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Very Rude Comments

Simon Wren-Lewis gets me going again

He wrote

Rational expectations do not prevent us understanding sustained periods of deficient demand when an inflation targeting central bank hits a lower bound. Indeed they help, because with rational expectations inflation targeting prevents inflation expectations delivering the real interest rate we need, as I have argued here.


The traditional Phillips curve has always seemed to me to be an advertisement for the dangers of not doing microfoundations. It seems plausible enough, which is why it was used routinely before the rational expectations revolution. But it contains the serious flaw noted above, which almost destroyed Keynesian economics.

After the jump, two very rude comments (in anti chronological order)

update: welcome Krugman readers. Oddly I kept secret the really rude comment which attempts to support the thin gruel claim as made by Krugman (I e-mailed it to myself). I think I will try to keep it secret (but I mean how the hell did Krugman know I had written a thin gruel comment ? ) Anyway I put a semi almost not totally utterly rude version as a comment on his post and below so now there are 3 comments in anti chronological order.

the very rude comments I posted are nothing like the rude comment I decided to e-mail myself instead. In particular, they don’t contain much of the thin gruel claim. I think I will summarize the ones I didn’t post.

Wren-Lewis discussed changes in Central bank independence and explicit or implicit inflation targets.

When claiming one has evidence, one really can’t use the word “implicit.” Explicit inflation targets are observable variables. The claim that, without an explicit target, the Fed targeted inflation certainly isn’t an explanatory variable (and is hard to reconcile with FOMC minutes) . I’d guess the conclusion that there was an implicit target is based on the fact that inflation stayed at roughly the same level. If so, the evidence is that in cases where inflation stayed at roughly the same level, inflation stayed at roughly the same level.

There has been no change in the legal independence of the Fed. Yet US inflation was high in the 70s and low in the naughties. Again there isn’t a pattern relating observable variables with outcomes.

I didn’t add that 1973 -1968 = only 5 years. In many countries, workers didn’t accept that they had to live with capitalists. Unions were more powerful and vastly more militant. One might ask if one can explain differences in inflation rates by looking at difference in labor movements. For example, one might as Colin Crouch.

End update:

You write (suspected typo elided) “inflation targeting … delivering the real interest rate we need.” I note that the ECB has consistently targetted inflation (at least you are willing to give inflation targetting credit for events in 2005 and 2006. You must conclude that the Eurozone has the real interest rate we need.

But the Eurozone suffered a severe recession, currently has extremely high unemployment and appears to be headed for a second dip.

I think you meant to qualify the claim with “with the right inflation target, assuming (for some reason) that the target is credible …”


I too have semi defended the rational expectations assumption recently. However, the basic advantage I see is that the assumption of rational expectations makes it more difficult (not impossible) for people to tell stories about how their preferred policies are good, because (it is assumed rather than argued) they will influence expectations in a desirable way.

Briefly, I think the point is to exorcise the confidence fairy. Less briefly, my reasoning was that, if one is not required to assume rational expectations, one can argue that cutting spending will cause increased growth by increasing business confidence. A model in which businessmen with rational expectations increase investment and production because of a spending cut is not easy to write. My guess is that it would be a model with sunspot equilibria, so anything can change investment. If so the case for expansionary austerity would be identical to the case that what we need is to burn incense to the flying spaghetti monster (which claim is consistent with the rational expectations assumption on models where sunspots can matter).

The key question, I think, is not rational vs irrational. It isn’t even rational vs adaptive. It is whether we should treat expectations as a policy variable imagining that policy makers can control them as they control, say, the federal funds rate.

Then I thought “same for the people who think that expected inflation is just like the federal funds rate” and here we are. I might add, I also thought “this time I won’t be very rude in comment” really honestly. But, as I see it, you leave me no choice.

Look why not just talk about a monetary authority which targets real yearly GDP. To a million pounds per capital You are simply assuming that a central bank can get the inflation expectations it wants. That rational people will believe its dynamically inconsistent promises.

Oddly the last time I remember defending rational expectations was when I tried to explain (to Matthew Yglesias) why Paul Krugman was skeptical about the effectiveness of monetary policy right now.

I note again that you have not identified one advance new Keynesians have made beyond Keynes. The alleged examples include speculation about UK consumption some of which, you note, is not incorporated into new Keynesian models yet and none of which has yielded an improved prediction and, of course, the old Phillips curve. The only connection between the old Phillips curve and Keynes is that he warned against believing in it as clearly as anyone could writing before Phillips.

You contest Krugman’s claim that those who seek microfoundations have had no successes since the critique of the old Phillips curve yet you go back to that again and again. I see no trace of a justification for your disagreement with Krugman in this post or in any other post of yours which I have read.

