Microeconomic models usually have negative feedback. Take a simple demand and supply model. Suppose there is a shock that causes the demand for apples to increase by 100 apples. That creates an excess demand for apples that causes the price to rise, that causes the quantity demanded to fall. If the supply and demand curves have the same elasticity, the equilibrium quantity of apples demanded will rise by only 50. That model has a multiplier of 0.5.
Now take a very simple macroeconomic model. The simple Keynesian Cross model with unemployed resources. That model has positive feedback. Suppose there is a shock that causes the demand for goods to increase by 100. That causes an increase in income and a further increase in the demand for goods. If the marginal propensity to consume is 0.5, the equilibrium quantity of goods demanded will rise by 200. The multiplier in that model is 2.
Negative feedback creates a multiplier of less than one, and positive feedback creates a multiplier of greater than one.
The Old Keynesian ISLM model has both positive and negative feedback processes at work. Inside the IS curve, there's a positive feedback process exactly the same as in the Keynesian Cross model. With mpc=0.5, a shock which increases the demand for goods by 100 shifts the IS curve right by 200. But that's maybe not the end of the story. If the LM curve is horizontal (perhaps because the central bank makes it horizontal by targeting an interest rate) it is the end of the story. We get a multiplier of 2, just like in the Keynesian Cross model. If the LM curve is vertical (perhaps because the central bank makes it vertical by targeting aggregate demand) the rate of interest rises and reduces the demand for goods and the multiplier is 0. Or somewhere in between, if the LM and IS curves are neither horizontal nor vertical.
One result from the ISLM model, that will be useful for later, is that the slope of the IS curve is given by (1-mpc)/i where i is the interest elasticity of demand. If a 1% cut in the interest rate directly increases demand by 2%, which is multiplied by 2 to get a 4% increase in equilibrium demand, the slope of the IS will be -1/4. (Yes, I'm muddling slopes, elasticities, and semi-elasticities here, but it doesn't matter.)
What about the New Keynesian model?
We need to make things as simple as possible so I can explain things clearly. Ignore investment, government spending and taxes, and net exports. Consumption is the only demand for goods.
Old Keynesian models assume that consumption is a function of current income and the real rate of interest. New Keynesian models assume that consumption is a function of permanent income and the real rate of interest. The Euler equation tells us that the planned growth rate of consumption will be a positive function of the difference between the real rate of interest and the rate of time preference. If the real rate of interest is above the rate of time preference, people will want to consume less than their permanent income now, and more than their permanent income in the future, which means that they plan to have consumption growing over time.
Start in equilibrium where the real rate of interest is equal to the rate of time preference, and the representative agent expects his income to stay the same in future, and is planning to consume all his income in all periods.
The marginal propensity to consume out of permanent income is one. If the representative agent expects his income to increase by 100 permanently, with the real rate of interest staying constant, he will increase his planned consumption by 100 permanently.
Does this mpc=1 mean that any permanent positive shock to demand will shift the IS curve an infinite amount to the right? Well, yes and no. Because with mpc=1, the IS curve is horizontal. In other words, if we put permanent income on the horizontal axis of the IS curve, there is only one real interest rate (strictly, only one time-path for the real interest rate) that is compatible with planned demand for goods equalling expected income from the sale of goods. But that one real interest rate is compatible with any level of permanent income. Permanent income is indeterminate in the New Keynesian model, even if the central bank sets the right interest rate.
If you shift a horizontal IS curve right by an infinite amount, it doesn't shift at all. We are not in Kansas any more.
All shocks to expected income can be decomposed into shocks to permanent income and shocks to transitory income. We have considered shocks to permanent income. Now lets consider shocks to transitory income (which means, by definition, shocks to the time-path of income that leave permanent income unchanged).
The representative agent in a New Keynesian model will have an mpc=0 in response to changes in transitory income. If we put transitory income on the horizontal axis, and hold permanent income constant, what will the IS curve look like?
The short answer is that it won't look like anything at all. Because the Euler equation tells us that the rate of change of consumption, not the level of consumption, is a positive function of the real rate of interest.
Holding permanent income constant, we should put the growth rate of transitory income on the horizontal axis of the New Keynesian IS curve, and draw an upward-sloping IS curve. A higher growth rate of income requires a higher real rate of interest for the growth rate of demand to equal the growth rate of income. We very definitely are not in Kansas any more.
Now let's introduce government demand for goods into the model. To keep it simple, assume that the representative agent's utility function is separable in consumption and government spending. This means that, holding private consumption constant, an increase in government spending may (or may not) increase utility, but it won't affect the marginal utility of consumption, and so won't affect the consumption-Euler equation.
We can decompose all changes in government spending into permanent and transitory changes.
A permanent increase in government spending shifts the permanent IS curve an infinite amount to the right. But that doesn't matter, since it's horizontal. So let's hold permanent government spending constant.
The growth rate of transitory income equals the growth rate of transitory consumption plus the growth rate of transitory government spending. So if we put the growth rate of transitory income on the horizontal axis, an increase in the growth rate of transitory government spending will shift that IS curve to the right, with a multiplier of one.
But remember, that IS curve slopes up, not down. This means an increase in the growth rate of government spending will reduce the real rate of interest compatible with keeping the economy growing at potential. 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.
