Uncertainty and the Keynesians

July 20, 2012

by Chidem Kurdas

At the current economic juncture two camps offer diametrically opposed macro policy prescriptions. Economists on the Keynesian side such as Joseph Stiglitz and Paul Krugman advocate further monetary easing by the Federal Reserve and massive new federal deficit spending. The opposing camp includes Austrians and monetarists. Among its distinguished members is Allan Meltzer, who in a recent Wall Street Journal op-ed column argues against monetary stimulus and favors reduced government spending.

These correspond to two ways of understanding the sluggishness of the US economy,  explanations based on different time horizons and levels of analysis. For Keynesians, the key is demand, which needs to be boosted by government action. For the other side, the key to slow growth and job creation is heightened uncertainty.

In part the uncertainty is caused by the European debt crisis, but also by the Obama administration’s massive new healthcare program and financial regulations, the looming Fiscal Cliff at the end of the year, and the political unknowns posed by the coming election.

Thus Mr. Meltzer writes: “Business investment is held back by uncertainty. No one can reliably calculate tax rates, health-care costs, and the regulatory burden until after the election, if then. How can corporate officers calculate expected return when they cannot know these future costs? How is more monetary stimulus today supposed to help?”

While businesses and households wait for information to achieve greater clarity, they spend less. Hence economic activity and job creation remains weak.

Ironically, it was John Maynard Keynes who highlighted the pivotal role of uncertainty, and though his followers have not developed his insight further, they generally accept it. The links between extreme uncertainty, low spending and slow growth can be expressed in a simple Keynesian model.

But as far as macro policy goes,  Keynesians focus on the spending angle—that is, the result of the uncertainty, not the shakiness of futures prospects that is causing the problem. Their policy levers  work on the immediate prospect of creating aggregate demand, while ignoring the effect on people’s expectations of the future. As Mr. Meltzer points out, the Fed has been pursuing short-term policies. The analysis that underpins calls for stimulus, both monetary and fiscal, is concerned with the symptom – low spending –  rather than the underlying doubts of which it is a result.

In today’s conditions, this short-term and superficial viewpoint is misleading. The federal government itself caused much of the uncertainty through Obamacare, regulatory explosion, giant budget deficits, anti-business rhetoric and threats of increasing taxes. And the push for more aggressive use of Keynesian nostrums, for greater deficits and higher inflation, are further eroding confidence.

This is like bopping somebody on the head and giving them speed pills to counter their woozy state. Government policies and rhetoric beat up on the economy; this discourages activity; which in turn leads to calls to stimulate some more.

It is not really helpful, to say the least.

43 Responses to “Uncertainty and the Keynesians”

  1. bill greene Says:

    Only a very abstract thinking theoretician could believe that they can help the economy by handing out money while ignoring the future cost of the debt obligations that the so-called stimulus created. Is it not obvious that much of that new money will merely be saved, used to pay down debt, or “wasted” by buying foreign products? None of those uses increase “demand.” And. to the extent the money is used to buy stuff made in China we are stimulating the Chinese economy! Only an intellectual could support such ill-logic and such a leap of fantasy. Why, even an uneducated child would know better! Lesson: It is a mistake to look for great intellect in our leaders–simple common sense will do. Krugman is a typical academic theorist who has parted company with both common sense and reality.


  2. Here is Joseph Stiglitz on EconTalk less than two weeks ago:

    “Monetary policy is not going to work. And that we know…we tried quantitative easing–QE1, QE2. And there’s a good theoretical reason why in a world of globalization monetary policy isn’t going to work…I don’t think it’s an open question. I think we’ve tried it and we’ve seen what’s happened. I mean, basically, why should we expect it to work? You provide liquidity out there and the global marketplace out there, it’s going to go where they think the returns are highest.”

    If you can point me to a public statement between July 9 and today in which Stiglitz advocates further monetary easing (and I hope he does come around) I will gladly eat these words, but this is an incredibly lazy post.


  3. Meltzer has been heavily attacked by market monetarists on the blogosphere. Most monetarists do support further “quantitative easing,” including David Glasner and Scott Sumner (who favor positive NGDP targeting, which would require further “monetary stimulus”).

  4. bill greene Says:

    Negativeinterest writes: “If you can point me to a public statement between July 9 and today in which Stiglitz advocates further monetary easing. . .I will eat (my hat)” as if the last 13 days utterances can be used to define Stiglitz’ position!!!! I guess in the world of economics a theorist can take refuge in the moment, reversing the position he took yesterday, and contrary to the one he might assume tomorrow. As if monetary easing would heve been essential two weeks ago but not today. That’s why they joke about lying all economists in the world in a row. . . Hopefully, Stiglitz will remain silent and not add his voice to those who advocate more paper money, more debt, and more wasted stimulus spending.