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How Keynesian Policy Led Economic Growth In the New Deal Era: Three Simple Graphs

by Mike Kimel

In this post, I will show that during the New Deal era, changes in the real economic growth rate can be explained almost entirely by the earlier changes in federal government’s non-defense spending. There are going to be a lot of words at first – but if you’re the impatient type, feel free to jump ahead to the graphs. There are three of them.

The story I’m going to tell is a very Keynesian story. In broad strokes, when the Great Depression began in 1929, aggregate demand dropped a lot. People stopped buying things leading companies to reduce production and stop hiring, which in turn reduced how much people could buy and so on and so forth in a vicious cycle. Keynes’ approach, and one that FDR bought into, was that somebody had to step in and start buying stuff, and if nobody else would do it, the government would.

So an increase in this federal government spending would lead to an increase in economic growth. Even a relatively small boost in government spending, in theory, could have a big consequences through the multiplier effect – the government hires some construction companies to build a road, those companies in turn purchase material from third parties and hire people, and in the end, if the government spent X, that could lead to an effect on the economy exceeding X.

This increased spending by the Federal government typically came in the form of roads and dams, the CCC and the WPA and the Tennessee Valley Authority, in the Bureau of Economic Analysis’ National Income and Product Accounts (NIPA) tables it falls under the category of nondefense federal spending.

Now, in a time and place like the US in the early 1930s, it could take a while for such nondefense spending by the federal government to work its way through the economy. Commerce moved more slowly back in the day. It was more difficult to spend money at the time than it is now, particularly if you were employed on building a road or a dam out in the boondocks. You might be able to spend some of your earnings at a company store, but presumably the bulk of what you made wouldn’t get spent until you get somewhere close to civilization again.

So let’s make a simple assumption – let’s say that according to this Keynesian theory we’re looking at, growth in any given year a function of nondefense spending in that year and the year before. Let’s keep it very simple and say the effect of nondefense spending in the current year is exactly twice the effect of nondefense spending in the previous year. Thus, restated,

(1) change in economic growth, t =
f[(2/3)*change in nondefense spending t,
(1/3)*change in nondefense spending t-1]

For the change in economic growth, we can simply use Growth Rate of Real GDP at time t less Growth Rate of Real GDP at time t-1. The growth rate of real GDP is provided by the BEA in an easy to use spreadsheet here.

Now, it would seem to make sense that nondefense spending could simply be adjusted for inflation as well. But it isn’t that simple. Our little Keynesian story assumes a multiplier, but we’re not going to estimate that multiplier or this is going to get too complicated very quickly, particularly given the large swing from deflation to inflation that occurred in the period. What we can say is that from the point of view of companies that have gotten a federal contract, or the point of view of people hired to work on that contract who saved what they didn’t spend in their workboots, or storekeepers serving those people, they would have spent more of their discretionary income if they felt richer and would have spent less if they felt poorer.

And an extra 100 million in nondefense spending (i.e., contracts coming down the pike) will seem like more money if its a larger percentage of the most recently observed GDP than if its a smaller percentage of the most recently observed GDP. Put another way, context for nondefense spending in a period of rapid swings in deflation and inflation can be provided by comparing it to last year’s GDP.

So let’s rewrite equation (1) as follows:

(2) Growth in Real GDP t – Growth in Real GDP t-1
f[(2/3)*change in {nondefense spending t / GDP t-1},
(1/3)*change in {nondefense spending t-1 / GDP t-2}]

Put another way… this simple story assumes that changes in the Growth Rate in Real GDP (i.e., the degree to which the growth rate accelerated or decelerated) can be explained by the rate at which nondefense spending as a perceived share of the economy accelerated or decelerated. Thus, when the government increased nondefense spending (as a percent of how big the people viewed the economy) quickly, that translated a rapid increase in real GDP growth rates. Conversely, when the government slowed down or shrunk nondefense spending, real GDP growth rates slowed down or even went negative.

Note that GDP and nondefense spending figures are “midyear” figures. Note also that at the time, the fiscal year ran from July to June… so the amount of nondefense spending that showed up in any given calendar year would have been almost completely determined through the budget process a year earlier.

As an example… nondefense spending figures for 1935 were made up of nondefense spending through the first half of the year, which in turn were determined by the budget which had been drawn up in the first half of 1934. In other words, equation (2) explains changes in real GDP growth rates based on spending determined one and two years earlier. If there is any causality, it isn’t that growth rates in real GDP are moving the budget.

Since there stories are cheap, the question of relevance is this: how well does equation (2) fit the data? Well, I’ll start with a couple graphs. And then I’ll ramp things up a notch (below the fold).

