New Vs. One-Time Keynesian Stimulus
While petty amongst a recent paper, "blog post), a elementary insight dawned on me on the speak together with key divergence betwixt New-Keynesian together with Old-Keynesian models of stimulus.
Old-Keynesian. The "Keynesian cross" is the most basic mechanism. (If yous are worried that I'm making this up, run into Greg Mankiw's Macroeconomics, p. 308 8th edition, "Fiscal policy together with the multiplier: Government Purchases.")
Consumption follows a "consumption function." If people instruct to a greater extent than income Y, they swallow to a greater extent than C
C = a + 1000 Y.
Output Y is determined yesteryear consumption C investment I together with regime spending G
Y = C+ I + G.
Put the 2 together together with equilibrium output is
Y = a + mY + I + G
Y = (a + I + G)/(1-m).
So, if the marginal propensity to swallow m=0.6, together with so each dollar of regime spending G generates non merely 1 dollar of output Y (first equation), but $2.5 dollars of additional output.
This model captures a satisfying story. More regime spending, fifty-fifty if on completely useless projects, "puts coin inwards people's pockets." Those people inwards plow become out together with spend, providing to a greater extent than income for others, who become out together with spend, together with so on. We describe ourselves upwardly yesteryear our bootstraps. Saving is the enemy, every bit it lowers the marginal propensity to swallow together with reduces this multiplier.
New-Keynesian. The view of the New-Keynesian model is a completely dissimilar persuasion of consumption. In its simplest version
Here consumption C, relative to trend, equals the total of all hereafter existent involvement rates i less inflation π i.e. all hereafter existent involvement rates. The parameter σ measures how resistant people are to consuming less today together with to a greater extent than tomorrow when offered a higher involvement rate.
(This is merely the integrated version of the measure outset gild condition, inwards discrete time
People inwards this model recollect virtually the hereafter when deciding how much to swallow together with allocate consumption today vs. tomorrow looking at the existent involvement rate. I've simplified a lot, leaving out trends, the score together with variation of the "natural rate" together with so on.)
In this model too, totally wasted regime spending tin sack heighten consumption together with thus output, but yesteryear a radically dissimilar mechanism. Government spending raises inflation π . (How is non of import here, that's inwards the Phillips curve.) Holding nominal involvement rates i fixed, either at the null fountain or amongst Fed cooperation, to a greater extent than inflation π means lower existent involvement rates. It induces consumers to pass their coin today rather than inwards the future, earlier that coin loses value.
Now, lowering consumption growth is usually a bad thing. But new-Keynesian modelers assume that the economic scheme reverts to trend, so lowering growth rates is good, together with raises the score of consumption today amongst no sick effects tomorrow. (More inwards a previous post service here)
Comparing stories
This new-Keynesian model is an utterly together with completely dissimilar machinery together with story. The view of the New-Keynesian model is Milton Friedman's permanent income theory of consumption, against which old-Keynesians fought so long together with hard! Actually, it's to a greater extent than radical than Friedman: The marginal propensity to swallow is exactly together with exactly zero inwards the new-Keynesian model. There is no income at all on the correct manus side. Why? By asset expected hereafter consumption constant, i.e. yesteryear assuming the economic scheme reverts to tendency together with no more, at that spot is no such affair every bit a permanent growth inwards consumption.
The old-Keynesian model is driven completely yesteryear an income number amongst no exchange effect. Consumers don't recollect virtually today vs. the hereafter at all. The new-Keynesian model based on the intertemporal exchange number amongst no income number at all.
Models together with stories
Now, why is Grumpy grumpy?
Many Keynesian commentators accept been arguing for much to a greater extent than stimulus. They similar to write the overnice story, how nosotros set coin inwards people's pockets, together with and so they become together with spend, together with that puts to a greater extent than coin inwards other people's pockets, together with so on.
But, alas, the old-Keynesian model of that even is wrong. It's merely non economics. H5N1 twoscore yr hollo for for "microfoundations" came upwardly amongst nothing. How many Nobel prizes accept they given for demolishing the old-Keynesian model? At to the lowest degree Friedman, Lucas, Prescott, Kydland, Sargent together with Sims. Since virtually 1980, if yous transportation a newspaper amongst this model to whatever one-half respectable journal, they volition turn down it instantly.
