Paul Krugman has some tweets harshly criticizing this article by Stephanie Kelton.
His claim appears to be that, as a Modern Monetary Theorists, she asserts that there are two schools of macroeconomics MMT and “the mainstream” which includes Paul Krugman. I am kicking myself for deciding to read the article to find if it is as horrible as he asserts. I think it is.
She wrote “There is a doctrine among mainstream economists holding that: (1) government deficits push interest rates higher and (2) rising interest rates crowd out private investment. The government can take more of the economy’s financial resources, but only at the expense of lost private investment. This means that running budget deficits has at least some downside.”
This proves that, by her definition Krugman isn’t a mainstream economist. He wrote this. For 20 years he has asserted that sometimes fiscal stimulus does Not cause higher interest rates and that, in those cases, it has no downside.
More generally, even when criticizing vulgar Keynesians (before the acronym MMT was coined) he stressed that the monetary authority can, and often will, cancel the effects of fiscal stimulus. Nothing about what must be true as in “at least some”. I don’s see how anyone who has read anything written by Krugman could type the quoted passage. I am extremely confident that Kelton has read almost exactly nothing Krugman has ever written on macroeconomics.
I don’t know what she means by federal funds, but I guess that would be loans on which the federal funds rate is paid. Since those are interbank loans, banks total demand for funds on which the federal funds rate is paid is always exactly zero. This is an accounting identity. I think she means banks borrowing at the discount window. I don’t think she knows that this was almost exactly zero until 2008 — it just isn’t important. Untill 2008 they borrowed from each other at the slightly lower federal funds rate.
Here I crop so you can see the numbers. An amount of money which it would be nice to have, but trivial compared to GDP, Bank assets, Fed liabilities or M1.
I have to pick up the pace and now flag every howler (after the jump)
“Leaving aside monetary and exchange rate policy … If the private sector wants to spend less and save more, the public sector will need to accommodate that desire by running a bigger deficit or the economy will be pushed away from full employment.”
This is false. It is possible to stimulate demand with a balanced budget increase in government consumption + investment financed by taxes. The government can alow the private sector to spend less and keep employment full by spending more. The spending increase does not have to be deficit spending. It can also convince the private sector to spend more by cutting taxes. The idea that the fiscal stance can be measured by the deficit is plain wrong. In theory it is totally wrong. The evidence (mostly from the balanced budget spending increase to finance the Korean war) shows it is wrong. Fiscal stimulus does not require deficits. It can work even if temporary tax cuts have no effect because there is Ricardian equivalance (see link to Krugman’s blog above). This is actually mainstream nonsense. It is standard to equate fiscal stimulus with deficit spending. But it is also nonsense. In the real world deficit financed spending has a larger effect on aggregate demand than tax financed spending. But tax financed spending should (in theory) and did in practice cause increased aggregate demand.
“He’s challenging that by asserting that you can have any size deficit and still have full employment because the central bank can always establish the “right size” interest rate to get you there.”
Of course Krugman does not assert this. Instead he asserted 20 years ago that the liquidity trap is “baaaaack”. It is insane to assert that Krugman asserted something when he has asserted the contrary innumerable times over the past 20 years.
My god. she asserts that interest rates don’t affect demand. What the hell happened in 1981 ? As Krugman notes, she looks at business investment. As he has explained many times, interest rates affect demand through residential investment. Has Kelton ever seen a house ? Has she asked home buyers whether interest rates matter to them ? Krugman explains this in a tweet.
I finally read the MMT argument that fiscal deficits automatically cause an increase in bank reserves. It is based on the assumption that deficits have no effect on the supply of treasury bonds (really)
“When you pay your taxes, your bank loses reserves, but with a trillion-dollar deficit, there is a huge net infusion of reserves into the banking system. If the central bank takes no action to prevent it from happening, the overnight lending rate — the federal funds rate — will fall to a zero bid.
