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Saturday, March 28, 2015
Brad DeLong — People Claiming That Even John Maynard Keynes Is No True Keynesian!
"Has insisting that expectations are volatile and unpredictable been helpful in this context? Actually, if anything it lends support to believers in the confidence fairy. After all, if it’s all animal spirits, who are we to say they’re wrong?"
"Has declaring uncertainty to be unquantifiable, and mathematical modeling in any form foolish, been productive? Remember, that’s what the Austrians say too."
I probably shouldn't say this, because it'll make me even more unpopular, but (what's one more spot for a leopard?) Krugman scored two points there, me thinks.
Call me obsessive, but there are some worrying points of intersection between some PoKe variants and Austrians (of the Radical Subjectivist kind).
Uncertainty *is* unquantifiable. You simply cannot know. In business you quite literally take punts based upon some subjective projection based upon past experience. That is how it works.
That the Austrians say that *and then* make the wrong decisions based on that is just Krugman playing logical fallacies again. A game he is very good at.
Krugman and his mates decided that everything has to come from micro foundation. And then like the Austrians they made a crucial mistake - choosing summation as the aggregation function and trying to chase invisible 'natural' targets you can't measure. That is *wrong*. Plain and simple as the SMD conditions prove and the capital debates should have put to bed.
Krugmanites fail because they don't understand dynamic system theory. There is a reason why weather forecasters tend to stick at a week or so.
DeLong and Krugman don't address the issues raised, but rather cite some views that Keynes embraced as evidence that they are "real Keynesians," in spite of the fact that both have said publicly that they are neoclassical, too. Hard to see how someone can be neoclassical and also a "real" Keynesian. Then there is also Wicksellian monetarism and the neutrality of money "in the long run."
Of course, Krugman and DeLong should be encouraged and praised for the aspects of Keynesianism they espouse and policy they push for.
But a key difference between "real" Keynesians and faux Keynesians is accepting Wicksell's view of monetary policy based on AD=AS and a natural rate, and Keynes's fiscal view of effective demand and employment as determinative. So it boils down to monetarism v. fiscalism.
Wicksell's most influential contribution was his theory of interest, published in his 1898 work, Interest and Prices. He made a key distinction between the natural rate of interest and the money rate of interest. The money rate of interest, to Wicksell, was merely the interest rate seen in the capital market; the natural rate of interest was the interest rate that was neutral to prices in the real market, or rather, the interest rate at which supply and demand in the real market was at equilibrium – as though there were no need for capital markets. This theory was adopted by the Austrian School, which theorized that an economic boom happened when the natural rate of interest was higher than the market rate.
This contribution, called the "cumulative process," implied that if the natural rate of interest was not equal to the market rate, demand for investment and quantity of savings would not be equal. If the market rate is beneath the natural rate, an economic expansion occurs, and prices, ceteris paribus, will rise. This gave an early theory of endogenous money – money created by the internal workings of the economy, rather than external factors, and various theories of endogenous money have since developed.[3]
Wicksell's theory of the "cumulative process" of inflation remains the first decisive swing at the idea of money as a "veil". Wicksell's process has its roots in that of Henry Thornton . Recall that the start of the Quantity Theory's mechanism is a helicopter drop of cash: an exogenous increase in the supply of money. Wicksell's theory claims, indeed, that increases in the supply of money leads to rises in price levels, but the original increase is endogenous, created by the relative conditions of the financial and real sectors. With the existence of credit money, Wicksell argued, two interest rates prevail: the "natural" rate and the "money" rate. The natural rate is the return on capital – or the real profit rate. It can be roughly considered to be equivalent to the marginal product of new capital.
The money rate, in turn, is the loan rate, an entirely financial construction. Credit, then, is perceived quite appropriately as "money". Banks provide credit, after all, by creating deposits upon which borrowers can draw. Since deposits constitute part of real money balances, therefore the bank can, in essence, "create" money.
