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Yes, Ezra Klein Should Believe Paul Krugman - Grasping Reality with Both Hands

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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, RealityBased, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.

Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch October 02, 2010

Yes, Ezra Klein Should Believe Paul Krugman Scott Sumner attempts to defend the honor of the "classical" economists: TheMoneyIllusion » Memo to Ezra Klein: Don’t believe Krugman: In the General Theory, John Maynard Keynes created a crude and inaccurate caricature of “classical economics.” He argued that people like Pigou had models that simply assumed full employment. In fact, economists like Pigou, Cassel, Hawtrey, Fisher, Hayek and others, believed that wages and prices were sticky in the short run. They believed that nominal shocks (decreases in the money supply or increases in money demand) would have real effects in the short run, but merely change the price level in the long run. Indeed this tradition goes all the way back to that most “classical” of classical economists– David Hume. The standard macro model of the 1920s is in some important respects far closer to the modern new Keynesian model than is the crude model of the General Theory, which lacks a self-correcting mechanism in the long run. Of course Keynes knew all this, and was being intentionally disingenuous in order to make his own model seem more revolutionary. I think Sumner is wrong here.

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Yes, Ezra Klein Should Believe Paul Krugman - Grasping Reality with Both Hands

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I cannot say how anyone can deny that Hawtrey and Hayek were definitely in the Eugene Fama camp. (Hawtrey later changed his mind.) And I do not believe Keynes classified Fisher and Wicksell as "classical" economists. The only places where Sumner might have a legitimate beef is with Pigou and Cassel. What I find more worrisome is Sumner's assessment of the current debate: In his recent post Krugman has misrepresented the views of those he disagrees with in much the same way that Keynes did. I’ve read most of the economists that he ridicules (except Fama), and they do not believe that nominal shocks have no short run real effects. There are debates about whether it is most useful to think about nominal shocks as being essentially monetary, or due to Keynesian expenditure shocks, and there are also disputes about how much of the unemployment in the current recession is due to insufficient AD and how much is due to structural problems. For instance, Cochrane holds NGDP constant when evaluating fiscal stimulus, as he assumes changes in NGDP are a monetary policy issue... To "hold nominal GDP constant when evaluating fiscal stimulus" is to go the full Treasury View. That's one. Sumner gives up on Fama. That's two. The others whom Krugman mentions are Mulligan, Ferguson, Meltzer, and Laffer. Krugman is completely right about Mulligan and Ferguson. I don't think Laffer has a coherent model of the economy at all. The only one of the six whom Krugman "ridicules" for whom Sumner has a case is Meltzer. And when I look back at Meltzer's piece, I side with Paul on this one: Alan Meltzer: Inflation Nation: May 4, 2009: If President Obama and the Fed continue down their current path, we could see a repeat of those dreadful inflationary years.... Paul Volcker is now the head of President Obama’s Economic Recovery Advisory Board. Mr. Volcker and the administration’s many economic advisers are all fully aware of the inflationary dangers ahead. So is the current Fed chairman, Ben Bernanake. And yet the interest rate the Fed controls is nearly zero; and the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain.... [T]he Fed has sacrificed its independence and become the monetary arm of the Treasury: bailing out A.I.G., taking on illiquid securities from Bear Stearns and promising to provide as much as $700 billion of reserves to buy mortgages.... Some of my fellow economists, including many at the Fed, say that the big monetary goal is to avoid deflation. They point to the less than 1 percent decline in the consumer price index for the year ending in March as evidence that deflation is a threat. But this statistic is misleading: unstable food and energy prices may lower the price index for a few months, but deflation (or inflation) refers to the sustained rate of change of prices, not the price level. We should look instead at a less volatile price index, the gross domestic product deflator. In this year’s first quarter, it rose 2.9 percent — a sure sign of inflation. Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.... That’s why the

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Yes, Ezra Klein Should Believe Paul Krugman - Grasping Reality with Both Hands

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Fed must start to demonstrate the kind of courage and independence it has not recently shown... For Meltzer to call in May 2009 for a rapid turn to monetary restraint is a very strange reading of the situation indeed. So Ezra Klein should believe Paul Krugman. I score this one Krugman 9, Sumner 2. Brad DeLong on October 02, 2010 at 09:48 AM in Economics, Economics: Economists, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Economics: Macro, Obama Administration | Permalink Favorite

