Keynesians and Monetarists
By Arnold Kling
I turn out to be more Keynesian than Brad DeLong, at least in an old-fashioned sense. In a long and interesting post, Brad DeLong finds little difference between new Keynesians and monetarists. The former he describes as believing in five propositions.
–The key to understanding real fluctuations in employment and output is to understand the process by which business cycle-frequency shocks to nominal income and spending are divided into changes in real spending and changes in the price level.
— Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy.
–Business cycle fluctuations in production are best analyzed from a starting point that sees them as fluctuations around the sustainable long-run trend (rather than as declines below some sustainable potential output level).
–The right way to analyze macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyze each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.
— Any sound approach to stabilization policy must recognize the limits of stabilization policy—the long lags and low multipliers associated with fiscal policy; the long and variable lags and uncertain magnitude of the effects of monetary policy.
I don’t much care for the third proposition, that business cycles are fluctuations around trend. It says that sometimes we have excess capacity, and sometimes we overtax capacity, but on average we get it right. I do not believe that. I believe the contrary proposition, which is that the economy is either at or near capacity, or below capacity.
If you really believe that the fluctuations around the long-term trend are roughly symmetric, then why should government bother about them? Recession? Don’t worry, be happy. We’ll be fluctuating to boom soon enough. Sorry, if that’s what new Keynesians believe, then call me an old Keynesian.
It’s the belief in symmetric fluctuations that drives the focus on policy rules rather than policy events. So I’m not a new Keynesian on that issue either. I am just fine with thinking about recessions as individual episodes requiring idiosyncratic policy responses.
I’m also not buying that monetary policy is clearly more useful than fiscal policy for stabilization. I would have to see a much stronger link between monetary policy and long-term interest rates to join that chorus.
I do believe that as the economy has become more complex, its ability to cope with recessions depends relatively more on private sector behavior, and traditional fiscal and monetary policy are less reliably effective. See Would Keynes Change His Mind?
Why is the framework of fluctuations around a sustainable trend now in vogue, compared with a framework of shortfalls relative to capacity? Did I miss some major empirical proof?