  5. Bill Woolsey Says:

    Spending on output fell absolutely in 2008 and while it begin rising again in mid-2009 and has reached and surpassed the previous peak, it remains approximately 14% below its growth path of the Great Moderation. While real expenditure and real output have both reached their previous peaks, they are about 12 percent below the trend of the Great Moderation. The recovery has been weak.

    Traditional monetarists made the empirical claim that M2 velocity (the ratio of spending on output to the M2 quantity of money) was quite stable and likely to be even more stable if M2 grew at a slow steady rate. If this were true, and M2 grew at a slow steady rate, then spending on output would be extremely unlikely to ever drop absolutely and even less likely to remain on a much lower growth path for years.

    However, traditional monetarism has dissappeared, and most former monetarists have recognized that M2 velocity might change significantly even if M2 remained growing at a stable rate. And so, few, if any, favor keeping M2 growing at a slow, stable rate.

    Meltzer’s recent writings suggest that he has joined with the conservative new Keynesians, and believes that a feed back rule from observed consumer price inflation to adjustments in a short and safe interest rate will work better than keeping M2 growing at a slow and steady rate. This is the framework of the mainstream, except that the conservative wing has dropped direct consideration of the output gap for an interest rate based policy.

    It is had to exaggerate how foreign an interest rate policy is to traditional monetarism. Anyway, much of the “uncertaintly” complaint is blaming the economy for the failure of the preferred policy rule. The policy innovations of the Obama administration aren’t much worse than those of the Clinton, Johnson, or Kennedy administration. (Actually, some of those, and those of the Nixon administration, were worse.) However, the notion that business confidence needs to be directly manipulated so that the relationship between inflation and short and safe interest rates is stable seems crazy to me.

    Since traditional monetarism claimed that a money growth rule would imply little change in velocity, as a matter of logic, it “proposed” stable growth in spending on output. As a matter of logic, such a rule means that supply-shocks would be allowed to change inflation. Difficulties in the middle east would result in higher oil prices, and this would result in higher inflation for a time. Any drag on productivity would result in slower growth in real output, and that would result in higher inflation for a time, and perhaps a modest increase for decades.

    And while it is possible (and perhaps obvously true at this point) that monetarists considered this a second best poicy, really prefering that the quantity of money and spending on output should change to offset the impact of supply shocks and so stabilize inflation even more, those of us who reject that sort of activism have an equal claim the mantle of monetarism.

    Market monetarists favor changing the quantity of money to offset changes in velocity (accomodate changes in the demand to hold money relative to income) and so keep nominal GDP on a target growth path. It is just a modification of traditional monetarism in response to the observed shifts in velocity of the last 20 years. We continue to reject using interest rates as an instrument or indicator of monetary policy, carrying on that tradition. And market monetarists reject using monetary policy to shift nominal spending on output (deviate from a nominal GDP target) to stablize inflation in the face of supply shocks. Again, this is consistent with tradtional monetarism.

    I am all in favor of “pro market” supply side policies, and I suppose some of these could be characterized as “pro-business.” But I reject the notion that we need pro-business polcies so that our interest rate target will generate more spending on ouput, or that the enhanced spending on output will be consistent with an inflation target becaused the supply side policies enhance productivity. The monetary regime should provide a stable environment for microeconomic coordination, and good or bad “supply side” policies should result in changes in market interest rates, real output, and the growth path of prices.

    This is exactly what traditional monetarism would have done, but only if velocity was very stable. Since Meltzer has thrown all of that overboard, it seems to me that calling him a monetarist is a misnomer. He has rejeced monetarism totally and has become a conservative new Keynesian. Manipulate interest rates according to a rule to stablize the inflation rate.

  6. Lee Kelly Says:

    Jonathan,

    Quantitative easing is not the preferred policy of market monetarists. While most market monetarists desire easier monetary policy, they would prefer it be achieved by expectations management. Quantitative easing is an ad hoc strategy that is unlikely to significantly boost nominal spending and may even undermine expectations of future monetary policy. Therefore, market monetarist support for quantitative easing is normally qualified: it may be better than nothing, but not much better.

    For example, Sumner has stressed that he would like to see the Federal Reserve’s balance sheet shrink; the monetary base is too big. However, he thinks this is best achieved by setting an explicit level target for nominal GDP. This would help clear any lingering shortage of money in the present by creating expectations of higher levels of spending (and perhaps inflation) in the near future. The Federal Reserve could then begin reducing the monetary base as bank reserves return to more ordinary levels.