Why? Because all banks are flush with non-interest-bearing reserves,”
I will complete this argument. So when you pay taxes, you can write a check and that reduces the banks reserves (the Treasury doesn’t use commercial banks so it doesn’t deposit your check). In contrast nothing like this happens if the Treasury prints a bond and you buy it by writing a check because …. uh well …
The story entirely relies on the assumption that the only asset is balances of checking accounts and that eithe we write a check to someone who deposits it in a bank (no effect on reserves) or we write it to the IRS (reducing reserves). But what if we buy a Treasury bond directly from the Treasury with it ?
The argument absolutely depends on the assumption that deficits don’t involve printing and selling Treasury securities. It would be valid if the Treasury covered deficits by printing money. It’s worse than I imagined possible.
“Yes, the Fed has a reaction function, and it can vote to raise rates in response to perceived inflationary pressures associated with deficit spending. But that is a different matter. That is fighting against the “natural” gravitation.” Note that this means that the argument above is irrelevant. This is exactly Krugman’s point. The interest rate is that chosen by the FOMC. The “natural” gravitation is not as she describes because there are assets other than deposits, and it is also irrelevant.
She looks at Krugman’s figure with 3 IS curves.
She assumes that there can’t be one half way between IS1 and IS2 which will give higher output and the same interest rate as IS1. Her argument “This framework shows that the government can expand its deficit and move the economy from a depressed condition at point A to full employment by shifting IS1 to IS2. The economy is now at full employment, but with higher interest rates and lower private investment.” must be completed with “because there is no IS curve between IS1 and IS2” She absolutely relies on assuming that Krugman drew 3 lines because he believes there are only 3 possibilities. I assert that no one who understands how graphs work could have written the quoted passage.
“his model assumes a fixed money supply, which paves the way for the crowding-out effect!”
In fact, his model does not assume a fixed money supply. If it did, then IS3 would give higher output than IS2 as the economy moves up the LM curve. He assumes that the monetary authority will reduce the money supply to keep unemployment at the target. Anyone who had any familiarity with the IS-LM model would see that Krugman assumes that the money supply is not fixed.
Krugman explains this in a tweet.
She asserts that fiscal policy is good because it increases private wealth. Here she assumes that fiscal policy is always expansionary. An actual Keynesian would say that ““The boom … is the right time for austerity at the Treasury ”
John Maynard Keynes (1937)
One might want a very high public debt, but even if one does, once the desired high level is reached, one might wisely turn to monetary policy to stabilize output (provided interest rates are above zero). Fiscal vs monetary stabilization is an issue entirely separate from the desired national debt. The assumption that fiscal policy is fiscal stimulus is crazy and very definitely un Keyenesian.
OK I sum up
1) Krugman’s tweets are immensely better than this post.
2) Kelton assumes that Krugman ignores the liquidity trap
3) she relies on the argument that if he drew 3 IS curves he asserts that they are the only 3 possible (this is absolutely critical to her argument)
4) she thinks that the fixed money supply fiscal multiplier in the IS-LM model is zero. She doesn’t seem to know that the LM curve slopes up in the standard IS-LM model.
5) she assumes that taxes are paid out of checking accounts and determine the balances of those accounts which can’t change when depositors buy bonds. She assumes that the supply of Treasury securities is not affected by budget deficits. She absolutely relies on this assumption. It is central to one of her arguments.
I think your column is better than you believe.
When you state:
” I don’s see how anyone who has read anything written by Krugman could type the quoted passage. I am extremely confident that Kelton has read almost exactly nothing Krugman has ever written on macroeconomics.”
it raised a memory of an ongoing saga of people misquoting PK on a constant basis. I have seen this on a constant basis at EV over the course of almost a decade.
I am by no means an economist, but I like the discussions and try to make sure I do not embarrass myself by showing by lack of knowledge about the subject. But I can probably find a couple hundred posts by PK where he says something like “a +b =c” and there are 40 responses that say “why does krugman say a=b =q?”
It is infuriating to read such straw men posts, and it appears that Kelton fits in with those people. It has always been bad, but the 2016 Dem primary brought it to a fever pitch.
