalent to raising its current-period level relative to its previously expected path, which is quite a standard NK result? This is in favour of fiscal stimulus and against austerity, where of course these are both strictly transitory. I feel like I'm missing quite a lot here though.

But what of Post-Keynesians who reject both IS-LM of Old Keynesians and microfoundations of New Keynesians?

Personally, I think this is fighting the last war. Today, Post Keynesians should be defending IS-LM as a better starting point for analysis.

Debates evolve. Minsky took a lot of shots at the income-expenditure orthodox Keynesians of the 1960s, but given where the front lines have moved to, he and they are now firing in the same direction.

Peter N: I am making no assumptions about velocity. This post is mostly about the IS curve, anyway, Old and New Keynesian versions.

Robert: JW gives a better answer to that than I could give. But this post is about New Keynesians.

TKG: you lost me there.

Determinant: you will understand the difference between the level of G and the rate of change of G. That's the difference between fiscal policy in old and new keynesian models.

JW: I am beginning to appreciate JC a lot more.

"But then the question is which do we care about more, the old Keynesian intuition or the New Keynesian model?"

I don't know. But I think we first need to understand the NK intuition better, then compare the OK intuition with the NK intuition. I've got a gut feel the NK intuition is trying to tell us something important too. I think the multiplier, in some sense, really is infinite. That demand comes mostly from itself. That demand really does scale up or down, and really is mostly self-fulfilling. And that the *only* thing that can make AD determinate is the quantity of money (which isn't in the NK model).

JH: "Isn't the implication of lowering the growth rate of spending to raise the natural real rate equivalent to raising its current-period level relative to its previously expected path, which is quite a standard NK result?"

*Almost*. The standard way to get fiscal policy to work in a NK model is to assume discrete time and a temporary increase in G. But the *reason* that works is that people expect G(t+1) to be less than G(t). It is the expectation of *falling* G between today and tomorrow that raises the natural rate of interest today; it has nothing to do with the *level* of G today. We could get exactly the same effects by leaving G(t) constant and reducing G(t+1) relative to its previously expected level.

Just suggesting go with Keynes macro to understand the problem but microeconomics to solve it. Pick labour intensive winners, expand Green GDP account to account regressive event and tyrannies. There's no such thing as permanent income. Maybe out to four or five years, the length of a LEAP contract. Why would you want to plan your retirement out like that even? I wanted to go to Quebec City last yr. Now it is hard to get there and I'd check out Ottawa's museums. I wanted the Spengler Cup in Switzerland until I got interested in peat and the Scottish Enlightenment. Only pensioners and disabled "people" have permanent incomes and they don't matter.

Determinant: you will understand the difference between the level of G and the rate of change of G. That's the difference between fiscal policy in old and new keynesian models.

I certainly do, and I've already covered it in previous threads. Fundamentally, it's bad modelling.

What should the government do, if there is an increased desire to save, and the central bank is unable or unwilling to cut real interest rates enough to offset it? The answer is that the government should cut the growth rate of government spending, to shift the IS curve left, which raises the natural rate of interest (i.e. prevents it falling), because the IS curve slopes up when we have the growth rate of transitory income on the axis.

Now you've talked yourself into a corner. Increased government spending is funded with increased taxes, increased borrowing, or both. Let us assume that fiscal policy is in fact countercyclical so that it is more heavily weighted towards borrowing.

The government issues debt, which is an asset for the private sector. The government itself satisfies the desire for saving through its borrowing. Problem solved. Last time I looked, Gilts were still gilts and the Government of Canada has a AAA Credit Rating.

It doesn't matter what the NK model says, the model is asking users to assume a fundamentally irrational and absurd theorem by not fitting well-observed behaviour across the world for the past century.

As an Engineer, I would have long since thrown the model out for not passing the real-world test.

Because with output growing at potential, faster growth of government spending means slower growth of consumption, which will only be an equilibrium if the real rate of interest is lower.

This assumes a Multiplier less than one, that government spending is not increasing potential consumption. The IMF has debunked this little assumption, demonstrating large Multipliers in depressed European countries. Ergo government spending will not eat into consumption, rather the opposite.

have you read Robert Waldmann on this?

http://angrybearblog.com/2013/11/why-does-fiscal-stimulus-work.html

I think he's writing about the same thing, but if I understand correctly, sharply disagrees with Cochrane's characterization of NK models.

Luis: yes, I just read it, and left a comment there.

There are posts by Paul Krugman and Brad DeLong and Simon Wren-Lewis too, all against John Cochrane. They probably won't read this post (Mark Thoma didn't include it in his daily links).

