How To Move A Novel Keynesian Together With An Onetime Keynesian At The Same Time

A recurring subject inward economic science blogs, especially those that tend to live disparaging of mainstream Keynesian theory, is that Keynesians similar to live New Keynesian (NK) when talking well-nigh theory, but Old Keynesian (OK) when talking well-nigh policy. John Cochrane has recently made a similar observation, which is picked up past times Megan McArdle. To accept only ane instance of this alleged sin, inward the basic New Keynesian theory Ricardian Equivalence holds (see below), so a taxation financed stimulus should live equally effective equally a debt financed stimulus, yet Keynesians ever look to prefer debt financed stimulus.

The divergence betwixt Old as well as New that Cochrane focuses on relates to models of consumption. In the outset yr textbook OK model, consumption only depends on electrical current income. The coefficient on electrical current income is something similar 0.7, which gives rising to a pregnant multiplier: plough over these consumers to a greater extent than to spend, as well as the additional spending volition itself generate to a greater extent than output, which leads to yet to a greater extent than income, as well as so the touching on of whatsoever stimulus gets multiplied up.

Basic NK models employ the gear upwardly of the (possibly infinitely lived) intertemporal consumer. To explain, these consumers facial expression at the introduce value of their expected lifetime income, as well as the income of their descendents if they assist well-nigh them (hence infinitely lived). This has 2 implications. First, temporary shocks to electrical current income volition possess got rattling piddling touching on on NK consumption (it is a drib inward the body of body of water of lifetime income). The marginal propensity to eat out of that temporary income (mpc) is close zero, so no multiplier on that account. Second, a taxation cutting today agency taxation increases tomorrow, leaving the introduce value of lifetime post-tax income unchanged, so NK consumers only salvage a taxation cutting (Ricardian Equivalence), whereas OK consumers pass most of it. However NK consumers are sensitive to the existent involvement rate, so if higher output today leads to higher inflation but the nominal involvement charge per unit of measurement remains unchanged, as well as so you lot become a multiplier of sorts because NK consumers react to lower existent involvement rates past times spending more.

So far, so different. But the NK consumption model assumes that agents tin borrow whatever they need to borrow. There are proficient theoretical reasons why that is unlikely to live truthful (e.g. asymmetric information), as well as fifty-fifty amend empirical bear witness that it is not. Empirical studies that facial expression for ‘natural experiments’, where agents obtain an unexpected increment inward post-tax income which is probable to live temporary, typically detect a mpc of closed to a tertiary (even for non-durables), rather than almost zip equally the basic intertemporal model would predict. (For only ane recent example: Consumer Spending as well as the Economic Stimulus Payments of 2008, past times Parker, Souleles, Johnson, as well as McClelland, American Economic Review 2013, 103(6): 2530–2553.)

So if mainstream Keynesian theory wants a to a greater extent than realistic model of consumption, it oftentimes uses the (admittedly crude) device of assuming the economic scheme contains 2 types of consumer: the unconstrained intertemporal type as well as the credit constrained type. Influenza A virus subtype H5N1 credit constrained consumer that receives additional income could eat all of that additional income, so their mpc out of electrical current income is one. [1] That credit constrained consumer is thus rather Old Keynesian inward character. But at that topographic point are besides enough of unconstrained consumers closed to (e.g. savers) who are able to acquit similar intertemporal maximisers, so past times including both types of consumer inward ane model you lot become a hybrid OK/NK economy.

So it is perfectly possible to live an Old Keynesian as well as a New Keynesian at the same time, using this hybrid model. It may non live a especially elegant model, as well as the microfoundations tin live a chip rough, but enough of papers possess got been published along these lines. It is a lot to a greater extent than realistic than either the unproblematic NK or OK alternatives. It explains why you lot powerfulness favour a bond financed stimulus over the taxation financed alternative, because at that topographic point are enough of credit constrained consumers closed to who are the contrary of Ricardian.[2] 

You tin brand the same betoken well-nigh ane of the other commutation differences betwixt OK as well as NK: the Phillips curve. The New Keynesian Phillips bend relates inflation to expected inflation side past times side period, as well as assumes rational expectations, piece a to a greater extent than traditional Phillips bend combined alongside adaptive expectations relates electrical current inflation to past times inflation. While I practise non recollect you lot volition detect many economists using the OK Phillips bend on its ain nowadays, you lot volition detect many (including this lot) using a hybrid that combines the two. The theoretical reasons for doing so are non that clear, but at that topographic point is enough of bear witness that seems to back upwardly this hybrid structure. So ane time over again it makes feel to live both OK as well as NK when giving policy advice.

Neither floor is equally exciting equally the thought that New Keynesians are actually cupboard Old Keynesians, who solely pay lip service to New Keynesian theory to gain academic respectability. Instead it’s a floor of how mainstream Keynesian economists try to adjust their models to live to a greater extent than consistent alongside the existent world. How dull, ho-hum as well as inelegant is that!

[1] I say ‘could’ here, because if the increment inward income lasts for less fourth dimension than the expected credit constraint, as well as so smoothing nevertheless applies, as well as the mpc volition live less than one.

[2] My ain persuasion is that the mpc out of temporary income is besides pregnant because of precautionary savings: run across the newspaper past times Carroll described here.