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Benn Steil has a new piece in the Weekly Standard entitled:

Why is Paul Krugman Still Calling for Fiscal Stimulus?

Here’s an excerpt:

With the Fed having raised rates in December, the zero bound – for whatever it might have meant – is gone in the United States. This should mean Krugman, if he is truly following economic science as he claims to understand it, abandoning his calls for fiscal stimulus. Yet he is not only still advocating a big increase in government spending, he is calling for government intervention to boost wages and union bargaining power. He further says that “mercantilism makes a fair bit of sense” in this environment. Yes, mercantilism – import barriers, export subsidies, and the like. Bring on the trade war. Krugman justifies all this by arguing that we are still in a topsy-turvy liquidity-trap world because rates are “near zero.” Yet whatever debate we might have about the effectiveness of negative rates and QE, there can be no debate over whether we are in a liquidity trap. We are not. When the Fed’s policy rate is above zero, by any amount, it means that it has determined (rightly or wrongly) that – given the current stance of government fiscal and other policies – the appropriate rate for the economy is positive. Not zero or negative. Importantly, this also means that if the government does significantly increase spending, as Krugman wants, the Fed will react to the higher level of demand by raising rates more rapidly than it would otherwise have done. This will counteract the higher government spending; such effect is known as “monetary offset,” a concept which Krugman considers uncontroversial. Thus calling for fiscal stimulus with positive interest rates is the logical equivalent of wanting to eat more because you are a little bit pregnant. It makes no sense: you cannot be a little bit pregnant, nor can you be in a liquidity trap when rates are positive.

Krugman ended the 1990s sounding much more market monetarist than Keynesian. As late as 1999, a year after his famous 1998 paper on liquidity traps, Krugman was still dismissive of fiscal stimulus, even at the zero bound:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy. Will somebody please explain this to me?

By 2012 he had shifted from monetarist to new Keynesian, believing fiscal policy can be useful, but only when rates are at the zero bound:

People in my camp have repeated until we’re blue in the face that the case for fiscal expansion is very specific to circumstance — it’s desirable when you’re in a liquidity trap, and only when you’re in a liquidity trap.

Here’s another example from 2012:

From the very beginning of the Lesser Depression, the central principle for understanding macroeconomic policy has been that everything is different when you’re in a liquidity trap. In particular, the whole case for fiscal stimulus and against austerity rests on the proposition that with interest rates up against the zero lower bound, the central bank can neither achieve full employment on its own nor offset the contractionary effect of spending cuts or tax hikes. This isn’t hard, folks; it’s just Macro 101. Yet a large number of economists — never mind politicians or policy makers — seems to have a very hard time grasping this basic concept.

Notice that he’s exasperated with dumb people who believe what he still believed in 1999.

And there are dozens of other examples over the past 8 years. As Benn Steil points out, Krugman has now shifted again, from new Keynesian to old-fashioned Keynesian. Krugman was right that EC101 says fiscal stimulus doesn’t work when rates are positive. EC101 also says that attempts to artifically raise wages will reduce employment. Ec101 also says the protectionism will impoverish a country. But EC101 doesn’t matter anymore to a growing number of Keynesians. Keynesian economics circa 2016 is starting to remind me of the most extreme forms of supply-side economics from the 1980s.

One begins to wonder if the theory and evidence produce the policy implications, or if the policy needs are producing an ever changing set of ad hoc theories.

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This entry was posted on April 01st, 2016 and is filed under Keynesianism, Liquidity trap. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



