Archive for the ‘macro’ category

A great quote from the Financial Times

February 8, 2009 / Comment / Opinion – Keynes and the triumph of hope over economics

“…we call for trillion dollar stimulus plans on the basis of little more than citing John Maynard Keynes – and politicians revere us. Citing Keynes gives us special licence to talk economics without using any. To paraphrase the lawyers’ dictum, when the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes– and to great effect.”

Keynes did a lot of great work, but here it is over 70 years later and people are still arguing about what he really meant; and it is difficult to make a lot of what Keynes said internally consistent…


I wish that I believed that a giant government spending stimulus would work to fix things,

February 8, 2009

because I would then support it, and with vigor.

Anyone who says that they have ‘computed’ how do to a stimulus is believing too much in a dodgy model.  Anyone who says ‘Nixon said that we are all Keynesians now’ in order to justify this  spending package is 30 years out of date.

We need to fix our banking system.  That likely involves building new financial institutions-or at least letting the dinosaurs die.

Our problem now is that everyone wants to invest ‘risk-free,’ so savings are going into cash, bank accounts, and government bonds and not being used for business investment or  consumer spending.   But in aggregate it is impossible for all this to really be ‘risk-free’ investment and instead is leading less production, investment, and consumption today.  Real physical investments are risky.  My guess is that once people start recognizing the inflation risk in cash, bank accounts, and government bonds, then capital will flow to businesses and eventually to consumers, and we will start to slowly recover.

The best the government can do now is to help the most economically vulnerable people quickly, and work on rebuilding financial institutions; not necessarily rebuilding the financial institutions that brought us here, either.

Increasing the money supply is eventually going to make it evident that money not intermediated into real investments is simply a waste.  Then people will spend on current consumption and start to invest in real physical projects again.

I should add that investing in public goods-if they have real economic value-is a perfectly sensible thing to do.  But it is not stimulus.

Quantitative Easing

January 24, 2009 You must be Brave or Foolish to go against UChicago econ

Finally, Robert Lucas. Lucas at least includes price and velocity — thank you for that! — but again misses the key element:

MV = Py

Given that V is going to zero (as people demand more savings) you need to increase M by a large amount so y can stay where it given that P is fixed. In the long term, P will fall and we will return to the 10 cent hamburger, but in practice the US is simply not going to be allowed to enter a 1930s style protracted and deep deflation.

The obvious solution at this point would be to talk about how we can increase M rapidly, in a way that is equally rapid to reverse! The obvious candidate, and it would be obvious to Keynes if he was alive today, would be a payroll tax holiday. It would avoid all the fiscal problems that all three economists mention, while still handling the money supply in a way that gets us to a rebalanced economy without having to do things the hard way and increase the deficit through unemployment.

Nice post.

Here, M is the money supply, V is velocity, P is the price level, and y is real GNP, so that Py is nominal GNP. If V is dropping, then Py must fall.  In one extreme with y fixed, P must fall, or deflation.  In the other, with P fixed, y must fall, or a drop in GNP.    Right now, prices and GNP are falling.  We have to crank up M, and try to get V back up, too (This is all kind of definitional, but to start the Great Depression, the Fed brought M down on purpose.  So there is some bite here.)

I think that effectively buying up new risky assets the way the Fed is doing now is probably the fastest way to crank up M. I hope that is what the lump sum tax cuts in the stimulus are trying to achieve as well.  If we can credibly commit to some future inflation, we can drop V as well.  (I recall that was Professor Krugman’s original prescription for Japan, so maybe it is not so easy to do given what happened there.  One sign it is working might be that our currency depreciates.)

But I don’t think that Professor Lucas missed the point, since he started out his talk pointing out that we can increase nominal spending by cranking up the printing presses and doing the famous helicopter drop of money, or by following Keynes and burying dollar bills in the ground to be dug up.

Cranking up M by buying more assets is the basis of the Fed’s policy of ‘quantitative easing.’  We need some faith, since monetary policy can  have long and uncertain lags.  It probably will act faster than fiscal stimulus by building infrastructure, though.