Lecturing on Keynes Today

Today in my political economy class I’m doing my Keynes lecture. This is one of my least favorites, and reading as much as I have over the last year about Keynes has just made it all the more confusing. My questions have grown while the answers have not, which makes it very hard to talk about to those who aren’t yet familiar with it. I think I need to spend the next year getting answers. Perhaps it’s time to try to strike up some direct communication with Brad DeLong–with any luck he’ll be pleased to try to teach a monetarist-leaning public-choice guy the logic of fiscal stimulus.

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About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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13 Responses to Lecturing on Keynes Today

  1. Brad DeLong says:

    Well, here’s one (perfectly valid and correct) way to look at it:

    1) Start with the quantity theory of money: PY = MV

    2) Note that V = V(i), that the lower are short-term nominal interest rates, the lower is velocity

    3) Observe that standard open-market operations swap bonds for cash–increase M by decreasing the supply of bonds to be held by the private sector

    4) Note that demand curves slope down–that if the supply of bonds drops, the price of bonds rises

    5) Note that a higher price of bonds is a lower nominal interest rate i

    6) Worry that under some circumstances–like right now–the velocity of money is especially sensitive to the interest rates–so that standard open-market operations that shrink the supply of bonds will have little or no effect on total spending PY because the bigger-M channel is offset by the smaller-B leads to lower-i leads to lower-V channel

    7) Observe that if the government increases the money supply M but holds the interest rate i constant by not reducing the supply of bonds B then this crowding-out problem does not arise, and monetary expansion is effective

    8) Figure out that if the government is going to expand M without shrinking B, then it has to buy stuff with the M–and ideally it has to buy stuff with the M that is as far from being a substitute for B as possible. Bridges seem good. So does cholesterol-reducing medicine. And smaller school class sizes

    9) Voila! The case for fiscal stimulus.

    Brad DeLong

  2. http://drx.typepad.com says:

    Wow, home delivery.

  3. James Hanley says:

    Yeah, I actually had in mind asking specific questions about certain elements of the pro-stimulus approach, and what the specific rebuttals are to certain monetarist critiques. Not really interested in a boilerplate lecture, so I guess I’m less grateful than I wish I could be..

    For instance, I’d ask why he pops in monetary expansion in 7. I get monetary expansion arguments as contra Keynesian arguments from Sumner, but I’m a bit confused when in the middle of an argument for increased government spending I see an argument for an increased money supply. Does contemporary Keynesianism necessary include expansion of the money supply? Has it incorporated monetarism that deeply? Or did Keynesianism always include a good dose of monetary expansion and I just didn’t know that?

    As I’ve said before, I’m a micro guy. I’m interested in what individuals do in response to incentives, so macro is all a bit outside my real zone of interest. But the macro arguments are pretty damned important and hard to ignore these days, so I’m making an effort to come to grips with them.

  4. Passing By says:

    Professor Hanley – “I’m a bit confused when in the middle of an argument for increased government spending I see an argument for an increased money supply.”

    I’m a micro guy too,and have always found macro frustrating, because my natural tool-kit just gets so little traction there. after all, short-run macroeconomics is about the business cycle–i.e., it’s precisely about the residual fluctuations around equilibrium that micro-based explanations don’t account for very well.

    That said, your reply to Prof. DeLong seems a bit unfair.

    He’s not arguing for increased government spending. He’s arguing for monetary expansion; and claiming that a temporary increase in government spending is a necessary step to achieve effective monetary expansion (due to the current very-low interest rates). He may be right or wrong about that … for example, Prof. Sumner would disagree. But his objective is clear.

  5. Lance says:

    Is there a way to expand the money supply with out government spending? Also, if there is deflation, each unit of money buying more stuff, do you need to increase the money supply since less of it now purchases more stuff? So long as there is no limiting denominator to the currency, such as a penny being too much to purchase the smallest available widget or service, what is the purpose of injecting more currency?

  6. James Hanley says:

    Is there a way to expand the money supply with out government spending?
    Yes, at least sort of, depending on definitions. 1) One concept is the “helicopter drop,” where government would just drop money out of helicopters and let people pick it up. At least some monetarists think that would do the trick, although it’s not necessarily their preferred approach. 2) But beyond that, when the Federal Reserve buys securities, it moves money that wasn’t circulating (that isn’t even counted in the normal calculations of the money supply) into circulation. In a sense it’s spending, but in a sense it’s not since it incurs neither more government indebtedness nor increased taxes. It’s more like creating money out of thin air, but making people give up something instead of giving it away for free, as in the case of the helicopter drop. 3) The Fed could also work to force the excess reserves out of deposit institutions and into circulation. That money technically counts in our money supply, but it’s money that’s not really circulating in the economy right now. The Fed started paying interest to banks on their excess reserves in 2008, and continues to do so (can anyone explain to me why this isn’t a bone-headed policy?). If it stopped doing that, and especially if we chose to tax excess reserves, it would force that money into circulation without any government spending.

    if there is deflation, each unit of money buying more stuff, do you need to increase the money supply since less of it now purchases more stuff?
    Yes, because deflation is deadly for an economy. Of course we all like lower prices, and when the price of Ipods or computers or whatever declines through competition and technological advances, that’s all for the good precisely because, as you say, we can now purchase more stuff with the same dollars. But deflation is a general phenomenon of falling prices, not just on specific products but across all (or very many) sectors. And as it creates an expectation among consumers that prices of goods will be cheaper next month, and will be cheaper the month after that, it causes people to delay purchases, creating a drag on the economy. Milton Friedman wrote that “inflation is always and everywhere a monetary phenomenon,” meaning it was always a consequence of excessive increases in the money supply. The same line would apply to deflation, except it would be a consequence of excessive decreases in the money supply.

    what is the purpose of injecting more currency?
    To encourage people to spend more by reducing the value of cash. Make cash cheap enough and people will start throwing it away (see; Zimbabwe). Obviously we don’t want to do that–we just want to make it cheap enough that people start trading it for goods and services again.