  7. N. Joseph Potts Says:

    Government spending is government power. Those in government want MORE spending, SOONER. A sluggish economy (sluggish in part BECAUSE OF this spending) merely provides a compelling excuse to spend more, sooner.

    Machiavelli could explain this much better than I can (at least in Italian).

  8. Mario Rizzo Says:

    One of the most important problems with the Keynsian stimulus approach is that it does not pay attention to whether lines of expenditure are “permanent” or not. Temporary stimuli in temporary or uncertain directions can have only temporary effects. For Keynes himself this was not so much a problem because he advocated the *permanent* “socialization” of investment.

  9. bill greene Says:

    M. Potts is right on target. Instead of atempting the impossibe–debating different economists widely different and ever-changing theories–he points to the real problem: Those in government want to expand their power and popularity by spending lavishly. To the extent such spending is deficit spending it will probably do more harm than good.

    M. Rizzo points out one of the well-known Keynsian fallacies by indicating the “expenditures are not permanent. . .and have only temporary effects.” However, the problem goes further, as indicated in my first post: The “expenditures” may have no effect at all, or even a bad effect, when used to buy foreign goods, added to savings, or used to by lottery tickets.

    People may start spending, and businesses may start investing in new productive capacity, as soon as government planners stop jerking them around with one crazy economic theory after another. Most average Americans know that the government and economic manipulators do not know what they are doing, will often create more problems than they solve, and will burden us with unfortunate unintended consequences. The resulting uncertainty is the drag on economic activity that is holding the country back.

  10. bill greene Says:

    B. Woolsey writes: “the notion that business confidence needs to be directly manipulated so that the relationship between inflation and short and safe interest rates is stable seems crazy to me.”

    I agree that the theoretical connections that are often used to justify such actions are absurd. However, “business confidence” is the backbone of our economy and the main task of government should be to maintain such confidence by providing a level playing field for the economic participants, thus ensuring reasonably fair and open competition, and by supporting healthy and corruption free financial and legal institutions. .

    While most “regulation” imposed by our government is unnecessary and creats impediments to the economy, many regulations to limit collusion, corruption and unfair trade practices are essential. We need an open and clear rule book governing our banking and financial markets. It is not a matter of being for or against regulation. It is a matter of facilitating competition and enforcing integrity in the marketplace.

    The reason we are in a slump, and people are talking about resusitating the economy, is that the government fell down on the job–and the faiure had little to do with money supply, inflation, or theoretical economics. When the government abolished Glass-Steagal, and allowed the banks, brokers, underrwriters and speculators to operate within gigantic and corrupt financial instirutions, they unleashed the crash in securities. Subsidizing sub-par mortgages was the frosting on the cake. The bail-outs were the crowning blow–the government giving taxpayers money to the fat cats who brought on the crash.

    Debating arcane economic theory will not solve our problems– Honest government will. Keeping Goldman Sachs execs in charge of the Treasury Department and Federal Reserve is inviting more of the same speculative binges. Breaking up the financial institutions into smaller separate competing entities would help a lot. Printing money and ballooning the national debt seems frought with danger.


  11. Bill Woolsey’s comments are too long and varied to respond to in their entirety, but he makes one statement so outrageous that I must comment: “traditional monetarism has disappeared.” Then to explain Allan Meltzer’s recent writings (which can’t be monetarism, since it has disappeared), he concludes that Meltzer has joined the conservative new Keynesians.

    Duh?

    Anyone who knows Allan or his work would be thunderstruck by this. Bill has been led by his relentless logic to complete madness.

    The essential feature of monetarism that Allan emphasizes (which is not stability of M2 velocity, as Bill suggests) is rule-based bevaior. That is a core monetarist principle and unites current and deceased monetarists (Meltzer, Taylor, Friedman, Schwartz, etc.). Allan read all of Milton’s Newsweek columns and found not a single instance in which Milton advocated discretionary policy, no matter how dire the economic situation.

    That is why I do not think market monetarism has any claim to the monetarist monicker. And I don’t see what is “market” about it.

  12. Lord Keynes Says:

    Mario Rizzo@July 21, 2012 at 10:55 am

    “One of the most important problems with the Keynsian stimulus approach is that it does not pay attention to whether lines of expenditure are “permanent” or not. Temporary stimuli in temporary or uncertain directions can have only temporary effects.”

    That stimulus is not permanent is true, but provides no argument against Keynesian policies.