Very rarely, I want to stand up on a soapbox and start yelling "READ THIS AND RESPOND!!!). The first time was when I was posting on the burden of the debt on future generations. This is a second time.

Cochrane is just performing the Holbo two-step of terrific triviality. The statement "so strong it is absurd" is that nobody takes Keynesian economics seriously anymore. The statement "so weak that it would be absurd even to mention it" is that the simple Keynesian Cross model works differently from the New Keynesian model. Now he's hopping from foot to foot, claiming that DeLong responded to Megan McArdle's argument and failed to address his.

The fact is that all sticky-price models create an opening for fiscal policy, whether they are Old Keynesian, New Keynesian, or Benassy's monetary OLG model which seems to meet all Nick Rowe's objections.

It's depressing how completely DeLong et. al. are failing to actually engage with Cochrane's point (or yours, for that matter). What's even more depressing is their commenters, who write pointed responses like "thanks for laying waste to this nonsense". You've been fighting the good fight for a while, engaging Krugman and his allies on the substance without getting political or pointed--I applaud you for that. There are a small number of us who actually care enough about the science to try our best and look past the theatrics, and your all-substance contributions in this environment are thus much appreciated. I take comfort in the fact that academic versions of these debates are more depersonalized and depoliticized, but these public debates don't bode well for the credibility of economists in the minds of the non-aligned. There is a purely technical issue here, a mathematical issue and an issue of model interpretation. Why can't everyone just acknowledge the point and respond to it, instead of changing the subject and lobbing grenades?

I don't know. But I think we first need to understand the NK intuition better, then compare the OK intuition with the NK intuition. I've got a gut feel the NK intuition is trying to tell us something important too. I think the multiplier, in some sense, really is infinite. That demand comes mostly from itself. That demand really does scale up or down, and really is mostly self-fulfilling. And that the *only* thing that can make AD determinate is the quantity of money (which isn't in the NK model).

Why do you say "*only*"? Why not just "one"?

Nick: I suspect TKG is not a native english speaker. What he means is merely what I was taught 40 years ago. Tax those with low MPC, like corp. who accumulate cash and irritate Mark Carney, and give it to those with high MPC. Either directly to middle-class-and income civil servants ( not a pay raise but an increase or at least a non-decrease in numbers unlike the bleeding of those sectors in the U.S.), or semi-directly to construction workers and the like. Call that fiscal policy and continue till full emplyment. Then ease back into monetary policy.
Essentially '30's Keynesianism. It worked then because it was appropriate for the times. It would work now because it is appropriate for the times.
Apart from rejoicing the ignoramuses, what's the point of Flaherty running a full-emplyment budget surplus? Sending us back to recession? To have a Royal British Recession like we went back to a Royal Air Force?

Nick: Here's one suggestion that might help raise the quality of the debate: Rewrite this in terms of a specific, canonical version if the NK model. Say, one that is in a widely used graduate textbook. It will be more work to go through the math but I think starting from a concrete example will really focus the conversation.

Very good, so the most credible way for the government to cut the growth rate of its expenditure is by spending more right now right? Then by the no-Ponzi condition, they must spend less in the future and hence, the growth rate is lowered.

Might be a bit German, JRG. Our economy is at the whim of commodity demand in Asia, and consumer/gvmt-stimulus demand of the USA. I would like Flaherty to develop other parts of the economy that use oil and finance to generate wealth. A surplus if we aren't diversifying this, and a deficit is fine if we are.
I think Gini is a symptom at least in modern/postmodern economies in the post Cold War, of a breakdown in market forces. A high Gini Index means there are rich people accumulating cash for lack of imagination. Gini is proportionate to MPC. At some income level, probably those earning below a million/yr in Canada, market forces again work and we don't need to ignore macro. Public housing and daycare federally, health care/R+D and teachers/prof-R+D provincially, are superior to continuing tax cuts. If debt is the worry, raise taxes on finance and petro at the same time. Not one thread about why this extra $150B in federal debt justifies $150B in big corporate cash because whoever dreamed the macro didn't understand when market forces apply and when a communist cabal is functioning.

Floris: "...by the no-Ponzi condition, they must spend less in the future...."

Or they may tax more. Old Keynesians assumed that changes in G don't affect expectations about the future. That being granted, a rise in current G implies a fall in the growth-rate of G. Hence the NK & OK views are not as different as Nick makes out.

by the no-Ponzi condition, they must spend less in the future and hence, the growth rate is lowered.

But the no-Ponzi condition is precisely what's in dispute here, I think. You can't just assume that the economy follows a reasonable long-run path; you have to provide a mechanism that prevents divergence.

"output growing at potential"

Gotta be careful with those assumptions not evident in reality.

