Tag: Economic Models

Skidelsky on “The Two Big Economic Policy Failures That John Maynard Keynes Would Be Disappointed by Today”

Posted on by Brad DeLong

I missed this six months ago:

Julie Verhage: The Two Big Economic Policy Failures That John Maynard Keynes Would Be Disappointed by Today: “The famous economist isn’t around for us to ask him…

…but here is probably the next best thing. Robert Skidelsky… said… Keynes would have found two things upsetting. First, he would be frustrated with the lack of  precautions taken to prevent a huge financial crash like the one we saw in 2008. Secondly, Lord Skidelsky believes Keynes… would have wanted a more ‘buoyant response,’ he said.  Specifically, he doesn’t think Keynes would have liked the Federal Reserve’s quantitative easing….

We’ve been for many years in a state of semi-stagnation, and the recovery is still very very weak in the European Union. The actual recovery measures we’ve taken, particularly quantitative easing, have actually skewed the recovery towards asset buying and real estate, thus threatening to recreate the circumstances that led to crash in the first place. I think he would have been disappointed by those policy failures…

Skidelsky is certainly correct in saying that Keynes would be driven raving mad by the failure of central banks and other regulatory agencies to take seriously the task of managing and bounding the illusion of collective liquidity, in order to curb the dangers created by systemic risk. And he is correct in believing that Keynes would be astonished at counterproductive fiscal austerity and incoherent worries about debt burdens at a time of extraordinarily low current and projected future interest rates.

But I am puzzled by Skidelsky’s third. He believes that Keynes would have seen not a second- but a first-order loss in responding to tighter-than-ideal fiscal policy with looser-than-ideal monetary policy in order to hold aggregate demand harmless. Good Belsky does not, and to my knowledge nobody has succeeded in, producing a coherent simple model of what they mean. I am going to have to put this down as yet another example of a case in which smart, sensible people claim to know more and know different then what is in the simple file-and-communications systems that are our standard economic models.

I can see that responding to inappropriately-austere fiscal policy with easier monetary policy and lower interest rates than in the first-best creates a world with too-little government capital, too-low a level of social insurance spending, an inappropriately low level of government-provided safe assets, and on inappropriately-high level of long-duration risky assets.

What I do not see is why all of this is a first-order loss, and why it is worth opening up a significant Okun Gap relative to full employment and potential output in order to prevent these Harburger Triangles.

So, I am once again pleading for an answer, or an explanation, preferably in the form of a simple model I can wrap my brain around.

Crickets…

Must-read: Martin Sandbu: “Free Lunch: On Models and Making Policy”

Posted on by Brad DeLong

Must-Read: Superb from the extremely sharp Martin Sandbu! Only three quibbles:

  1. There are indeed “three great economists” in the mix here, but their names are Summers, Krugman, and Blanchard…
  2. This isn’t really a conversation that would have taken place even in an academic setting. If I have ever been in the same room at the same time with Larry, Paul, and Olivier–let alone all of Olivier’s coauthors, Michael Woodford, Danny Vinit, and Lukasz Rachel and Thomas Smith–I cannot remember it. And discussions and exchanges in scholarly journal articles are formal and rigid in an unhelpful way.
  3. Do note that Keynes was on Summers’s side with respect to the importance of maintaining business confidence: cf.: General Theory, ch. 12, “The State of Long-Term Expectation”

Martin Sandbu: Free Lunch: On Models and Making Policy: “The internet has… open[ed] up to the public…

…discussions… that previously took place mostly in face-to-face gatherings or scholarly journal articles. Neither medium was particularly accessible….

Summers posted a characteristically succinct statement on why he disagreed with the Federal Reserve’s decision to begin tightening… His analysis is well worth reading in full, but the trigger of the ensuing debate was his explanation for why the Fed thinks differently: ‘I suspect it is because of an excessive commitment to existing models and modes of thought. Usually it takes disaster to shatter orthodoxy.’… DeLong expressed doubts that the Fed’s analysis was indeed compatible with existing models; Krugman asserted that conventional models straightforwardly showed the Fed to be in the wrong, and that… policy was driven… by… ‘a conviction that you and your colleagues know more than is in the textbooks’….

Summers then responded… showed a fascinating divergence…. DeLong and Krugman think the Fed erred by ignoring… models…. Summers thinks the Fed erred by ignoring things that such models do not capture…. Summers is also much more comfortable with the notion that policymakers should aim to underpin market confidence. That notion has often been derided by Krugman…. Two quotes rather nicely capture the methodological disagreement here. Summers writes: ‘I think maintaining confidence is an important part of the art of policy…. Paul is certainly correct in his model but I doubt that he is in fact.’ DeLong responds: ‘Larry, however, says: We know things that are not in the model. Those things make Paul’s claim wrong. My problem with Larry is that I am not sure what those things are.’…

What is a policymaker to do if she thinks this is the case in reality, even if no extant model captures it? Surely not wait for 30 years in the hope that new mathematical techniques enable economists to model that reality. In his willingness to listen to those who may have an untheoretical ‘feel’ for the market, and in his intellectual respect for the limits of his own knowledge, Summers comes across as the most Keynesian of these three…