    The private sector provides the further investment and consumption spending to drive the boom once stimulus is withdrawn. What Keynesian has ever argued that stimulus must be “permanent”? This is just a straw man.

    Even Hayek understood this:

    “To return, however, to the specific problem of preventing what I have called the secondary depression caused by the deflation which a crisis is likely to induce. Although it is clear that such a deflation, which does no good and only harm, ought to be prevented, it is not easy to see how this can be done without producing further misdirections of labour. In general it is probably true to say that an equilibrium position will be most effectively approached if consumers’ demand is prevented from falling substantially by providing employment through public works at relatively low wages so that workers will wish to move as soon as they can to other and better paid occupations, and not by directly stimulating particular kinds of investment or similar kinds of public expenditure which will draw labour into jobs they will expect to be permanent but which must cease as the source of the expenditure dries up.” (Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas, Routledge & Kegan Paul, London. pp. 210–212). “

  13. Bill Woolsey Says:

    O’Driscoll:

    Suppose the rule were– fix the T-bill rate at zero percent forever.

    Is that monetarist?

    It is a rule. Does monetarism just mean some rule or other?

    Of course, It think taht would be an awful rule, and I think the conservative new Keynesian rule of a formula relating inflation and the output gap (or just inflation) to changes in the Federal fund rule (R = 1.5 times the inflation rate plus .5 times the output gap) is a better rule, but not a very good one. Meltzer appeares to have adopted that rule.

    Market Monetarists actually do favor a rule–keep nominal GDP growing at a slow, steady rate. This at least has the same form as keep the M2 measure of the quantity of money growing at a slow steady rate. It is also similar to the M2 rule in that the M2 rule required changes in the monetary base to offset changes in the M2 money multiplier. Market Monetarists favor changes in the monetary base to offset changes in base velocity.

    Just as traditional monetarists did not develop a formula for the monetary base so that M2 would stay on target, Market Monetarists don’t favor reifying some formula for relating spending on output to the monetary base.

    As I mentoned above, like old fashioned monetarists, whose M2 rule did not allow for shifts in nominal GDP to stablize the inflation rate in the face of supply shocks, Market Monetarists’ rule for a nominal GDP growth path doesn’t allow for shifts in nominal GDP to stabilize the inflation rate in the face of supply shocks.

    Inflation targeting, of course, does imply such variation in base money (or the interest rate target) in response to supply side factors.

    So…

    Melzter:

    Rule based — consistent with traditional monetarism

    Interest rate target — inconsistent with tradtiional monetarism

    Use monetary policy to stablize inflation in the face of supply shocks — Differenet from, if not inconsistent with, traditional monetarism.

    Insistence that policy instrument have a concrete forumula — different from, if not inconsistent with, traditional monetarism.

    Market Monetarism:

    Rule based — consistent with traditional monetarism

    No target for interest rates — Consistent with traditional monetarism.

    Doesn’t use monetary policy to stabilize inflation in the face of supply shocks — Consistent with traditional monetarism.

    Doesn’t have specific rule tying base money to a measure of the quantity of money or nominal GDP — consisent with traditional monetarism.

    Obvious difference — Market monetarists favor adjusting base money to keep spending on output on a stable growth path rather than a measure of the quantity of money.

    Find one bit of evidence that traditional monetarists argued that even if velocity was subject to large and persisent changes, a money growth rule would still be desirable.

  14. Bill Woolsey Says:

    Bill Greene:

    I support free market policies and believe that they will generally result in a higher standard of living in the long run for everyone.

    I think electing a Hugo Chavez type character would be really bad, though I still think that the least bad monetary regime is one that will keep spending on output growing at a slow, steady rate despite worries by business about future (or actual) policies.

    The result could well be very low nominal interest rates and higher inflation, though interest rates could rise. It depends.

    In my view, trying to stabilize nominal interest rates would be a disaster and stabilizing inflation wouldn’t be much better.

  15. Bill Woolsey Says:

    P.S.

    I think treating Obama as if he is Chavez, or even Roosevelt in 36, is absurd.


  16. @Bill Woosley.

    In both posts, you misrepresent the positons of the people you criticizie (including me in the second post).

    On so-cllaed market monetarism, George Selgin has an RAA post.


  17. Bill Greene: I have no idea what you’re talking about. Stiglitz has publicly stated that he does not support further monetary easing, and that he thinks it will be counterproductive. Chidem Kurdas describes him as a Keynesian who supports further monetary easing by the Federal Reserve. I am simply asking her to point to the evidence she used to conclude that Joe Stiglitz is an advocate of monetary easing. I suspect she cannot, but if she manages to do so I will retract my statement that this is a lazy post that doesn’t bother to figure out the views of the people she is writing about.