But people honey the story. Policy makers honey the story. Most of Washington loves the story. Most of Washington policy analysis uses Keynesian models or Keynesian thinking. This is actually curious. Our whole policy institution uses a model that cannot endure published inwards a peer-reviewed journal. Imagine if the climate scientists were telling us to pass a trillion dollars on carbon dioxide mitigation -- but they had non been able to let out whatever of their models inwards peer-reviewed journals for 35 years.
What to do? Part of the fashion is to say that all of academic economic science is nuts together with merely abandoned the eternal verities of Keynes 35 years ago, fifty-fifty if nobody e'er actually did instruct the foundations right. But they know that such anti-intellectualism is non totally convincing, so it's also stylish to utilization new-Keynesian models every bit holy water. Something similar "well, I didn't read all the equations, but Woodford's mass sprinkles all the correct Lucas-Sargent-Prescott holy H2O on it together with makes this all respectable again." Cognitive racket allows 1 to brand these contradictory arguments simultaneously.
Except new-Keynesian economic science does no such thing, every bit I recollect this event makes clear. If yous desire to utilization new-Keynesian models to defend stimulus, exercise it forthrightly: "The regime should pass money, fifty-fifty if on totally wasted projects, because that volition crusade inflation, inflation volition lower existent involvement rates, lower existent involvement rates volition cause people to swallow today rather than tomorrow, nosotros believe tomorrow's consumption volition revert to tendency anyway, so this pace volition growth demand. We disclaim whatever income-based "multiplier," sorry, our novel models accept no such effect, together with we'll stand upwardly up inwards world together with tell whatever pol who uses this declaration that it's wrong."
That, at least, would endure honest. If non specially effective!
You may disagree amongst all of this, but that reinforces about other of import lesson. In macroeconomics, the pace of crafting a even from the equations, figuring out what our short quantitative parables hateful for policy, together with agreement together with explaining the mechanisms, is actually hard, fifty-fifty when the equations are really simple. And it's important. Nobody trusts dark boxes. The Chicago-Minnesota equilibrium schoolhouse never actually got people to empathise what was inwards the dark box together with trust the answers. The DSGE novel Keynesian dark box has about really unexpected stories inwards it, together with is really very far from providing justification for old-Keynesian intuition.
Old-Keynesian. The "Keynesian cross" is the most basic mechanism. (If yous are worried that I'm making this up, run into Greg Mankiw's Macroeconomics, p. 308 8th edition, "Fiscal policy together with the multiplier: Government Purchases.")
Consumption follows a "consumption function." If people instruct to a greater extent than income Y, they swallow to a greater extent than C
C = a + 1000 Y.
Output Y is determined yesteryear consumption C investment I together with regime spending G
Y = C+ I + G.
Y = a + mY + I + G
Y = (a + I + G)/(1-m).
So, if the marginal propensity to swallow m=0.6, together with so each dollar of regime spending G generates non merely 1 dollar of output Y (first equation), but $2.5 dollars of additional output.
This model captures a satisfying story. More regime spending, fifty-fifty if on completely useless projects, "puts coin inwards people's pockets." Those people inwards plow become out together with spend, providing to a greater extent than income for others, who become out together with spend, together with so on. We describe ourselves upwardly yesteryear our bootstraps. Saving is the enemy, every bit it lowers the marginal propensity to swallow together with reduces this multiplier.
New-Keynesian. The view of the New-Keynesian model is a completely dissimilar persuasion of consumption. In its simplest version
Here consumption C, relative to trend, equals the total of all hereafter existent involvement rates i less inflation π i.e. all hereafter existent involvement rates. The parameter σ measures how resistant people are to consuming less today together with to a greater extent than tomorrow when offered a higher involvement rate.
(This is merely the integrated version of the measure outset gild condition, inwards discrete time
In this model too, totally wasted regime spending tin sack heighten consumption together with thus output, but yesteryear a radically dissimilar mechanism. Government spending raises inflation π . (How is non of import here, that's inwards the Phillips curve.) Holding nominal involvement rates i fixed, either at the null fountain or amongst Fed cooperation, to a greater extent than inflation π means lower existent involvement rates. It induces consumers to pass their coin today rather than inwards the future, earlier that coin loses value.