I was going to get to that. Currently, we have output growing at less than potential, so additional government spending with a positive multiplier is beneficial. Nick's model describes an economy at capacity/full employment. The model he is using has a category error and everything else flows from that.

I don't doubt we could get to that state, indeed I hope we do, but we aren't there right now.

"You can't just assume that the economy follows a reasonable long-run path; you have to provide a mechanism that prevents divergence. "

If your model depends on certain boundary conditions and enforces some sort normalization at each time step, then you have to justify these, not just the equations of the model.

Determinant,

You have it exactly backward. Nick is trying to show why NK models DO NOT imply convergence to full employment, but are consistent with any level of demand.

Luis Enrique posted a link to a Robert Waldman blog entry

http://angrybearblog.com/2013/11/why-does-fiscal-stimulus-work.html

which had a link to a Krugman blog entry which in turn had a link to a Krugman article on NK models and the zero lower bound. I found the article very enlightening, so I'm posting this direct link with thanks to Luis Enrique.

http://www.princeton.edu/~pkrugman/optimalg.pdf

from the article:

"What I’ve illustrated here is the marginal cost and benefit of government purchases of public goods in and near a liquidity trap. The marginal benefit is presumably a downward-sloping curve. If G is low, so that monetary policy cannot achieve full employment, the marginal cost of an additional unit of G is low, because the additional government purchases don’t crowd out private spending. Once G is high enough to bring full employment, however, any further rise in government purchases will be offset by a rise in the interest rate, so that extra G does come at the expense of C, implying a jump in the marginal cost."

Note his marginal cost curve has an effective discontinuity at full employment.

Determinant, to me there are 3 factors affecting the natural rate of unemployment.
1) Work ethic, which is what people are most afraid of if a GAI, and which I know is an issue in regions subject to addictions, like T.O. City Hall.
2) Retraining/education time. Ideally done co-op.
3) Job search time.

To get to the full employment model, you need to get 3 as low as possible; ideally measured in weeks (I get job offers from Ont and Que and I'd take them if it was assured and travel paid for). I guess something like RESP subsidies or GWB's prtofolio pensions, would help if applied to education. You don't give the cash to dividend yielding companies, you give it to individuals as a condition of future education.
I'm not sure about #1. I'm happy I grew up in the prairies with the farmer work ethic and the winter that forces some work ethic and socialization away from mental illnesses (though alcoholism). I know when people with high human capital experience unemployment/poverty, and then move to a region with growth surrounded by peers, their human capital is even higher than before. There must be some way to subject adults to this...

Kevin: "The fact is that all sticky-price models create an opening for fiscal policy, whether they are Old Keynesian, New Keynesian, or Benassy's monetary OLG model which seems to meet all Nick Rowe's objections."

That may be true, but the fiscal policy recommended by New Keynesian models is very different from that recommended by Old Keynesian models. At the ZLB, the latter says increase G, and the former says decrease Gdot. That is an important substantive difference.

Ram: thanks! I appreciate that.

JW: "Why do you say "*only*"? Why not just "one"?"

I can't explain, because my head isn't clear enough yet. But an excess demand or supply of money is the *only* thing that prevents Say's Law working.

JW: "Rewrite this in terms of a specific, canonical version if the NK model. Say, one that is in a widely used graduate textbook. It will be more work to go through the math but I think starting from a concrete example will really focus the conversation."

That would be good advice, if I were better at math and could follow it! I took the risk of putting just a little bit of math in my new post.

Peter N: yes, but in Paul Krugman's model it is not an increase in G(t) that works, but an increase in G(t)/G(t+1), which is the same as a decrease in Gdot. (He assumes that a permanent increase in G will cause a permanent increase in Y, which contradicts all the other NK models, and misses the whole indeterminacy issue I've raised, by shifting the horizontal IS curve to the right.)

Sorry for not responding more to comments. And they are good comments. I need a little time out, or I will get over-excited. And it's a lovely day here.

This is my attempt to show temporary income versus saving calculated on the same basis. I take temporary income as income[t]-(income[t-1]+consumption[t-1])/2 and saving as income[t]-consumption[t]. A little crude, but the story it tells seems plausible. Both are in real dollars

Nick, you are really driving me crazy with these kinds of posts. Here's my concern:

(1) Cochrane isn't saying (in the post you linked) that the NK models give different policy recommendations from the OK ones, he rather is saying that the mechanism by which the NK justify more government spending is totally different. So is he just wrong about what a NK model implies for policy? Or, are you saying there are multiple policy solutions that pop out?


(2) Can't you use your macro street cred to get Dean Baker, Brad DeLong, and (dare I ask?) Paul Krugman to comment *specifically* on this recurring claim you make? I have never seen them get anywhere in the same ZIP code of saying that the NK model implies an expected drop in government spending can restore full employment.

