Must-Read: Nick Rowe: Cheshire Cats and New Keynesian Central Banks

Must-Read: Nick Rowe continues his long twilight struggle to try to explain what is really going on in the New Keynesian DSGE model to the world. I think this is a Sisyphean task:

Nick Rowe: Cheshire Cats and New Keynesian Central Banks:

How can money disappear from a New Keynesian model, but the Central Bank still set a nominal rate of interest and create a recession by setting it too high?…

Ignore what New Keynesians say about their own New Keynesian models and listen to me instead. I will tell you how it is possible…. The Cheshire Cat has disappeared, but its smile remains. And its smile (or frown) has real effects. The New Keynesian model is a model of a monetary exchange economy, not a barter economy. The rate of interest is the rate of interest paid on central bank money, not on bonds. Raising the interest rate paid on money creates an excess demand for money which creates a recession. Or it makes no sense at all.

I will take “it makes no sense at all” for $2000, Alex…