    Look here, for example, at our inflation rates since 2000–our years of lowest inflation are not our strongest years economically.

  7. James Hanley says:

    Passing By,

    Thank you. That helps a bit. It also seems to suggest how deeply Keynesianism has been displaced by monetary thinking and relegated to special circumstances. That’s not meant as a critique of Keynesians or Keynesianism; it just seems an interesting bit of intellectual history, and–if accurate–relevant to my class. When I talk to my students about Marx I have no difficulty explaining how little role he plays in today’s mainstream economics. With Keynes I’m still a bit uncertain on that.

    Please pass by again someday.

  8. Vincent says:

    “Yeah, I actually had in mind asking specific questions about certain elements of the pro-stimulus approach, and what the specific rebuttals are to certain monetarist critiques. Not really interested in a boilerplate lecture, so I guess I’m less grateful than I wish I could be..”

    That is, you’re “less grateful than [you] wish [you] could be” if you had actually asked those specific questions in your first post? How about simply thanking the man for dropping by your site, leaving information pertinent to the current state of affairs and, well, maybe then asking in a normal way the questions you have and didn’t state previously? “Yeah”, you know, like a normal dialogue?

  9. James Hanley says:

    Vincent,

    Actually I sent Dr. DeLong an email asking if he would be willing to answer specific questions. I thought it polite to ask before< I peppered him with those question. Your complaint is reasonable given the amount of information that was available to you, but there was some releant information that I hadn’t made publicly available.

  10. Brad DeLong says:

    Re: “I’d ask why he pops in monetary expansion in 7. I get monetary expansion arguments as contra Keynesian arguments from Sumner, but I’m a bit confused when in the middle of an argument for increased government spending I see an argument for an increased money supply.”

    Well then you really haven’t been listening to the conversation at all, have you?

    Every single claim I have ever seen that expansionary fiscal policy will be effective has presumed that the Federal Reserve will keep expanding the money supply and make sure interest rates do not rise enough to crowd out private investment.

    Unless you make an effort to follow the conversation, it will be really hard to teach you anything.

  11. James Hanley says:

    Hmm, I actually want to learn this,* but apparently I can’t be taught it until I learn it (I won’t bother to give a bibliography of what I’ve read on the issue, which would not be too short–I’ll just note again that I’m not a macro guy, so sometimes I miss things a macro person would find obvious)? It appears that either Mr. DeLong suspects I’m just a closed-minded right-wing shill, or he’s more interested in demonstrating his superiority than in helping non-experts understand the issue. I hope it’s only the first possibility, and not the second.

    Despite his condescending tone, there is a useful answer in his third paragraph, although I wish it had a little more explanation. As I understand things, one of Friedman’s critiques of fiscal policy (at least in the form of increased gov’t spending) is precisely that it would crowd out private investment, and Mr. DeLong here says that there is an assumption that crowding out will be prevented by an expanding money supply.

    So if Mr. DeLong happens to return here, I have three questions:
    1) Have I read his third paragraph right?
    2) Does this mean that that contemporary fiscal advocates have accepted Friedman;s critique and incorporated it into their theories?
    3) Or is the concept of an expanding money supply to offset crowding out there in Keynes’s original arguments, and overlooked or downplayed by Friedman?

    I guess I also have a fourth, broader question? Is there in fact a clear demarcation line between monetary and fiscal policy approaches, or are they (now or always?) so deeply entwined that they can’t be fully separated and understood in isolation?

    ________________________________________________________
    * 1) So I can present it properly in my political economy class, even though macro stuff is just a sideline there and not the primary focus (and, by the way, I don’t teach it as “monetary theory is right” and “Keynesianism is wrong,” but “here are the basics, for you political science students, of the two ideas underlying this current political debate”). . 2) Because as I told my students this is one of the most critical current political issues in the U.S., so it behoove me as a political scientist to understand it. 3) Because I like actually understanding issues, rather than just taking a pre-packaged ideological stance on them. Therefore, although I’m initially skeptical (mostly because of skepticism about Congress’s capacities), I’m open to persuasion.

  12. Kevin Donoghue says:

    James,
    No reputable university will ever ask me to teach macro to a political economy class, or to anybody else either; but if they did I think I’d consider including the paper which Greg Mankiw and Matthew Weinzierl recently did on optimal stabilization policy. (See link just up at Mankiw’s blog.) It uses a pretty straightforward model without all that Dixit-Stiglitz stuff which always wears me down; basically it’s Old Keynesian (or Old Monetarist) macro in presentable dress. And since it’s Mankiw your Republican students might be more receptive than they would be to Krugman.

  13. James Hanley says:

    Kevin,

    Thanks for the tip. I’ll take a look at it. For my political science students, though, it needs to be really straightforward. Some of them are so math-phobic they get nervous when I write B > C on the whiteboard. (Is there an emoticon for a grin combined with a sigh?)

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