Figure 1 below shows the right hand side of equation (2) on the left axis, and the left hand side of equation (2) on the right axis. (Sorry for reversing axes, but since the right hand side of the equation (2) leads it made sense to put it on the primary axis.)

Notice that the changes in nondefense spending growth and the changes in the rate of real GDP growth correlate very strongly, despite the fact that the former is essentially determined a year and two years in advance of the latter.

Here’s the same information with a scatterplot:

So far, it would seem that either the government’s changes to nondefense spending growth were a big determinant of real economic growth, or there’s one heck of a coincidence, particularly since I didn’t exactly “fit” the nondefense function.

But as I noted earlier in this post, after the first two graphs, I would step things up a notch. That means I’m going to show that the fit is even tighter than it looks based on the two graphs above. And I’m going to do so with a comment and a third graph.

Here’s the comment: 1933 figures do not provide information about how the New Deal programs worked. After all, the figures are midyear – so the real GDP growth would be growth from midyear 1932 to midyear 1933. But FDR didn’t become President until March of 1933.

So… here’s Figure 2 redrawn, to include only data from 1934 to 1938.

While I’m a firm believer in the importance of monetary policy, for a number of reasons I don’t believe it made much of a difference in the New Deal era. As Figure 3 shows, changes in nondefense spending – hiring people to build roads, dams, and the like, explain subsequent changes in real GDP growth rates exceptionally well from 1934 to 1938. This simple model explains more than 90% of the change in real GDP growth rates over that period.

Of course, after 1938, the relationship breaks down… but by then the economy was on the mend (despite the big downturn in 1938). More importantly (I believe – haven’t checked this yet!), defense spending began to become increasingly important. People who might have been employed building roads in 1935 might have found employment refurbishing ships going to the Great Britain in 1939.

As always, if you want my spreadsheet, drop me a line. I’m at my first name (mike) period my last name (kimel – note only one “m”) at

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Another Look at Keynesianism and the Great Stagnation

by Mike Kimel

Another Look at Keynesianism and the Great Stagnation

Cross-posted at the Presimetrics blog

Last week I had a post noting that the US government followed more or less naive Keynesian policies (whether on purpose or not I cannot say) from the early 1930s to the late 1960s. The post also notes that what Tyler Cowen calls The Great Stagnation, a period of relatively slow economic growth, began just about when the government moved from naive Keynesian policies to a regime that could mostly be described as “all deficits all the time.”

In this post, I’d like to present a couple of graphs that are pretty self-explanatory. The data in the graphs comes from the BEA’s NIPA Table 1.1.5 The black line runs from 1929 to 1967, and the gray line from 1968 to the present.

Figure 1

Figure 2

I’ll be coming back to this topic in future posts, but I’d like to make a few quick comments:

1. The Great Stagnation Tyler Cowen comments on seems to, at a minimum, coincide very strongly with the period where the government quit Keynesian policy, where the private sector’s share of the economy stopped shrinking and began growing, and where the government’s role in the economy stopped growing and started shrinking.

2.  Even if you assume the growth of the private sector or the shrinking of the government isn’t causing or contributing to the Great Stagnation, the data still leaves libertarian and conservative economic views at a loss.  After all – shouldn’t growth increase as the private sector becomes more important and the government shrinks in size? 

3.  Bear in mind that marginal tax rates – reduced in 1964 and then reduced again multiple times since then – were lower during the Great Stagnation period than they had been since the 1930s.  Needless to say, this is yet another fact that makes the data inconsistent with libertarian and conservative economic theory.

4.  As always, if you want my spreadsheet, drop me a line. I’m at my first name (mike) period my last name (one m only in my last name!!!) at gmail period com. And don’t forget which post your writing about.

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A Critique of Tyler Cowen’s The Great Stagnation, by way of Alex Tabarrok’s Criticism of Keynesian Politics

by Mike Kimel

A Critique of Tyler Cowen’s The Great Stagnation, by way of Alex Tabarrok’s Criticism of Keynesian Politics

Cross posted at the Presimetrics blog

Alex Tabarrok and Tyler Cowen are libertarian professors from George Mason University who post at the very popular Marginal Revolution blog. I often don’t agree with what they write, but its usually well reasoned and grounded in reality.  (Unlike, say, what comes up in a number of other libertarian blogs.)

Cowen recently wrote an e-book called The Great Stagnation&lt I haven’t read it – I’m swamped these days.  However, there have been many reviews (and comments by Cowen himself, so I think I can provide a brief summary.  Essentially, Cowen notes that in the last few decades (since about the early ’70s), real economic growth in the US has slowed.  (That won’t be a surprise if you read Presimetrics.)  His thesis is that this has to do with technological development – we’ve eaten the low hanging fruit, and further technological progress (and hence real economic growth) will be slow until we get off the plateau we’re on. 

