Lucas on Keynes and "spending flows"
By Scott Sumner
If you rely on bloggers like Paul Krugman and Brad DeLong, you’ll end up with a very crude caricature of Robert Lucas’s views on macro. The following was from a 2003 Lucas paper (sent to me by Marcus Nunes), which I saw Lucas deliver at Duke University:
The problem is that the new theories, the theories embedded in general equilibrium dynamics of the sort that we know how to use pretty well now–there’s a residue of things they don’t let us think about. They don’t let us think about the U.S. experience in the 1930s or about financial crises and their real consequences in Asia and Latin America. They don’t let us think, I don’t think, very well about Japan in the 1990s. We may be disillusioned with the Keynesian apparatus for thinking about these things, but it doesn’t mean that this replacement apparatus can do it either. It can’t. In terms of the theory that researchers are developing as a cumulative body of knowledge–no one has figured out how to take that theory to successful answers to the real effects of monetary instability. Some people just deny that there are real effects of monetary instability, but I think that is just a mistake. I don’t think that argument can be sustained. I do think that most of the post-World War II fluctuations of GDP about trend can be accounted for in real terms. I’ve estimated that would be something on the order of 80 percent. People can argue with that. But that’s not because money doesn’t matter. That’s because monetary policy in the postwar United States has been so good.
So that’s I think where Keynes’s real contribution is. It’s not Einstein level theory, new paradigm, all this. I am in agreement with my neighbor Sue Freehling, that’s just so much hot air. I think that in writing the General Theory, Keynes was viewing himself as a spokesman for a discredited profession. That’s why he doesn’t cite anyone but crazies like Hobson. He knows about Wicksell and all the “classics,” but he is at pains to disassociate his views from theirs, to overemphasize the differences. He’s writing in a situation where people are ready to throw in the towel on capitalism and liberal democracy and go with fascism or corporatism, protectionism, socialist planning. Keynes’s first objective is to say, “Look, there’s got to be a way to respond to depressions that’s consistent with capitalist democracy.” What he hits on is that the government should take some new responsibilities, but the responsibilities are for stabilizing overall spending flows. You don’t have to plan the economy in detail in order to meet this objective. And in that sense, I think for everybody in the postwar period–I’m talking about Keynesians and monetarists both–that’s the agreed-upon view: We should stabilize spending flows, and the question is really one of the details about how best to do it. Friedman’s approach involved slightly less government involvement than a Keynesian approach, but I say slightly.
So I think this was a great political achievement. It gave us a lasting image of what we need economists for. I’ve been talking about the internal mainstream of economics, that’s what we researchers live on, but as a group we have to earn our living by helping people diagnose situations that arise and helping them understand what is going on and what we can do about it. That was Keynes’s whole life. He was a political activist from beginning to end. What he was concerned about when he wrote the General Theory was convincing people that there was a way to deal with the Depression that was forceful and effective but didn’t involve scrapping the capitalist system. Maybe we could have done it without him, but I’m glad we didn’t have to try. Thank you.
Of course “spending flows” are NGDP. I view this as one of the very best summaries of why Keynes was so important. The technical aspects of his model weren’t very good, but the overall message was extremely important. Stabilize NGDP.
Unfortunately, the post-WWII Keynesian model didn’t do a good job of handling the distinction between NGDP and RGDP. Only now, in the 2010s, are we rediscovering the importance of NGDP—a variable that was mostly ignored for decades, but is actually the key to macroeconomics.