Wicksell's main thesis, that disequilibrium engendered by real changes leads endogenously to an increase in the demand for money – and, simultaneously, its supply as banks try to accommodate it perfectly. Given full employment, (a constant Y) and payments structure (constant V), then in terms of the equation of exchange, MV = PY, a rise in M leads only to a rise in P. Thus, the story of the Quantity Theory of Money, the long-run relationship between money and inflation, is kept in Wicksell. Primarily, Say's Law is violated and abandoned by the wayside. Namely, when real aggregate supply does constrain, inflation results because capital goods industries cannot meet new real demands for capital goods by entrepreneurs by increasing capacity. They may try but this would involve making higher bids in the factor market which itself is supply-constrained – thus raising factor prices and hence the price of goods in general. In short, inflation is a real phenomenon brought about by a rise in real aggregate demand over and above real aggregate supply.
Finally, for Wicksell the endogenous creation of money, and how it leads to changes in the real market (i.e. increase real aggregate demand) is fundamentally a breakdown of the Neoclassical tradition of a dichotomy between monetary and real sectors. Money is not a "veil" – agents do react to it and this is not due to some irrational "money illusion". However, we should remind ourselves that, for Wicksell, in the long run, the Quantity Theory still holds: money is still neutral in the long run, although to do so, Wicksell have broken the cherished Neoclassical principles of dichotomy, money supply exogeneity and Say's Law. — Wikipedia emphasis added.
Thank you Tom!I wrote that part of the Wicksell article,so i am of course glad you you qoute it :)!! And of course you are absolutly right!! And by the way,it's not so known that Wicksell himself infact abandon his Naural Rate concept altogether in his last year in life!
Paul Krugman also respond to, Lars Syll in his blog.
ReplyDeletehttp://www.amielandmelburn.org.uk/collections/mt/pdf/81_07_12.pdf
Paul Krugman:
ReplyDelete"Has insisting that expectations are volatile and unpredictable been helpful in this context? Actually, if anything it lends support to believers in the confidence fairy. After all, if it’s all animal spirits, who are we to say they’re wrong?"
"Has declaring uncertainty to be unquantifiable, and mathematical modeling in any form foolish, been productive? Remember, that’s what the Austrians say too."
I probably shouldn't say this, because it'll make me even more unpopular, but (what's one more spot for a leopard?) Krugman scored two points there, me thinks.
Call me obsessive, but there are some worrying points of intersection between some PoKe variants and Austrians (of the Radical Subjectivist kind).
Uncertainty *is* unquantifiable. You simply cannot know. In business you quite literally take punts based upon some subjective projection based upon past experience. That is how it works.
ReplyDeleteThat the Austrians say that *and then* make the wrong decisions based on that is just Krugman playing logical fallacies again. A game he is very good at.
Krugman and his mates decided that everything has to come from micro foundation. And then like the Austrians they made a crucial mistake - choosing summation as the aggregation function and trying to chase invisible 'natural' targets you can't measure. That is *wrong*. Plain and simple as the SMD conditions prove and the capital debates should have put to bed.
Krugmanites fail because they don't understand dynamic system theory. There is a reason why weather forecasters tend to stick at a week or so.
DeLong and Krugman don't address the issues raised, but rather cite some views that Keynes embraced as evidence that they are "real Keynesians," in spite of the fact that both have said publicly that they are neoclassical, too. Hard to see how someone can be neoclassical and also a "real" Keynesian. Then there is also Wicksellian monetarism and the neutrality of money "in the long run."
ReplyDeleteOf course, Krugman and DeLong should be encouraged and praised for the aspects of Keynesianism they espouse and policy they push for.
But a key difference between "real" Keynesians and faux Keynesians is accepting Wicksell's view of monetary policy based on AD=AS and a natural rate, and Keynes's fiscal view of effective demand and employment as determinative. So it boils down to monetarism v. fiscalism.
