Keynesianism and market monetarism By Scott Sumner

Paul Krugman has a new post that summarizes Keynesian economics:

I would summarize the Keynesian view in terms of four points: 1. Economies sometimes produce much less than they could, and employ many fewer workers than they should, because there just isn’t enough spending. Such episodes can happen for a variety of reasons; the question is how to respond. 2. There are normally forces that tend to push the economy back toward full employment. But they work slowly; a hands-off policy toward depressed economies means accepting a long, unnecessary period of pain. 3. It is often possible to drastically shorten this period of pain and greatly reduce the human and financial losses by “printing money”, using the central bank’s power of currency creation to push interest rates down. 4. Sometimes, however, monetary policy loses its effectiveness, especially when rates are close to zero. In that case temporary deficit spending can provide a useful boost. And conversely, fiscal austerity in a depressed economy imposes large economic losses.

If I were to do the equivalent for market monetarism, it might look something like the following:

1. Economies sometimes produce much less than they could, and employ many fewer workers than they should, because there just isn’t enough spending. Such episodes occur because monetary policy is too contractionary, causing NGDP to fall relative to the (sticky) wage level.

[As an aside, economies can also produce too little due to real shocks, such as higher minimum wages. That’s also true in the Keynesian model.]

2. There are normally forces that tend to push the economy back toward full employment. But they work slowly; a hands-off policy toward depressed economies means accepting a long, unnecessary period of pain.

[Notice this one is identical.]

3. It is often possible to drastically shorten this period of pain and greatly reduce the human and financial losses by “printing money”, using the central bank’s power of currency creation to boost M*V, i.e. NGDP, via the “hot potato effect”.

4. Monetary policy remains highly effective at the zero bound. As a result, demand-side fiscal policy is mostly ineffective in countries with an independent monetary authority—offset by monetary policy. Fiscal actions that shift the aggregate supply curve, however, can be effective.

James Alexander has a new post with a really useful graph:

HT: Dilip