    I can’t figure out what point you’re trying to respond to when you write things like “I guess in the world of economics a theorist can take refuge in the moment, reversing the position he took yesterday, and contrary to the one he might assume tomorrow” and “As if monetary easing would heve been essential two weeks ago but not today,” because neither of them seem to have any relevance to the discussion.

  18. Allan Walstad Says:

    “Lord Keynes” comment offers an opportunity to clarify somewhat Mario’s statement about whether the lines of expenditure are permanent or not. During the boom that was artificially stimulated or maintained by Fed manipulation of credit and the money supply, there is a buildup of malinvestment — capital investment along unsustainable lines — such as in the surfeit of dot-coms in the 90s or in housing in the 2000s. Another way of putting it is that the structure of production is distorted. Once that happens, unless you can get people to work harder for no increase in real income, output must fall.

    When the Keynesians look at the recession, they see unused labor and capital that could be put to work with a stimulus. But this can’t get us out of the hole if the capital structure remains distorted, or, to put it another way, if the stimulus has the effect of propping up or nursing along the malinvestments. Perhaps our wise pols and bureaucrats can direct the stimulus to where the efforts will straighten out the distortions? If you believe that, you believe in socialism.

    So I would like to make Mario’s statement a bit more specific, by emphasizing not just the impermanence of the lines of expenditure, but their frustration of the necessary restructuring (and, indeed, their likely generation of additional distortions that will also have to be straightened out).

  19. Bill Woolsey Says:

    Wallstad:

    Your are blinded by ERE presumptions. The economy is in a full equilibrium, and then, assuming that saving supply, investment demand, and the demand to hold money were constant (which I guess fits in with the ERE, leaving aside the demand for money,) the quantity of money and credit rise. The excess supply of money and credit results in a lower market rate. Then we imagine the ERE starts making adjustments to the new interest rate, and given all of these assumptions, the signaled adjustments are not feasible.

    So now we must readjust. But to where? The previous ERE allocation?

    But we know the ERE only exists in our mind.

    The real world is a kalediscope of creative destruction. I am sure that is is something that you know in other contexts.

    Well, that means that there the notion that the economy needs to work out distortions is a chimera. Taking the wreckage of failed plans and applying them to something new is _normal._ Where the economy is heading now is somewhere new.

    Targeting the growth path of real output or the unemployment rate is dangerous. In the real world, aggregate real output can’t be expected to stay on a constant growth path nor can we be expected to hit a target for the number of people looking for jobs relative to the labor force,

    The old Keynesian economics of the sixties was a mistake. New Keynesian economics is greatly improved, though with its own set of problems.

    Anyway, there are misallocations of resources all the time. And it is possible that sometimes they are less and other times more. If the missallocations are exceptionally bad, what is the least bad enviromenment for readjustment? In my view, it is the same as when the missallocations are “normal” or less severe than normal. Slow, steady growth in spending on output. The nominal quantity of money should always adjust to the demand to hold it in the context of steady growth in spending on output.

  20. Bill Woolsey Says:

    What is Raa? Where is the post?

    “On so-cllaed market monetarism, George Selgin has an RAA post”

  21. Mario Rizzo Says:

    My point about the expectation of “permanent” lines of expenditure was not intended to apply to temporary deflationary periods. What I am concerned about is the effect of stimulus to “correct” stubbornly high unemployment resulting from a recession. Complementary forms of investment (that is, complementary to the stimulus expenditure) are going to be quite limited if firms worry about the permanence of stimulus. Simple complementary increases in output are likely to take effect without major, irreversible, commitments to new employees, etc.

  22. chidemkurdas Says:

    I am much edified by the argument between Jerry O’Driscoll and Bill Woolsey. My post assumes the position that Jerry explicates, of which Meltzer is a representative.

  23. chidemkurdas Says:

    Re Joseph Stiglitz and monetary policy– what he and others including Krugman have generally argued for — for at least a couple of years — is that monetary policy is not enough and more spending is necessary. This is a common Keynesian policy prescription, a pitch for more aggressive intervention. It only strengthens the case I make that they ignore the impact on expectations and uncertainty.

    Here is a quote from a piece by Stiglitz in the FT: “monetary policy has not worked to get the economy out of its current doldrums. The best that can be said is that it prevented matters from getting worse.” So yes, not sufficient, get more aggressive. This preference for more fiscal action, a traditionally Keynesian skew, makes no difference for my argument.

