Jonathan picks up on this dichotomization of the ways of thinking about monetary policy. He starts by saying that my argument relies on entrepreneurial expectations of deflation, which it doesn't at all. Horrendous as policy has been, I'm not particularly worried about long bouts of deflation per se. The monetary authority can fiddle while Rome burns at one or two or three percent, but I'm fairly confident deflation will get them motivated to do something. I think most entrepreneurs share this expectation. That means that our understanding of the monetary policy reaction function is such that we're not expecting deflation. So, no Jonathan.
He then says that my point that the interest rate channel is a no-go "assumes that the “marginal efficiency of capital” is lower than the rate of interest, but there is no evidence that entrepreneurs perceive a lack of profitable investment opportunities [!!!!!!].
"There are three stronger explanations (which can work in conjunction):
- Incentives against lending: Banks’ excess reserves have risen as a result of Federal Reserve policy — namely, paying interest on reserves (Todd Keister and James J. McAndrews, “Why Are Banks Holding So Many Excess Reserves?”);
- Asset weakness: I am not sure this applies to American banks, but Spanish banks have had trouble extending liquidity to new borrowers, because much of their available liquidity has been lent to maintain non-performing assets. This allows banks to avoid a panic amongst investors;
- Regime Uncertainty: The expected profitability of investment is not just derived from the “marginal efficiency of capital,” but also from the expectation that the project will be completed and left intact by government interference. There may also be some element of what many have used to criticize Austrian business cycle theory: expectations of another fluctuation."
In other words - exactly the MEC argument!!!!
On the second point, I think it's helpful to first remember that supply and demand is a schedule, not (just) a quantity. Jonathan points out that banks decide to loan out less money to new borrowers because they're trying to avoid a run by maintaining current assets. To put it another way, the return on new investments is not high enough to entice banks to lend money to those new investors.
Not exactly the MEC argument as it is usually composed (since we are not exactly comparing MEC to a liquidity premium in this case), but pretty close to the MEC argument!!!!
And the third point is bonkers as an alternative. That is a statement about MEC! Investors ask themselves "given the cost of this purchase of a piece of capital, what is the discount rate that produces a net present value of my expected future earnings equal to the cost I am paying today? Is it higher or lower than the interest rate?". If anything lowers those expected future earnings (such as something uncertain about the policy regime or the economy), you get a lower MEC.
Since Keynes's primary argument for why MEC might drop dramatically was uncertainty about the future, you can't get much more Keynesian than discussions about regime uncertainty (whether regime uncertainty is actually the problem in a given situation is of course an open question).
And all this talk about expectations brings us full circle to my initial point: expectations are the primary channel through which monetary policy is working right now.