Monday, November 22, 2010

John Taylor on Keynesianism

John Taylor has a post up on Keynesian economics that's a little interesting and a little odd. I'll just quote in full:

"This past weekend Columbia University hosted a conference on the occasion of the 40th anniversary of the famous Phelps volume on the micro foundations of macroeconomics. In addition to the technical papers, which will eventually be published in a conference volume, important lunch and dinner talks were given by two of the most recent Nobel Prize winners in economics--Dale Mortenson and Chris Pissaredes--as well as by Fool’s Gold author Gillian Tett of the FT and Ned Phelps.

Ned spoke about what he called the “recrudescence of Keynesian economics.” He explained why, as he put it in his New York Times column of last August, “The steps being taken by government officials to help the economy are based on a faulty premise. The diagnosis is that the economy is ‘constrained’ by a deficiency of aggregate demand. The officials’ prescription is to stimulate that demand, for as long as it takes, to facilitate the recovery of an otherwise undamaged economy — as if the task were to help an uninjured skater get up after a bad fall. The prescription will fail because the diagnosis is wrong.”

The problem with these Keynesian policies is that at best they give short term boosts to the economy, but then fizzle out as we are seeing now. Sustaining growth in employment requires sustaining investment, which requires government policy that encourages investment and innovation, not short-run stimulus packages that try to boost consumption and government purchases, which crowd out investment.

Will there be an end of this recrudescence? Politics as well as economics will be an important determining factor, at least that’s what the historical analysis in the paper I presented at the conference shows. The good news then is that more people are beginning to see the problems with these stimulus packages and the political process is responding."

I find his position quite reasonable, but what's strange to me is that he's describing sort of an odd version of Keynesian economics. He's playing fast and loose with terms like "demand" and "consumption", acting like the point of stimulus is to boost the latter. The point of a Keynesian stimulus isn't (primarily) to boost consumption, and the fact that the fiscal stimuli we've seen largely do is a valid critique of the focus of the stimulus package. But it's not really a valid critique of Keynesianism, whose primary emphasis is to boost investment demand through (1.) reducing interest rates, and (2.) the enigmatic "socialization of investment". The General Theory is not really a consumption story at all. Consumption is that psychologically stable-sloped slide that a depressed economy drifts down. To use classic econ 101 phrasing - "we move down the consumption schedule in this case, the consumption schedule doesn't move". Other points, like the idea that stimulus packages crowd out private investment, are of course absurd - but if you don't think it is true then you are forced to accept some important Keynesian premises, which I don't think John Taylor wants to do.

I do think there's an extent to which what we traditionally think of as "innovation policies" can be put to good use as "stimulus policies". We categorically separate them because of how we think of innovation as a determinant of secular growth, but it's not clear why that's necessary.


  1. "the idea that stimulus packages crowd out private investment, are of course absurd"

    Did you mean to qualify that with "during a liquidity trap", or am I missing the boat on something here?

  2. Oh yes - I mean in this current situation.

    Although I should say, the idea of "crowding out" is somewhat odd even in normal times. Private investments crowd out other private investments all the time, and we don't worry about it. Why? Because we assume the price mechanism arbitrates between them to pick the better investment.

    So what of public investments that "crowd out" private investments. There's no good a priori reason to believe that the private investment is the better investment... but there are problems with the operation of the price mechanism as an arbitrator here. The problem isn't irreconcilable of course. Governments do have to pay for their borrowing, just like private companies do. But besides that, it can be tough. How do you assess the value of government infrastructure, security, or research measures. The whole problem with government is that you can't. But the whole problem with the public sector is that while you can assess private costs and benefits, you can't assess social costs and benefits with the market.

    So you're kind of screwed in both directions, right? In that sense, no real precise method of arbitration is possible (as it is when we're dealing with purely private costs and purely private benefits). But it seems to me that doesn't solve anything. If we don't know the exact value of a public investment, it's just as likely that private investments would crowd out good public investments in normal times as it is that public investments would crowd out good private investments.


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