  24. chidemkurdas Says:

    I couldn’t link to the FT but the Stiglitz piece is republished in

    http://economistsview.typepad.com/economistsview/2010/10/stiglitz-it-is-folly-to-place-all-our-trust-in-the-fed.html

    I did not claim that he wants to leave it all to the Fed; on the contrary, the deficit spending part is clearly key from the Keynesian perspective.


  25. @Chidem,

    Always happy to edify.

    @Bill Woolsey
    Go to the Free Banking blog. RAA= reductio ad abursdam

  26. Allan Walstad Says:

    Woollsey–I assure you I am not “blinded by ERE.” And I highly doubt you can read my mind.


  27. Lee,

    Whether QE is preferred or not, my point stands: market monetarists heavily criticized Meltzer’s op ed.


  28. [...] Robert Higgs, “Regime Uncertainty,” Independent Review 1, 4(1997), pp. 561–590).  Some of the economists in this second category see the fundamental difference between them and the “stimulus” [...]

  29. Bill Woolsey Says:

    O’Driscoll:

    Thank you. There has been a good bit of discussion of Selgin’s posts of Free Banking. Reductio? All Selgin argued is that wages should have stopped rising some time ago, and that by now, they should be on an appropriately lower growth path–consistent with the 14% lower growth path of nominal GDP. In reality, wages are only about an about 3% lower growth path. If they had ceased rising in 2008, given the trend growth rate of 3%, they would now be on a 12% lower growth path (ignoring compounding.) So, they would be in the right ball park. But wages didn’t stop rising. What has happened is that their growth rate has become progessively slower.

    Interestingly, since the GDP deflator is on about a 2% lower growth path, real wages have fallen a tad.

    Anyway, draw a supply and demand for labor diagram and explain that. If nominal wages grown any less there would have been shortages of labor?

  30. Bill Woolsey Says:

    Kurdas:

    There are many reasons why the demand to hold money might rise. If people are uncertain, and choose to hold money, why shouldn’t we have a monetary regime that supplies it?

    The demand for credit is low, because people are waiting to borrow, and the supply of credit is high, because people want to lend their funds for a time and then spend later, why shouldn’t market interest rates be low. Doesn’t a decrease in demand and increase in supply result in a lower price?

    Regardless of why there is an increase in the demand to hold money, if the quantity of money fails to match it, then the result will be reduced demand for ouput. Those made unemployed by the situation will reduced their demand to hold money, resulting in the demand for money falling back (or rising no more) than the acutal quantity.

    With perfectly flexible prices, then the unemployed workers would undercut the wage offers of the currently employed. The wage rate would fall. Profits would expand. Competition would force down prices. And the real quantity of money would rise to match the demand. That is, greater uncertainty might raise the demand for money, and the real supply would rise due to a lower price (and wage) level. Employment and production would be maintained.

    To the degree some of those will the higher money balances lend them, this would tend to lower interest rates. To the degree this uncertainty is considered temporary (it is due to uncertainty of some special sort) the price level would be expected to recover, reducing the real interest rate. Of course, there could be a pigou effect, so that people would become so wealthy due to their higher real balances of outside money that they would consume more after all.

    Of course, prices and wages aren’t that flexible, especially if the increase in money demand is temporary, so any decrease in prices and wages will soon be reversed.

    But, you and Metlzer say that we just should suffer reduced output and employment because of the increase in the demand for money due to uncertainty.

    But really, this argument is that we should elect Romney, and reelected the Republican house, and elect some Republican Senators, so that the bad Obama policies will no longer be a worry, and so the demand for money can fall.

    I think that the market system needs a monetary regime that doesn’t create Great Recessions when worrisome political developments occur. Slow, steady growth in spending on output. The quantity of money and interest rates should adjust however much is needed to maintain spending growth. Actual production should shift with actual productivity, and the price level adjust so that real expenditures matches actual productivity given slow steady growth in nominal expenditures.

    Think about it.

  31. Jon Finegold Says:

    Bill Woolsey,

    What if high unemployment isn’t caused by wage stickiness per sé (wages are growing because entrepreneurs expect higher income by retaining less workers at higher wages), but because of a lack of productivity? And, what if a lack of productivity isn’t caused by a “shortage of money,” but by a lack of lending due to a highly indebted banking system funding bad debt to avoid a loss in confidence (something which has been occurring in Spain, for example)?

