In fairness I've thought it was defended in a confusing way in the past.
Bob scrutinizes Krugman's posts more than anyone I know, so I was a little surprised to see him miss the whole point in this post. Here he suggests that Christina Romer is parting from Krugman on the confidence fairy.
Look there are a couple things investors could have confidence in:
1. Balanced budgets (ceteris paribus, that's a nice thing to see)
2. Maintenance of demand (ceteris paribus, that's a nice thing to see)
3. Maintenance of future demand (ceteris paribus, that's a nice thing to see)
Mocking the confidence fairy - as I have always read it - is mocking the idea that #1 is going to turn the economy around when the major problem is a lack of demand, not a lack of loanable funds. Call me crazy, but that's just what Krugman has referenced every single time. And there were times - like during the Bush or the Clinton years - when Krugman noted the benefits of balancing budgets. Context matters, people.
But don't take my word for it. Read this Krugman post where he spells it out to others that apparently don't get the point:
"Expectations and the Confidence Fairy
Some readers have asked whether there isn’t an inconsistency between my view that the Fed can promote economic recovery by changing expectations about future policy, and my ridicule of austerity proponents who invoke “confidence” as a reason to believe that austerity will actually be expansionary. But there isn’t really any inconsistency; it’s an orders of magnitude thing.
What the expansionary austerity types are claiming is that the indirect effect of austerity on confidence will outweigh the large direct depressing effect of cutting government spending now. That’s a very tall order. Consider a very simple New Keynesian model, like the one I used in my old Japan paper (pdf). This model assumes infinitely lived consumers with free access to capital markets, assumptions that would seem to be very favorable to the notion that changes in expected future policy matter. Yet even there, a perceived permanent fall in government spending will at best have zero effect on output; if there’s any notion that the cuts are temporary, they’ll be contractionary. Add more realism, and the odds of expansionary austerity get even worse.
By contrast, expectations-based monetary policy has no direct effect on the economy today, so any positives from expectations make it favorable over all. You don’t have to believe that the effects are really big to believe that they might be there.
Now, there is room for skepticism over the effectiveness of “credibly promising to be irresponsible” — which is why from the beginning of this crisis I’ve always favored using fiscal policy as the main answer, with unconventional monetary policy as a supplement. But the Fed should be doing what it can — and finally, it seems to be moving in that direction."
Now can anyone tell me with a straight face that Krugman and Romer aren't essentially on the same page? Just like Romer wrote: "Recent research suggests that New Deal programs may actually have had their primary impact on the economy by influencing consumer and business expectations of future growth and inflation."
Tuesday, October 30, 2012
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What I'd like to know is what you Keynesians think about profits.
ReplyDeleteLots of you say that misallocation is unlikely to be a problem for the economy in practice because entrepreneurs are forward-looking. If the central banks cuts interest rates, and increases profits across the economy then they'll understand that this is only a temporary phenomenon and won't expand production.
If this is true then how come they will expand production in the case of a rise in demand caused by extra government spending? Why can't they see through that change too?
" If the central banks cuts interest rates, and increases profits across the economy then they'll understand that this is only a temporary phenomenon and won't expand production.
DeleteYet that is a response using rational expectations and associated with Bryan Caplan's argument against ABCT. Bryan Caplan is a libertarian.
The non-neoclasssical, Post Keynesian critique of ABCT does not use rational expectations at all.
It points out that, amongst other things, that:
(1) modern ABCT is essentially Hayekian ABCT.
(2) Sraffa's critique still applies, certainly to any that version that uses a unique Wicksellian natural rate of interest.
(3) the Hayekian ABCT is flawed precisely because it requires all sorts of assumptions derived from general equilibrium theory and ignores the role of subjective expectations:
http://socialdemocracy21stcentury.blogspot.com/2012/01/hayeks-trade-cycle-theory-equilibrium.html
(4) the Hayekian ABCT makes flawed assumptions about the nature of capital goods:
http://socialdemocracy21stcentury.blogspot.com/2012/10/hayek-on-his-simplified-capital-theory.html
http://socialdemocracy21stcentury.blogspot.com/2012/10/repapis-on-hayeks-business-cycle-theory.html
"Yet that is a response using rational expectations and associated with Bryan Caplan's argument against ABCT. Bryan Caplan is a libertarian."
DeleteYes, my point here is that you can't have your cake and eat it. Either you agree with rational expectations, in which case there is no argument for stimulus, or you don't. If you don't then you can't deny that changes in profit rates and interest rates will have an effect on production.
As I understand it LK you're a Post Keynesian. So, I suppose your overall argument is that although changing profits change investment they don't do so in a harmful way. Is that correct?
