Scott Sumner isn’t happy with me. Not surprising. I wouldn’t be happy with me either. I basically think Monetarism is filled with errors and misrepresentations of the monetary system and the way things work in the economy and I’m not exactly quiet about it. But this criticism and back and forth is also part of the process of progress. In order to make progress people are going to be wrong along the way. And that means that some people’s beliefs and “schools of thought” will be forced to evolve, change and even whither away with time. It’s nothing personal. I am sure Scott is a fantastic person with good intentions. But the bad ideas need to die or change. The fact that people are vocal about what they believe in is a good thing because it creates a discourse which leads to progress. So we shouldn’t have to apologize for being vocal about what we believe in even though I should have been more technically accurate and compared Scott to an ape and not a monkey.
In his latest post Scott says:
“Roche says it’s obvious I was referring to new Keynesianism, whereas I thought it was obvious I was referring to the older variant, the one that took liquidity traps much more seriously.”
I don’t really know what this means. I am not technically a trained economist, but I have read the General Theory more times than is healthy. And I often get the impression that many trained economists aren’t all that familiar with the text. For instance, Keynes was pretty clear about what he thought a liquidity trap was:
“after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest.”
– The General Theory, Ch 15
So, when Scott refers to the “older variant” he is obviously confused about what the “older variant” means because the “new variant” (the New Keynesian version we often hear about today by people like Paul Krugman) is not the same thing that JM Keynes originally referred to. That is, the Central Bank has not lost control of the rate of interest because of liquidity preference. I’ve criticized Paul Krugman for deviating from this definition and creating an alternative definition which is so wide open that it is actually meaningless (basically, he defines the LT as an environment in which traditional monetary policy has lost traction which could really mean anything one wants it to). So Sumner is not being critical of the “older” concept of the Keyenesian Liquidity Trap because no Keynesian would actually call today’s environment a Liquidity Trap in the same sense that Keynes discussed in the General Theory.
“Roche admits that much of new Keynesian economics is based on Friedman’s work, so I guess he thinks NK is also completely discredited.”
Well, not “completely discredited”, but I don’t exactly think the NK views are perfect or even all that “Keynesian”. I have criticized Paul Krugman because much of his thinking is rehashed Monetarist ideas. People call Paul Krugman a “Keynesian”, but he has a good deal of Monetarist thought in his underlying model of the world. That’s basically what the crux of this post was all about. Dr. Krugman thinks the “price is wrong” which is an extension of the idea of a natural rate of interest. The idea of the natural rate of interest is a Wicksellian concept that has infiltrated New Keynesian models and has become a key piece of their models. It’s something Keynes himself rejected and Monetarists embraced. And it’s why Dr. Krugman and Dr. Sumner both agree that QE is an effective way to boost the economy (though they disagree on some of the details).
The basic idea there is that the Fed just has to alter expectations and get the real rate of interest low enough to get us back to some equilibrium. This is just a different version of Monetarist thinking where, instead of using the Fed to steer the economy through the money supply or the interest rate channel, you’re steering through an expectations channel. And it all comes back to the same laissez-faire policy approach implemented through what is supposedly an omnipotent Central Bank. This theory might be fine in an alternative universe, but in a world where Central Banks are severely limited (legally) in what they can do I just don’t see the transmission mechanism through which Central Banks can achieve this. And every time I push Monetarists and New Keynesians to explain the transmission mechanism they just give vague hand wavey answers about changing expectations.
This all just doesn’t add up. Sumner is criticizing the Liquidity Trap and its “Keynesian” roots, but the modern adherents of the LT don’t even use the concept in the same way Keynes did so you can’t criticize “Keynesians” just because some people label themselves Keynesians while adhering to the LT view that Keynes himself didn’t even believe in. And then the New Keynesians propose fixing the economy through monetary policy rationalizing the policy approach based on ideas like the Natural Rate of Interest which Keynes also rejected. So when Scott Sumner rips into “Keynesians” what he’s really ripping into are ideas that are largely consistent with the same movement he supports. It’s all just a big muddled mess if you ask me. It makes me wonder if the meaning of the term “Keynesian” has any discernible meaning in today’s debates or if economists just throw it around as a very general way to describe people who sometimes advocate for government spending programs (something Keynes also wasn’t a huge fan of at all times)….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.