The last New Keynesian left alive
By Scott Sumner
I’ve done numerous posts pointing out that prior to 2008, New Keynesian economists believed the fiscal multiplier was roughly zero. Paul Krugman used to say that aggregate demand was essentially whatever Alan Greenspan wanted it to be. Jared Pincin sent me another great example from a 2006 textbook by Brad DeLong and Martha Olney:
As a rule, today’s Federal Reserve does routinely neutralize the effects of changes in fiscal policy. Swings in the budget deficit produced by changes in tax laws and spending appropriations have little impact on real GDP unless the Federal Reserve wishes them to” (pg. 399). They also write on pg. 400: “The rule that prevails today and probably will prevail for the next generation is that the Federal Reserve offsets shifts in aggregate demand created by the changing government deficit.
At this point many Keynesians will respond that the zero lower bound (now the minus 0.75% lower bound) changes everything. But that certainly wasn’t the view a recently as a decade ago. Here are some examples of mainstream economists pre-2008:
1. Frederic Mishkin said that monetary policy remained “highly effective” at the zero bound.
2. Ben Bernanke agreed, and suggested the BOJ do level targeting.
3. Lars Svensson said currency depreciation was a “foolproof” way of escaping a liquidity trap.
4. Paul Krugman spoke of the need to “promise to be irresponsible,” i.e. a higher inflation target.
A decade ago I was right in this New Keynesian mainstream. I believed the central bank could and should keep NGDP growing at a fairly stable rate. I believed that the fiscal multiplier was roughly zero. Like Bernanke and Mishkin, I believed low interest rates to not imply money is easy. Etc., etc.
Some Keynesians cite Keynes’s famous quote:
When the facts change, I change my mind. What do you do?
There are two problems with this argument.
1. I see no facts that would have led a sensible person to abandon the zero multiplier view.
2. Many Keynesian roll their eyes at zero multiplier claims, as if they are obviously absurd. How can an idea that was right in the New Keynesian mainstream in 2006, when the Japanese liquidity trap was already well understood, suddenly become a cranky heterodox view in 2009? Especially given the complete failure of the 2013 “test” of the anti-austerity theory. If nothing else, anti-austerian Keynesians are engaging in intellectual dishonesty any time they ridicule the arguments of the stimulus skeptics. After all, they believed those things just a few years ago.
If someone I hadn’t seen since 2006 bumped into me, they might say to me; “I thought you were a centrist on macroeconomic policy. What made you decide to suddenly become an extremist?” My response would be that I am still a centrist; it’s the rest of the New Keynesians that have migrated to the view that Krugman called “Vulgar Keynesianism” in 1997.
Which reminds me of one of the most unfortunate technological innovations in the history of art, the disastrous invention of the talking picture:
PS. What picture is most diminished by the invention of sound (actually talking)? My vote is Titanic. Woulda been a great silent flick.