    By theory of imputation, factor prices should be formed on the basis of expectations. That is, expectations concerning income streams from the use of these factors. If so, then why shouldn’t producers’ goods fall in price? In fact, empirically we can verify that it was these goods which fell in price dramatically as the recession unfolded. Also, consumption has recovered, meaning demand for output should be relatively stable now. Given theory and history, I don’t see the shortage of money story as particularly persuasive.

  32. Bill Stepp Says:

    Didn’t Friedman advocate a simple monetarist rule of a constant rate of growth in the money supply with a computer running it? Neither monetarism, at least that rendition, nor market monetarism are pro-free market, advocating as they do that the money supply be controlled by the Fed entity.
    Freedom in the monetary sphere boils down to fee banking.

  33. bill woolsey Says:

    Finegold:

    A “shortage of money” is not a shortage of loans. A shortage of money is that the demand to hold money is greater than the quantity of money. Usually, few people borrow money to hold it.

    The quantity of money can increase without any increase in new lending. In fact, total lending growth can be negative–ddebts can be paid down. It is just more of the existing debt would need to be held by banks. Also, banks can create more money by funding their asset portfolios with more monetary liabilities and less nonmonetary liabilities.

    When people have less money than they want to hold, they spend less of their current money receipts. This builds up the money holdings of the individual household or firm.

    Of course, those would would have sold them them earn lower incomes and have smaller money balances.

    In practice, what happens is some people and firms have large money balances that they find satisfactory. They don’t want even higher balances. Other households and little or no income and very small money balances. While they would like more income, they don’t want higher money balances.

    Still, this is a symptom of inadequate money balances.

    No one necessarily desires to borrow more money in this situation. Experience shows that it is consisent with low credit demand, high credit supply and very low interest rates.

    Those who see this situation and say that there is no shortage of money because interest rates are low and there is no unusual desire to borrow more simply do not understand monetary economics.

    Unfortunately, Chairman Bernanke is quite infected with the “credit view.”

    If labor productivity falls, then real wages need to fall to maintain employment. This could occur through lower nominal wages today or higher expected prices in the future.

    The nominal value productivity of labor depends on how much the labor will produce and how much people will pay for the output. Market monetarists argue that the nominal value productivity has fallen because the quantity of money has failed to increase enough to match the demand to hold money (perhaps caused by greater uncertainty.) With higher spending on output in the future, either more will be produced and sold or it will be sold at higher prices, making current nominal wages closer to market clearing.

    If real productivity has fallen, then real wages need to fall. If spending on output remains on a constant growth path, then the reduced future production will reduce the current equilibirum nominal wage, but the higher prices of the output (less output with given expenditure implies higher prices) will raise the equilibrium nominal wage. There would be little net change.

    Now, if you argue that the supply of labor is highly elastic with respect to the real wage, so that peopel will work less because, for example, they anticipate having to pay more for gas at the pump with no cost of living increase, then this could result in a decrease in employment. I find these sorts of arguments much more implausible than arguments that lower nominal wages and prices would result in increases in real expenditure, increases in the volume of sales, and additional production and employment. Why don’t they all lower their prices and wages? Or more importantly, why do they increase them at only a slightly lower rate? I don’t know. Perhaps it is because the Fed promises everyone that prices will go up 2% per year. But that wages and prices have such awful inertia is more plausible to me than the supply of labor being nearly perfectly elastic.

    Perhaps it is just introspection. But if my employer failed to keep up with inflation, I wouldn’t just stay home. I would keep on working at my current job until I found something better.


  34. Bill,

    My comments on the demand for money and the current health of the banking system should be considered separately. I don’t mean to imply a confusion between the demand for money and the demand for credit. I understand the theory of monetary disequilibrium fairly well.

    A few comments, though.

    Regarding employment, I’m not sure the situation is quite that simple. Wage statistics, I think, show one overarching phenomenon: employers prefer to keep few workers at higher prices. This doesn’t mean, though, that the disutility of labor for the unemployed is equally as high. It might just mean that there is a lack of sufficient job creation that isn’t necessarily related (or only related) to the cost of labor.

    Like I wrote in my previous comment, demand for final output has more-or-less return to its pre-recession level. What this mean is that demand for intermediate output has fallen (just compare the proper CPI index with the proper PPI index). I don’t see a compelling reason to believe that liquidity injections can raise demand for these intermediate products. In fact, I see this as an undoubtedly structural issue; since, even an increase in the demand for final output doesn’t translate for an increase in demand for the output of intermediate products produced during the boom years. (In fact, Hayek argues that the only way to increase demand for these products is to decrease demand for final output, or increase the rate of savings.)