See the quotation about Wicksell below.
Continued
Wicksell's most influential contribution was his theory of interest, published in his 1898 work, Interest and Prices. He made a key distinction between the natural rate of interest and the money rate of interest. The money rate of interest, to Wicksell, was merely the interest rate seen in the capital market; the natural rate of interest was the interest rate that was neutral to prices in the real market, or rather, the interest rate at which supply and demand in the real market was at equilibrium – as though there were no need for capital markets. This theory was adopted by the Austrian School, which theorized that an economic boom happened when the natural rate of interest was higher than the market rate.
ReplyDeleteThis contribution, called the "cumulative process," implied that if the natural rate of interest was not equal to the market rate, demand for investment and quantity of savings would not be equal. If the market rate is beneath the natural rate, an economic expansion occurs, and prices, ceteris paribus, will rise. This gave an early theory of endogenous money – money created by the internal workings of the economy, rather than external factors, and various theories of endogenous money have since developed.[3]
Wicksell's theory of the "cumulative process" of inflation remains the first decisive swing at the idea of money as a "veil". Wicksell's process has its roots in that of Henry Thornton . Recall that the start of the Quantity Theory's mechanism is a helicopter drop of cash: an exogenous increase in the supply of money. Wicksell's theory claims, indeed, that increases in the supply of money leads to rises in price levels, but the original increase is endogenous, created by the relative conditions of the financial and real sectors. With the existence of credit money, Wicksell argued, two interest rates prevail: the "natural" rate and the "money" rate. The natural rate is the return on capital – or the real profit rate. It can be roughly considered to be equivalent to the marginal product of new capital.
continued
ReplyDeleteThe money rate, in turn, is the loan rate, an entirely financial construction. Credit, then, is perceived quite appropriately as "money". Banks provide credit, after all, by creating deposits upon which borrowers can draw. Since deposits constitute part of real money balances, therefore the bank can, in essence, "create" money.
Wicksell's main thesis, that disequilibrium engendered by real changes leads endogenously to an increase in the demand for money – and, simultaneously, its supply as banks try to accommodate it perfectly. Given full employment, (a constant Y) and payments structure (constant V), then in terms of the equation of exchange, MV = PY, a rise in M leads only to a rise in P. Thus, the story of the Quantity Theory of Money, the long-run relationship between money and inflation, is kept in Wicksell. Primarily, Say's Law is violated and abandoned by the wayside. Namely, when real aggregate supply does constrain, inflation results because capital goods industries cannot meet new real demands for capital goods by entrepreneurs by increasing capacity. They may try but this would involve making higher bids in the factor market which itself is supply-constrained – thus raising factor prices and hence the price of goods in general. In short, inflation is a real phenomenon brought about by a rise in real aggregate demand over and above real aggregate supply.
Finally, for Wicksell the endogenous creation of money, and how it leads to changes in the real market (i.e. increase real aggregate demand) is fundamentally a breakdown of the Neoclassical tradition of a dichotomy between monetary and real sectors. Money is not a "veil" – agents do react to it and this is not due to some irrational "money illusion". However, we should remind ourselves that, for Wicksell, in the long run, the Quantity Theory still holds: money is still neutral in the long run, although to do so, Wicksell have broken the cherished Neoclassical principles of dichotomy, money supply exogeneity and Say's Law. — Wikipedia emphasis added.
End
Thank you Tom!I wrote that part of the Wicksell article,so i am of course glad you you qoute it :)!! And of course you are absolutly right!! And by the way,it's not so known that Wicksell himself infact abandon his Naural Rate concept altogether in his last year in life!
ReplyDeleteNicely done, Jan.
ReplyDeleteI didn't realize that Wicksell eventually thought better about the natural rate.
People like Krugman need to catch up!
You jest surely.
ReplyDeleteEven Hicks himself dumped the IS/LM model in 1981. Krugman is still using the damn thing.