Wednesday, May 4, 2011

"We're all Pigovians Now"

That's probably what Friedman should have said. Surprisingly, I actually agree with a lot that Casey Mulligan has to say in this post.

Anyone that doubts what Mulligan is saying here needs to answer the question of why prices have been consistently eight points higher than we estimate they should be for over two years. "Sticky prices" doesn't give you a two year delay in price adjustment. Zero lower bound stuff is useful for talking about what policy can and can't accomplish but even that's inadequate here: not ever price is at a zero lower bound, after all. Some institutional explanations - "disrupted credit channels" - admittedly might play some role. But this issue that Mulligan points out is not trivial. We need to be in search of explanations which present a situation where we would not expect the market to right itself - even after two years.

UPDATE: Paul Krugman is much less sympathetic. Krugman, of course, is New Keynesian born-and-bred, so it's not surprising that he points out the nuances of New Keynesianism and the simplification that Mulligan provides. This is fair to a certain extent. The zero lower bound that Krugman mentions has been incorporated in some New Keynesian work. You've got things like the old Kenyesian IS and LM material which is reincarnated in an IS-MP model, or re-derived from microeconomic frictions, etc. New Keynesianism isn't simply "stick prices did it" economics, as Mulligan presents. But price rigidity is featured very prominently, and Krugman himself has demanded that the discipline be reinvigorated with some old Keynesianism insights. My point on Mulligan was this: he's right that anyone relying largely on price rigidities should be seriously reconsidering things right now. Krugman is probably right as well that Mulligan has dumbed down New Keynesianism.

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