I mean, if you are right, Nick, then you have the power to save the world economy in your hands. The Tea Party will gladly endorse a proposal to slash government spending in two years by 10%, and Krugman et al. will gladly endorse a policy that will (according to their professed model) restore aggregate demand today.

Can you please get them to comment on this? This is unbelievably important, if you are right. My guess is that they will NOT agree with you.

Bob,
For my money the person most likely to address Nick's claim authoritatively is Simon Wren-Lewis. He's more committed to the NK model than Krugman or DeLong. But as things stand, it's not fair to expect a response. What precisely is Nick's claim? I think it's something like this: the policy rule, cut G(t+1) in response to a period-t adverse demand shock, works just as well as the more conventional rule, raise G(t).

My intuition is that this claim is false. The effects of demand shocks typically persist for 6 periods or more in the NK model so I'd guess that Nick's policy would aggravate booms and slumps.

Don't be to sure about getting the Tea Party on side. Nick's policy will presumably involve increases in government spending when the economy is overheating. They won't go for that.

Kevin: "For my money the person most likely to address Nick's claim authoritatively is Simon Wren-Lewis."

I agree. He would be the best person to give a good response. He is closer to the NK literature, plus he has an economic intuition.

"What precisely is Nick's claim? I think it's something like this: the policy rule, cut G(t+1) in response to a period-t adverse demand shock, works just as well as the more conventional rule, raise G(t)."

It's clearer in continuous time: cut Gdot(t); G(t) is irrelevant. (And, if half the agents are non-Ricardian Hand-To-Mouthers, raising Tdot(t) would work as well. See my latest comment in my other post, for the "mathematical proof". But the Tea Party would really hate that policy!)

Bob:

1. Yes, he's wrong. He's half-way there, but hasn't realised that NK models actually give very different policy advice from OK models.

2. Outside the blogosphere, I have almost zero street cred. I take my hat off to Mark Thoma for linking my other post, even though he will (probably) dislike the results. I can't force Paul Krugman or Brad Delong to respond. But as Kevin says, I think Simon Wren-Lewis would be the best blogger to respond. He could do it better.

3. I (think) I am right about what the NK model says. But I am very sceptical these policies would work. One very big problem is that I have assumed away the whole indeterminacy problem in NK models (just as NK modellers assume it away themselves). I am NOT (in these posts) trying to influence policy. I am trying to force NK modellers (and those economists who cite the NK model in support of their policy recommendations) to recognise that they have some very serious problems. Massive contradictions.

4. In a slump, the Tea Party would love "my" recommendation for G, and hate "my" recommendation for Taxes. In a boom, it would be the other way around.

In other words: the really big problem in NK models is the indeterminacy problem. And John Cochrane is waaay ahead of the field there. And my posts here are just a way to force NK economists to re-examine the NK model, and to force them to confront the indeterminacy problem. I'm holding their feet to the fire. Their only escape will be to put money back into the NK model to resolve the indeterminacy.

Nick Rowe,

"Their only escape will be to put money back into the NK model to resolve the indeterminacy."

Such a tease! I have to see a blog post/article/book that explains that, because I love New Keynesianism, except for the lack of money in the models...

Or rather the hokey way of neutralising money e.g. giving it a demand-function but no causal significance on anything else.

(Sorry for the triple post.)

* hokey WAYS of neutralising money.

W. Peden: I too have a weird love/hate relationship with New Keynesian macro, for much the same reason! All these posts are really just self-therapy.

Nick Rowe,

If I were a cynic, I'd say that New Keynesians's strategies for emasculating money are a way that they can avoid being called New Monetarists, given that pretty much everything else they say is monetarism + RatEx - the k percent rule. That would be less cynical, in fact, than saying that New Keynesianism is a massive hoax to get around criticisms of the Old Keynesian model and that New Keynesians don't actually believe their own models. I think that Woodford REALLY BELIEVES in New Keynesianism (Krugman, I'm not so sure about).

AFAICT the term New Keynesian was coined by Michael Parkin, a monetarist. It seems to me that part of the idea was to rescue monetarist insights from sterile debates about the definition of money and the money-demand function.

One of the best things in NK macro, IMO, is that it let us do macro with monopolistic competition.

But the role of money, both supply and demand, is the big question. The disappearance of money supply and demand and its replacement by natural vs market rates of interest didn't come until fairly recently in the NK lifespan. I say it then switched from being New Keynesian to being Neo-Wicksellian.

Kevin: "AFAICT the term New Keynesian was coined by Michael Parkin, a monetarist."

I didn't know that. (Mike Parkin was one of my profs at Western.)

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