The Keynesian Revolution, the Monetarist Counterrevolution, the New Classical Purge, the Neo-Keynesian Restoration: Saturday Focus (December 14, 2013)

I think that the intelligent and thoughtful Binyamin Applebaum gets it somewhat wrong here:

Binyamin Applebaum: Young Stanley Fischer and the Keynesian Counterrevolution:

Consider the 1977 paper for which [Stanley Fischer] is most famous. It helped to transform the practice of monetary policy, creating the world in which Ben S. Bernanke has operated, but its opening lines sound like conventional wisdom, which now it is…. Central banks, in other words, have the power to stimulate economic activity. Monetary policy can help countries to recover from recessions…. You’re underwhelmed. I can tell. But this really was a big deal. And the key part is those last three words: “Rational expectations notwithstanding.”… During the 1970s, it gradually became orthodox among economists to regard governments as impotent in the face of recessions. The field was dominated by proponents of the view that people behaved rationally, or close enough. People could not be fooled by policies that effectively let them eat today and pay tomorrow. Rational people would only eat as much as they could afford to pay tomorrow…. “By about 1980, it was hard to find an American academic macroeconomist under the age of 40 who professed to be a Keynesian,” the Princeton economist Alan S. Blinder has written. “By 1980 or so, the adage ‘there are no Keynesians under the age of 40’ was part of the folklore of the economics profession.”

But in truth, by 1980, the counterrevolution was well underway…

The meaning of “Keynesian” underwent a shift between the 1965-1975 and the 1975-1985 period. In 1965-1975 a “Keynesian₁” economist was somebody who believed that:

1. The Phillips Curve was a well-anchored relationship so that you could create and maintain a high-pressure low-unemployment economy with a slightly higher inflation if only the government would exercise minimal guidance to coordinate average wage and price changes at their desired level.

2. Fiscal policy was a more powerful and effective macroeconomic stabilization policy tool than monetary policy.

While in 1965-1975 a “monetarist” economist was somebody who believed:

1. That inflation expectations could not be kept far below actual inflation for long, and that proper microeconomic policy sought not to exploit any Phillips-Curve tradeoff but rather to focus on stable money-supply growth, stable nominal GDP growth, and an unemployment rate at its natural rate.

2. Monetary policy was a more powerful and effective macroeconomic stabilization policy tool than fiscal policy.

I believe that when Alan Blinder says that there were no young Keynesians by 1980, he is referring to “Keynesian₁“.

But by 1975-1985 the meaning of the terms had shifted. Basically, the monetarists split, with half of them joining the Keynesians in “Keynesian₂“, and half of them going further out into monetary-policy-cannot-systematically-affect-any-real-variables wagga-wagga-land. And there were lots of young Keynesian₂ economists in 1980–indeed, practically everyone who has since made a useful mark in macroeconomics.

This was, indeed, the point of my J. Bradford DeLong (2000): The Triumph of Monetarism?, If I may repeat myself:

Twentieth century macroeconomics ends with the community of macroeconomists split across two groups, pursuing two research programs. The New Classical research program walks in the footprints of Joseph Schumpeter’s Business Cycles (1939), holding that the key to the business cycle is the stochastic character of economic growth. It argues that the “cycle” should be analyzed with the same models used to understand the “trend” (Kydland and Prescott, 1982; McCallum, 1989; Campbell, 1994).

The competing New Keynesian research program is harder to summarize quickly. But surely its key ideas include the following five propositions:

1. The frictions that prevent rapid and instantaneous price adjustment to nominal shocks are the key cause of business cycle fluctuations in employment and output.
2. Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy.
3. Business cycle fluctuations in production are best analyzed from a starting point that sees them as fluctuations around the sustainable long-run trend (rather than as declines below some level of potential output).
4. The right way to analyze macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyze each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.
5. Any sound approach to stabilization policy must recognize the limits of stabilization policy, including the long lags and low multipliers associated with fiscal policy and the long and variable lags and uncertain magnitude of the effects of monetary policy.

Many of today’s New Keynesian economists will dissent from at least one of these five planks. (I, for example, still cling to the belief–albeit without much contemporary supporting empirical evidence–that policy is as much gap-closing as stabilization policy.) But few will deny that these five planks structure how the New Keynesian wing of macroeconomics thinks about important macroeconomic issues. Moreover, few will deny that today the New Classical and New Keynesian research programs dominate the available space.

But what has happened to the third school, monetarism, at the end of the 20th century? Monetarism achieved its moment of apogee with both intellectual and policy triumph in the late 1970s. Its intellectual triumph came as the NAIRU grew very large and the multiplier grew very small in both journals and textbooks. Its policy triumph came as both the Bank of England and the Federal Reserve declared in the late 1970s that henceforth monetary policy would be made not by targeting interest rates but by targeting quantitative measures of the aggregate money stock. But today explicit monetarism seems reduced from a broad current to a few eddies.

What has happened to the ideas and the current of thought that developed out of the original insights of Irving Fisher and his peers?

The short answer is that much of this current of thought is still there, but its insights pass under another name. All five of the planks of the New Keynesian research program listed above had much of their development inside the 20th century monetarist tradition, and all are associated with the name of Milton Friedman. It is hard to find prominent Keynesian analysts in the 1950s, 1960s, or early 1970s who gave these five planks as much prominence in their work as Milton Friedman did in his…

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