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Comments Robert Waldmann said... I really don't understand why you take Scott Sumner seriously enough to comment on his posts. His accusation against Keynes is simply false. Keynes accurately described Pigou's theory of unemployment. Keynes also described a self correcting mechanism. Sumner is, of course, right that Keynes would describe the new Keynesians as classicals. He is not responsible for the use made of his name and many people have pointed out that new-Keyensian economics has little to do with the economics of Keynes (Lionhead in Swedish, Clower, Quiggin http://tinyurl.com/38ldqbf). Keynes described unemployment due to high wage demands by labor unions as voluntary. Basically the new Keynesians are (often very explicitly) members of the Pigou club. It is not Keynes's fault that new-classicals have reached a level of unreasonable abstraction from all economic reality inconceivible to Marshall or Pigou. I am not willing to read Sumner except for your quotations, so I have to ask if Sumner had any actual quotes of Keynes in his post accusing Keynes of intellectual dishonesty ? I'd say that if he didn't, then he showed reckless disregard for the truth and should not be admitted to polite debate. O hell you agree with Sumner on Keynes on Pigou. So what is the falsehood or distortion in The General Theory ... chapter 19 Changes in Money Wages appendix On Professor Pigou's Theory of Unemployment ? I quote Keynes "the following important passage in which Professor Pigou sums up his point of view: “With perfectly free competition among workpeople and labour perfectly mobile, the nature of the relation (i.e. between the real wage-rates for which people stipulate and

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the demand function for labour) will be very simple. There will always be at work a strong tendency for wage-rates to be so related to demand that everybody is employed. Hence, in stable conditions everyone will actually be employed. The implication is that such unemployment as exists at any time is due wholly to the fact that changes in demand conditions are continually taking place and that frictional resistances prevent the appropriate wage adjustments from being made instantaneously.”[2]" In more modern words, In The General Theory ... Keynes asserted "Pigou is a "New Keynesian"" yet somehow Sumner feels that the fact that Pigou is just like the New Keynesians proves that Keynes dishonestly described Pigou. You agree. How do you reconcile that agreement with my quotation of what Keynes actually wrote about Pigou ? Reply October 02, 2010 at 12:10 PM Robert Waldmann said... I guess I should have quoted the next 2 paragraphs in full "He [Pigou] concludes (op. cit. p. 253) that unemployment is primarily due to a wage policy which fails to adjust itself sufficiently to changes in the real Demand function for labour Thus Professor Pigou believes that in the long run unemployment can be cured by wage adjustments;[3] whereas I maintain that the real wage (subject only to a minimum set by the marginal disutility of employment) is not primarily determined by “wage adjustments” (though these may have repercussions) but by the other forces of the system, some of which (in particular the relation between the schedule of the marginal efficiency of capital and the rate of interest) Professor Pigou has failed, if I am right, to include in his formal scheme." Oh and the last paragraph in the appendix "I have criticised at length Professor Pigou’s theory of unemployment not because he seems to me to be more open to criticism than other economists of the classical school; but because his is the only attempt with which I am acquainted to write down the classical theory of unemployment, precisely. Thus it has been incumbent on me to raise my objections to this theory in the most formidable presentment in which it has been advanced." It is obvious that when Keynes discussed what he called "the classical theory of unemployment" he discussed what we call "New Keynesian Macroeconomics." It is not Keynes's fault that New Classicals and New Keynesians use the words to mean completely different things than he did, although if he were alive, I'm pretty sure he'd consider suing new Keynesians for diluting his brand or something. In any case if he were to have registered Keynesian as a trademark then and return and sue now, he would win.

Reply October 02, 2010 at 12:21 PM Andy Harless said... "To 'hold nominal GDP constant when evaluating fiscal stimulus' is to go the full Treasury View." Scott will argue that holding NGDP constant is the appropriate Ceteris Paribus when studying fiscal policy because NGDP is the result of monetary policy. (He argues that NGDP is the only coherent measure of the ease/tightness of monetary policy.)