    With regards to demand for credit, I think that after four years the demand for credit ought to pick up. Expectations should readjust. The problem doesn’t seem to be demand, but the willingness to lend — i.e. the willingness for banks to endogenously create money.


  35. [...] “Uncertainty” plays a major role in the debate about what ails the US economy. Conservative bloggers, columnists and economists tend to emphasize the role of uncertainty and blame the sluggish recovery on government actions which may increase uncertainty. Tax policy and health care reform are the two big ones. I definitely have doubts about some of their specific claims in regards to the degree of uncertainty present in these issues, and the degree to which current policy (and the current administration) is responsible for this uncertainty. But that is not the point of this post. What is missing from the discourse is a clear agreement about what are the important causes and drivers of uncertainty for both businesses and consumers. The idea that uncertainty can have negative economic effects is not a new or controversial idea, even for those on the left. Keynes himself talked about it (uncertainty-and-the-keynesians). [...]


  36. [...] example of such tension is reported by Chidem Kurdas last July 20, 2012 in his article, Uncertainty and the Keynesians.  The future of global economy is uncertain. Two schools of economics offer their distinct [...]


  37. [...] Woolsey makes a fantastic point buried in the comments section of a Thinkmarkets post from about a week ago. Market Monetarists actually do favor a rule–keep nominal GDP growing at a [...]

  38. negativeinterest Says:

    Can you find a single part of that Stiglitz op-ed that implies that he believes that more monetary stimulus is necessary? Is it the part where he put “worked” in scare quotes? The part where he warns of the intergenerational effects of turning to monetary policy? Surely it’s not the part where he says that “monetary has not worked” or that monetary advocates are spouting “nonsense in current economic circumstances.”

    If the best evidence you have for Joe Stiglitz supporting further monetary easing is his begrudgingly charitable “The best that can be said is that it prevented matters from getting worse” then you have an extraordinally weak case for suggesting that Joe Stiglitz supports further monetary easing. It’s okay to cut your losses.

    You should actually make an attempt to differentiate between the views of different people who fall under the Keynesian umbrella. People like Paul Krugman, Brad Delong, Tim Duy, Christina Romer – these are Keynesians who advocate for further monetary easing. People like Joe Stiglitz who argue that “monetary policy has not worked” and that “monetary policy is not going to work” do not. A few minutes of Googling would have revealed this. It would be like saying “Economists on the New Keynesian side like Greg Mankiw and Paul Krugman argued against a large fiscal stimulus package” or “Economists on the libertarian side like Milton Friedman and Murray Rothbard argued that leaving the gold standard was the key to recovering from the Great Depression.”

  39. bill greene Says:

    Eleven days ago I wrote: “Debating arcane economic theory will not solve our problems– Honest government will. Keeping Goldman Sachs execs in charge of the Treasury Department and Federal Reserve is inviting more of the same speculative binges. Breaking up the financial institutions into smaller separate competing entities would help a lot. Printing money and ballooning the national debt only makes things worse.”

    I would add that, the continuing corrupt practices of speculators, bankers, Congressmen, fund managers, Fannie Mae, HUD, et al. will continue to rock the economy and investors’ savings. The recent mortgage-market collapse was clearly a miscarriage of regulatory controls. Economic theory had lttle to do with it, except that the government did help blow up the bubble by subsidizing sub-prime loans.

    The past few economic crises in America demonstrate that corruption and manipulation in high places trump economic theory. All the uncertain and confused efforts to manipulate interest rates, inflation, demand, money supply, and unemployment have been wasted, have proven fruitless, and have been overshadowed by the corrupt practices and loopholes allowed those at the center of the nation’s financial operations.

    I assume those posting here prefer to debate the extremely varying theories on how central planners could theoretically improve the soundness of our economy provided all their conflicting theories could be reconciled. I prefer to dream of a new Joe Kennedy going in and closing down all the corrupt and speculative practices that have brought our nation to its knees.


  40. [...] I don’t see there, which I think should be there, is ThinkMarkets. Sure, they might have some bad posts sometimes but at least they make up for it with some good posts [...]

  41. bArun Says:

    I imagined your posting was neat and will pay a visit to frequently.


  42. [...] Diokno gave such advice dated January 2 this year. In the US, Joseph Stiglitz and Paul Krugman gave similar advice as reported by Chidem Kurdas last July 20, 2012. These economists therefore are Keynesian and they [...]


  43. [...] example of such tension is reported by Chidem Kurdas last July 20, 2012 in his article, Uncertainty and the Keynesians.  The future of global economy is uncertain. Two schools of economics offer their distinct [...]


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