I agree that there are plenty of problems with Hayek's theories, and later forms of ABCT too. But what I don't see is why everyone is so confident that the problems fully counteract the theory and lead to no important effect. Furthermore, some of these criticisms just lead to different changes to the production structure, not necessarily a production structure free of problems.
The points here are:
Delete(1) Post Keynesians and heterodox Keynesians in general reject rational expectations.
(2) The "misallocation" problems in ABCT don't occur in the way the theory postulates. Take the single natural rate of interest, for example. It does not exist: the belief FR banks or central banks drive a market rate below it, causing miscalulation problems just isn't true. It's also all dependent on a untrue, non-monetary, "real" theory of interest rates anyway. Whatever resources are available in an economy at any one time is an empirical matter.
(3) capital goods are certainly heterogeneous. But heterogeneous capital can also have a significant degree of durability and substitutability. A capital structure in a capitalist economy where we find some important degree of adaptability, versatility and durability in the nature of capital goods means that the Austrian business cycle theory of Hayek, as propounded in Prices and Production, is not a realistic vision of modern economies.
Hayek even admitted this in a letter to Keynes:
http://socialdemocracy21stcentury.blogspot.com/2012/10/hayek-on-his-simplified-capital-theory.html
- LK
"The 'misallocation' problems in ABCT don't occur in the way the theory postulates. Take the single natural rate of interest, for example. It does not exist: the belief FR banks or central banks drive a market rate below it, causing miscalulation problems just isn't true. It's also all dependent on a untrue, non-monetary, 'real' theory of interest rates anyway. Whatever resources are available in an economy at any one time is an empirical matter."
DeleteThere are problems with the old theories of interest rate determination that rely on barter. I don't think they're robust when explained in any way I've yet seen published, but I think something similar to them would be the best model we can hope for. That said, lets suppose that these theories aren't true. In that case how could there be any predictability in the economy at all? Bringing up reswitching or interest rates that differ with the distribution of wealth doesn't make the problems go away, it just makes them harder. Neither of these effects can be relied upon to push the economy in the opposite direction to ABCT.
"capital goods are certainly heterogeneous. But heterogeneous capital can also have a significant degree of durability and substitutability. A capital structure in a capitalist economy where we find some important degree of adaptability, versatility and durability in the nature of capital goods means that the Austrian business cycle theory of Hayek, as propounded in Prices and Production, is not a realistic vision of modern economies."
No, and that's why he wrote so much more about the subject later, as you know :)
Certainly you're right that much capital is durable. If you look work for a large business, as I do, then they buy a lot of durable capital. But everything can't be durable. A large part of capital will always be circulating capital and besides durable capital can still be misallocated. There is certainly a *degree* of versatility and substitutability between capital goods. But it's by no means perfect. Take a factory, for example, such as the one I'm typing this in. If the company I worked for went bankrupt, or if sales decreased and the factory became redundant then it could be repurposed by another purchaser (or even the same company). But, doing so would require a great deal of resources, a significant fraction of the value of the buildings. If there's already sufficient factory space in the vicinity (and there is) then the factory may be of no use for many years to come.
Let's suppose that due to misallocation the average project were to yield only 5% less than was expected. That would have a huge effect on GDP, firstly through the decrease in income to captialists and secondly because of change to the supply curve for each good. In percentage terms it doesn't take large changed to cause a recession because recessions are only themselves minor changes in percentage terms.
Current: "Either you agree with rational expectations, in which case there is no argument for stimulus, or you don't."
DeleteRational expectations is no argument against stimulus, either. Stimulus, no stimulus, it does not matter.
In truth, though, isn't the idea of rational expectations an argument for putting money in the hands of the lower classes, who are unable to save against future taxes, no matter what their expectations are?
AFAICT, economics has no generally accepted theory of confidence or expectations. Which is why you get the Confidence Fairy and Nick Rowe's Chuck Norris, Central Banker. (I doubt if the idea of Rational Expectations deserves to be called a theory. It's an assumption, AFAICT.)
ReplyDelete"Rational Expectations" is generally taken to be a lot more than a theory of expectations. There's a whole lot of macroeconomic ideas centered around it.
DeleteNow, you're point earlier is like Kalecki's, the poor consumer may be liquidity limited. Generally, this view is taken as being against the big "Rational Expectations" theory, but it can be consistent with assumption of rational expectations.
So, there is a get-out here. One can believe that in general everyone has rational expectations, both worker/consumers and entrepreneurs. One can then criticise ABCT on account that entrepreneurs have rational expectations and can act on them, then praise stimulus because worker/consumers have rational expectations but can't necessarily act on them. But, how realistic is this view? I agree that many workers are liquidity limited, but don't think that either entrepreneurs or workers can have rational expectations. It's expecting too much of everyone to be so clever about the economy, there's little evidence that it's a valid assumption.
Thanks, Current. :)
DeleteBusy, busy, so I'll leave things here.