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He also seems to argue that, on the margin, the Fed's actual reaction function (in combination with the aggregate supply curve) holds NGDP constant, just at a lower level than it used to be. That is, the Fed will move Heaven and Earth to make sure the inflation rate doesn't go below its current level, so whatever level of NGDP is associated with the current inflation rate on the aggregate supply curve, that is what NGDP will be, regardless of fiscal policy. Of course this doesn't rule out the efficacy of a looser fiscal policy (which would raise NGDP above the lower end of the Fed's effective target range), but I think Scott is right to believe that such a policy is not being contemplated and that the issue on the table is whether to tighten fiscal policy. Reply October 02, 2010 at 01:02 PM Rob said in reply to Andy Harless... But if you hold NGDP constant because you assume it's set by monetary policy you assume your answer. Reply October 02, 2010 at 01:16 PM Brad DeLong said in reply to Rob... Re: But if you hold NGDP constant because you assume its set by monetary policy you assume your answer. Yes. Exactly. That was Hawtreys mistake back in 1925... Reply October 02, 2010 at 01:23 PM Brad DeLong said in reply to Andy Harless... Well, yes. And I can talk to Scott as long as it is made clear to everyone beforehand that he thinks that fiscal policy can be monetary policy. But I do wonder, with Paul Jrugman, what the point of such definitions are... Reply October 02, 2010 at 01:40 PM Robert Waldmann said... I have now read your whole post. I still won't read Sumner. I have a question. Does he quote anyone ? As far as I can guess from your post, he doesn't even list which of the the economists whom Krugman "ridicules" he has read. In plain English he asserted that he had not read all of them except Fama, but rather Most of them except Fama or,in plain English "three or four" of them. I assume he meant to type that he has read "most of them (all of them except Fama)." He doesn't seem to present any evidence for his claim. I'd say that the word "ridicules" is a cheap rhetorical trick. He is hinting that Krugman was rude, which would not imply that he was wrong. In fact, Krugman presents actual arguments (with quotes) and criticizes them. His conclusion is very harsh, but he seriously engages with the actual writings of other people. I know of no quarter way consistent counterargument either to his interpretation of the quoted passages or to his counter argument contesting the conclusions of the quoted passages. I know of many cases in which Krugman rather than his arguments were attacked. Those*, unlike Krugman's, are ad hominem arguments. *here very mildly with Sumner's use of "ridicules," George Will saying "if certainty were oil...," well lots of them so many they mix toegether in my mind. Reply October 02, 2010 at 01:43 PM Robert Waldmann said in reply to Andy Harless... A bit more detail on the moving of Heaven and Earth might be in order. I assume you http://delong.typepad.com/sdj/2010/10/yes-ezra-klein-should-believe-paul-krugman.html

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don't mean to suggest that Bernanke controls the Heavens and that you have in mind a different proposal for effective monetary policy in a liquidity trap. I think you might want to spell it out. Oh and explain how it differs from Krugman's proposed monetary policy (which he noted requires a pre-commitment technology). Reply October 02, 2010 at 02:11 PM Robert Waldmann said... Can't stop commenting. I think the key issue with Sumner and Krugman is that Sumner thinks that "first of all, the other side in this debate generally adheres, more or less, to something like what Keynes called the “classical theory� of employment" is identical to the flexible price special case. I must assume that Sumner clicked the link, and note that a more useful link would be to the appendix to Chapter 19 and not to chapter 2. However, Krugman has found an online General Theory with a less embarrassing URL than marxists.org. Any familiarity with what Keynes actually wrote about that which he called the "classical theory" of unemployment would have prevented prof. Sumner from making a total fool of himself. He really shouldn't insult Keynes for what he imagines Keynes wrote without refreshing his memory (I assume Sumner has actually read something written by Keynes). He should not go on to insult Krugman because Krugman accurately uses what Keynes wrote to define his terms (and provides a link which Sumner really should have clicked). It's quite all right if Sumner has such utter contempt for Keynes that he doesn't bother to check what he wrote. I haven't read anything by most people who have written. However, he should not write about what Keynes wrote without reading it (and rereading it when he has forgotten it). Reply October 02, 2010 at 02:20 PM Andy Harless said in reply to Robert Waldmann... The Fed can buy bonds of various kinds and can stop paying interest on reserves. Scott's position seems to be that the Fed will do these things sufficiently aggressively to avoid a further decline in the inflation rate. And that it's possible for the Fed to do so. (I agree -- though not with anything near certainty -- that it is possible. I disagree about what the Fed will actually do.) In practice, Krugman is vague about the pre-commitment technology, and he seems to regard mere current actions to be a partially effective pre-commitment technology. (Otherwise, why would he advocate more QE?) And I think he is correct to do so: anything the Fed does is rightly taken as giving information about its long-term intentions. I don't think there is much of difference in monetary policy recommendations between Krugman and Sumner. Sumner is just more optimistic, both about the transmission mechanism and about the Fed's likely actions. Reply October 02, 2010 at 02:55 PM Andy Harless said in reply to Brad DeLong... I'm not sure how you normally define fiscal vs. monetary policy. Is it not reasonable to define monetary policy as anything the Fed can legally do? The Fed can buy bonds. The Fed can lend against various collateral. The Fed can stop paying interest on reserves. The Fed can indicate its future intentions in various ways. By my reading, Scott thinks these actions, taken with sufficient intensity, could produce any desired level of NGDP, and he also thinks there is a floor on NGDP that the Fed will enforce.