It might seem unrelated, at first, but Cowen’s partner at Marginal Revolution, Alex Tabarrok, recently had written a post that received some comment. Tabarrok argues that whether Keynesian economics can work or not (he does not believe it can – presumably he wouldn’t be a libertarian if he did), Keynesian politics has failed, in that it simply hasn’t been tried in this country, not during the two big economic disasters of the last 100 or so years:  the Great Depression and the Great Recession. 

Tabarrok is wrong – wrong that Keynesian economics hasn’t been tried, and wrong that it hasn’t worked.  And Cowen, it turns out, is wrong about exactly the same thing in his book.

The basic Keynesian idea is this:  economic downturns (and meltdowns) can occur and/or be prolonged and worsened when the private sector becomes worried and cuts back.  In those circumstances, the government should step in and buy things, lots and lots of things, replacing the shrunken private sector demand.  Once the economy picks up again, the government should cut back on its spending and start saving up money, first to pay for its recent spending bout and second to have cash in hand to cover its next necessary spending bout.

Put another way – a government thinking along Keynesian lines will tend to run a deficit when real private sector spending falls below some prior highwater mark.  It will run a surplus in years real spending exceeds prior real private sector spending.  There may, of course, be exceptions in any given year, but a Keynesian government will generally follow that sort of behavior.  A government that runs a deficit when real private sector spending is rising, or runs a surplus when real private sector spending is falling, and behaves this way in general is most definitely not operating under Keynesian principles. 

Which brings us to data.  Surplus and deficit information was computed using current federal gov’t receipts and expenditures from the BEA’s NIPA Table 3.2 Real private sector spending is made up of real “personal consumption expenditures” and real “gross private domestic investment” from BEA’s NIPA Table 1.1.5 Data goes back to 1929, the first year for which the BEA computed data.

The following graph may look a bit odd, since it has no curve on it.  But it shows something cool.  If I did this correctly, the gray bars show periods when:

1.  real private sector spending hit a new high and the government ran a surplus

2.  real private sector spending fell below a previous high and the government ran a deficit

Keynesian governments will generally behave in that way.  The turquoise bars show non-Keynesian behavior:

1.  real private sector spending hit a new high and the government ran a deficit

2.  real private sector spending fell below a previous high and the government ran a surplus

Here’s what it looks like:

Figure 1

Here’s what I get from this graph… from until some time around the late 60s or early 70s, US governments generally stuck to Keynesian policies and not incidentally, generally produced relatively rapid growth.  After that, the US government generally abandoned Keynesian policies and produced Tyler Cowen’s Great Stagnation.   I am not prepared on to comment on whether there has been technological stagnation though.

Perhaps the graph can be improved. Its important not to consider individual years Keynesian or not, but rather overall behavior over a number of years. For instance, the fact that the government ran a deficit during the recession in 1990 – 1991 doesn’t make it Keynesian behavior (though it does appear to have a gray graph) since it had been running a deficit already, even when times were good. Running a deficit when times are bad is only Keynesian if you’re paying down debt (i.e., running a surplus) when times are good. The fact that the government has been running a deficit more or less continuously since the late 1960s (except for a brief period in the 90s) indicates that it definitely wasn’t following Keynesian economic theory – else it would be running surpluses when real private spending was up.

Well, gotta run.  As always, if you want my spreadsheet, drop me a line.  I’m at my first name (mike) period my last name (one m only in my last name!!!) at gmail period com.  And don’t forget which post your writing about.  Toodle-oo, folks. 

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Why There’s Little Inflation, In One Easy Graphic

Ex-food and energy, inflation is at 0.9% for the past twelvemonth. Even if you include those in the longer measure, annual inflation has been 1.7%. (Recall that we paid an average of more than $3.00/gallon for most of the Spring of 2010, for instance.)

There is a simple reason “everyone” expected higher numbers: they were looking at money supply, not circulation.

As Jim Hamilton notes, money is only supply when its being circulated.

The “intermediaries” aren’t intermediates; they’re SPOFs. Hamilton’s graphic tells all:

All that “extra” money is being kept in mattresses. Financial-Institution-shaped mattresses, but mattresses nonetheless. The velocity of monetary reserves is 0. So the weighted-average velocity of money is much less than the standard formula would imply.

There is inflation out there. For instance, China, whose “stimulus” was an impossible 17% of its GDP (h/t Susan of Texas, of course), is seeing inflation.

The U.S. needs to deal with financial institution mattress stuffing before it can have such problems.

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