Now let's introduce some shocks to the model. For simplicity, let there be shocks to the rate of time preference. Sometimes the rate of time preference is low, so people want to save; and other times the rate of time preference is high, so people want to dissave. A positive shock to the rate of time preference (a decreased preference for saving) would shift the IS curve up, vertically, by the amount of the shock. A negative shock to the rate of time preference (an increased preference for saving) would shift the IS curve down, vertically, by the amount of the shock.
Normally the New Keynesian model says that monetary policy should handle those shocks, by raising or lowering the real interest rate in response to upward and downward shifts in the IS curve, to keep output growing at potential. But suppose we want fiscal policy to handle those shocks (maybe because the central bank is unwilling or unable to change the real interest rate in response to those shocks). How should fiscal policy respond, to keep output growing at potential?
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.
I'm going to end with a quote from John Cochrane, from his post on a related topic:
"You may disagree with all of this, but that reinforces another important lesson. In macroeconomics, the step of crafting a story from the equations, figuring out what our little quantitative parables mean for policy, and understanding and explaining the mechanisms, is really hard, even when the equations are very simple. And it's important. Nobody trusts black boxes. The Chicago-Minnesota equilibrium school never really got people to understand what was in the black box and trust the answers. The DSGE new Keynesian black box has some very unexpected stories in it, and is very very far from providing justification for old-Keynesian intuition."
I especially like the bits I've bolded. Fiscal policy in Old and New Keynesian models is even more different than John Cochrane thinks it is. And understanding why is hard.
Aren't you assuming that government spending has never has any effect on the velocity of money?
Posted by: PeterN | November 13, 2013 at 04:26 PM
But what of Post-Keynesians who reject both IS-LM of Old Keynesians and microfoundations of New Keynesians?
Posted by: Robert Nielsen | November 13, 2013 at 06:51 PM
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.
Posted by: The Keystone Garter | November 13, 2013 at 07:31 PM
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.
Posted by: Determinant | November 13, 2013 at 08:12 PM
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?
Posted by: JW Mason | November 13, 2013 at 10:51 PM
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.
Posted by: JHazell | November 13, 2013 at 10:55 PM
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.
Posted by: JW Mason | November 13, 2013 at 10:55 PM
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.
Posted by: Nick Rowe | November 13, 2013 at 11:28 PM
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.
Posted by: The Keystone Garter | November 14, 2013 at 01:05 AM
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.
Posted by: Determinant | November 14, 2013 at 01:13 AM
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.
Posted by: Luis Enrique | November 14, 2013 at 07:00 AM
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.
Posted by: Nick Rowe | November 14, 2013 at 07:20 AM
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.
Posted by: Kevin Donoghue | November 14, 2013 at 09:12 AM
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?
Posted by: Ram | November 14, 2013 at 09:46 AM
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"?
Posted by: JW Mason | November 14, 2013 at 10:00 AM
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?
Posted by: Jacques René Giguère | November 14, 2013 at 10:00 AM
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.
Posted by: JW Mason | November 14, 2013 at 10:06 AM
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.
Posted by: Floris | November 14, 2013 at 10:27 AM
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.
Posted by: The Keystone Garter | November 14, 2013 at 10:44 AM
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.
Posted by: Kevin Donoghue | November 14, 2013 at 10:55 AM
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.
Posted by: JW Mason | November 14, 2013 at 10:57 AM
"output growing at potential"
Gotta be careful with those assumptions not evident in reality.
Posted by: daenku32 | November 14, 2013 at 11:01 AM
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.
Posted by: Determinant | November 14, 2013 at 01:37 PM
"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.
Posted by: Peter N | November 14, 2013 at 02:05 PM
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.
Posted by: JW Mason | November 14, 2013 at 02:08 PM
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.
Posted by: Peter N | November 14, 2013 at 02:35 PM
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...
Posted by: The Keystone Garter | November 14, 2013 at 02:52 PM
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.
Posted by: Nick Rowe | November 14, 2013 at 03:58 PM
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
Posted by: Peter N | November 15, 2013 at 12:15 PM
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.
Posted by: Bob Murphy | November 16, 2013 at 12:14 PM
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.
Posted by: Kevin Donoghue | November 16, 2013 at 01:49 PM
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!)
Posted by: Nick Rowe | November 16, 2013 at 03:48 PM
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.
Posted by: Nick Rowe | November 16, 2013 at 04:02 PM
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.
Posted by: Nick Rowe | November 16, 2013 at 04:09 PM
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...
Posted by: W. Peden | November 19, 2013 at 07:52 AM
Or rather the hokey way of neutralising money e.g. giving it a demand-function but no causal significance on anything else.
Posted by: W. Peden | November 19, 2013 at 07:53 AM
(Sorry for the triple post.)
* hokey WAYS of neutralising money.
Posted by: W. Peden | November 19, 2013 at 07:53 AM
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.
Posted by: Nick Rowe | November 19, 2013 at 08:16 AM
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).
Posted by: W. Peden | November 19, 2013 at 01:03 PM
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.
Posted by: Kevin Donoghue | November 19, 2013 at 04:53 PM
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.)
Posted by: Nick Rowe | November 19, 2013 at 09:46 PM