Now, lowering consumption growth is usually a bad thing. But new-Keynesian modelers assume that the economic scheme reverts to trend, so lowering growth rates is good, together with raises the score of consumption today amongst no sick effects tomorrow. (More inwards a previous post service here)
Comparing stories
This new-Keynesian model is an utterly together with completely dissimilar machinery together with story. The view of the New-Keynesian model is Milton Friedman's permanent income theory of consumption, against which old-Keynesians fought so long together with hard! Actually, it's to a greater extent than radical than Friedman: The marginal propensity to swallow is exactly together with exactly zero inwards the new-Keynesian model. There is no income at all on the correct manus side. Why? By asset expected hereafter consumption constant, i.e. yesteryear assuming the economic scheme reverts to tendency together with no more, at that spot is no such affair every bit a permanent growth inwards consumption.
The old-Keynesian model is driven completely yesteryear an income number amongst no exchange effect. Consumers don't recollect virtually today vs. the hereafter at all. The new-Keynesian model based on the intertemporal exchange number amongst no income number at all.
Models together with stories
Now, why is Grumpy grumpy?
Many Keynesian commentators accept been arguing for much to a greater extent than stimulus. They similar to write the overnice story, how nosotros set coin inwards people's pockets, together with and so they become together with spend, together with that puts to a greater extent than coin inwards other people's pockets, together with so on.
But, alas, the old-Keynesian model of that even is wrong. It's merely non economics. H5N1 twoscore yr hollo for for "microfoundations" came upwardly amongst nothing. How many Nobel prizes accept they given for demolishing the old-Keynesian model? At to the lowest degree Friedman, Lucas, Prescott, Kydland, Sargent together with Sims. Since virtually 1980, if yous transportation a newspaper amongst this model to whatever one-half respectable journal, they volition turn down it instantly.
But people honey the story. Policy makers honey the story. Most of Washington loves the story. Most of Washington policy analysis uses Keynesian models or Keynesian thinking. This is actually curious. Our whole policy institution uses a model that cannot endure published inwards a peer-reviewed journal. Imagine if the climate scientists were telling us to pass a trillion dollars on carbon dioxide mitigation -- but they had non been able to let out whatever of their models inwards peer-reviewed journals for 35 years.
What to do? Part of the fashion is to say that all of academic economic science is nuts together with merely abandoned the eternal verities of Keynes 35 years ago, fifty-fifty if nobody e'er actually did instruct the foundations right. But they know that such anti-intellectualism is non totally convincing, so it's also stylish to utilization new-Keynesian models every bit holy water. Something similar "well, I didn't read all the equations, but Woodford's mass sprinkles all the correct Lucas-Sargent-Prescott holy H2O on it together with makes this all respectable again." Cognitive racket allows 1 to brand these contradictory arguments simultaneously.
Except new-Keynesian economic science does no such thing, every bit I recollect this event makes clear. If yous desire to utilization new-Keynesian models to defend stimulus, exercise it forthrightly: "The regime should pass money, fifty-fifty if on totally wasted projects, because that volition crusade inflation, inflation volition lower existent involvement rates, lower existent involvement rates volition cause people to swallow today rather than tomorrow, nosotros believe tomorrow's consumption volition revert to tendency anyway, so this pace volition growth demand. We disclaim whatever income-based "multiplier," sorry, our novel models accept no such effect, together with we'll stand upwardly up inwards world together with tell whatever pol who uses this declaration that it's wrong."
That, at least, would endure honest. If non specially effective!
You may disagree amongst all of this, but that reinforces about other of import lesson. In macroeconomics, the pace of crafting a even from the equations, figuring out what our short quantitative parables hateful for policy, together with agreement together with explaining the mechanisms, is actually hard, fifty-fifty when the equations are really simple. And it's important. Nobody trusts dark boxes. The Chicago-Minnesota equilibrium schoolhouse never actually got people to empathise what was inwards the dark box together with trust the answers. The DSGE novel Keynesian dark box has about really unexpected stories inwards it, together with is really very far from providing justification for old-Keynesian intuition.
No comments