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To my mind, the issue is not the definition of monetary policy but the Fed's reaction function. The Fed is (perhaps with good reason) hesitant to pursue unconventional policies aggressively. My view is that the appropriate thing to hold constant is the Fed's actual reaction function, not some idealized "degree of tightness/ease," however one might define that. Scott seems to have a "kinked" model of the Fed's reaction function, where we are currently close to the kink. So he would say, for example, that without the fiscal stimulus, we would merely have gotten to the kink sooner, and the Fed would be doing all kinds of wild and crazy stuff (although he wouldn't consider it wild and crazy) to (successfully) prevent the economy from getting any worse than what it actually is today. Reply October 02, 2010 at 03:20 PM chrismealy said... When I took honors intermediate macro back in 1991 my prof told us how lucky we were to be using Barro's textbook, how RBC models were the most accurate, that because people had inflation expectations money was neutral, and that if we ever took the econ GRE we'd need to learn the IS/LM curve but he wasn't going to teach it. That was the last macro class I took. I should ask for a tuition refund. I have question: setting aside his weird assessment of Keynes, where is Sumner wrong about the current situation? His NGDP story makes sense to me (like I said, I was poorly educated) and it worries me. Reply October 02, 2010 at 06:10 PM Ron Calitri said... Sumner says that the GT, "...lacks a self-correcting mechanism in the long run." One must read through; but the relationship between productivity and wages is pretty close to that. In ch. 24, though, something "new" is needed, "... enlargement of the functions of government involved in adjusting to one another the propensity to consume and the inducement to invest, would seem to a nineteenthcentury publicist or to a contemporary American financier to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative." Etc. It would seem that we (communally) are the self-correcting mechanism we (individually) have been waiting for. Reply October 02, 2010 at 07:49 PM SomeCallMeTim said in reply to chrismealy... Consider yourself lucky. My 1981 BA in econ included two courses in monetarism and a seminar in Austrian Economics. The most memorable moment of the seminar was the prof, otherwise was a true believer, sheepishly apologizing for Hayek's rant about lefties in Hollywood and arguing for a much narrower scope of freedom of speech. The last part seems sickeningly up-to-date these days. {Yes, all three were electives - mea maxima culpa} Reply October 02, 2010 at 11:15 PM himaginary said... As for Krugman vs Meltzer debate of May 2009, Sumner clearly supported Krugman. See http://www.themoneyillusion.com/?p=1126 Reply October 03, 2010 at 01:10 AM Nick Rowe said... http://delong.typepad.com/sdj/2010/10/yes-ezra-klein-should-believe-paul-krugman.html

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In my humble opinion (and my immediate reaction on reading it) the biggest problem with Paul Krugman's post was that it ignored people like Scott Sumner, who are definitely different from the "classicals" Paul was describing, but who sometimes disagree (yet often agree) with Paul Krugman's perspective. In his defence though, there's only so much space to write stuff. You can't cover everyone who disagrees with you. Robert: you really should read some Scott Sumner. I know there's only so many hours in the day, and we can't read everyone. We should all try to make a point of reading people we think we disagree with. Even if it's just a little, as penance! Reply October 03, 2010 at 05:24 AM nkirsch said... Another "parrot" blog entry. Wonder what is the significance here. Reply October 03, 2010 at 12:33 PM Porlock Junior said in reply to SomeCallMeTim... Please, please, can someone give me a link relevant to the matter of Hayek vs. unbridled free speech for Hollywood lefties? This intrigued me, as I hadn't heard of it, and I've now spent too much time on incompetent Google searches that naturally lead me to one Hayek site after another, none of which was going to take up something that could make him look bad. Reply October 03, 2010 at 02:23 PM chrismealy said in reply to Porlock Junior... I couldn't find it either. Reply October 04, 2010 at 03:27 PM Comment below or sign in with TypePad

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Yes, Ezra Klein Should Believe Paul Krugman - Grasping Reality with Both Hands  

Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch October 02, 2010 The Semi-Daily Journal of Economist J....