It does make for some interesting reading at EV and at Brads. I am afraid I am not in that league either until the light bulb goes off after reading through it all.
It is 100 percent probable that some time in recent past government has increased the deficit to approach equilibrium, having a positive effect.
My claim is that otherwise we would not have a distribution of countable government purchases. It is an equilibrium identity, a slightly different class of identity. So we should quit identifying theory by their boundary conditions but look for their equilibrium identities.
All very good but there is even more over at Brad DeLong’s place:
What Brad noted was OK but check out the various comments which add so much more.
March 3, 2019 11:04 am
may be letting Kelton off the hook. As we noted over at Brad’s place, her latest was a lot of gibberish. But read what Matt wrote and tell me that is not gibberish-squared!
“it raised a memory of an ongoing saga of people misquoting PK on a constant basis. I have seen this on a constant basis at EV over the course of almost a decade.”
EMichael may be wondering if I have abandoned him over at Thoma’s place. Sad to say I have as the nonstop Hillary is a bitch and Krugman got paid became a total waste of time. I do read Mark’s links with interest. I sort of noticed Mark has avoiding this MMT dust off. Maybe smart on his part because I suspect Mark has grown tired of the tribal warfare!
“It is infuriating to read such straw men posts, and it appears that Kelton fits in with those people.”
Kelton’s latest is this and much more worse. As I read it – it reminded me of the kid who got a C in intermediate macroeconomics. Did she really go to graduate school? If so – she did not learn much. Does any serious university allow her to teach her babble as if it is macroeconomics?
Look, I have taught macroeconomics so I need that sometimes we can get into some strange weeds about the role of the banking sector in the macroeconomy. So I get her sentences when taken into isolation. But she clearly is lost when it comes to the big picture. Totally lost.
thanks pgl and emichael
Matt Young > I am 100 certain that deficit spending in 2009, 2010 and 2011 via the ARRA pushed the economy towards equilibrium.
I am a very strong supporter of fiscal stimulus when the economy is in a liquidity trap and of automatic fiscal stabilizers even when it isn’t.
I am very unconvinced by the arguments that unconventional monetary policy can substitute for fiscal stimulus when the econmy is in a liquidity trap.
I am not worried about the US public debt and, in general, not worried about debt borrowed in a nation’s own currency (here I strongly agree with MMT about how that is key). I think more debt can be positively good when the safe rate of interest is lower than the growth rate of the economy (as it almost always has been in the USA except during the strange period of Reaganite deficits and Volcker’s tight money).
You might be interested in OJ Blanchard’s AEA presidential address and citations in it.
I agree about Dr. Thoma. I think it can be clearly seen with the changes in the threads he provides.
Long gone are the days where he posted a specific article about a specific subject in an attempt to keep that discussion in that subject. It is becuase whatever the subject was, the thread would soon be infected by the usual cast of characters spouting their thoughts on totally different subjects like China’s GDP; military spending; the DNC screwed bernie; etc. The 2016 Dem primary was the end.
Realizing that, Dr. Thoma now just uses a daily links to on the blog, knowing that any attempt to change the dialogue is hopeless. And often he goes days and days without new links until the thread is filled with hundreds of posts. And that makes it really difficult for any meaningful discussion, not that such is frequent with the tribal warfare.
EMichael – back in the day where there were only 3 Angrybears (AB, Kash, and yours truly) we had a small problem with overheated partisans. All three of us sort of got worn out and AB passed the blog off to those who currently contribute. I come back here in part because those who run this place contribute AND have a really good way of controlling the comment section. God bless them.
Now Econospeak gave me blogging privileges at their place. We don’t have that much in the way of trolls but then we do not get as much notice either. Which is why we are grateful that our posts show up here as well.
I’ve noticed two other economist blogs where the trolls are well checked. Brad DeLong does not tolerate them. Good for him. Menzie at Econbrowser does tolerate them but then Menzie has an incredible sense of humor keeping them in their place! BTW – that applies to the “Usual Suspect” (what I call the cast of Trumpsters) AND to the Bernie Bros!
I am happy to see you, Barkley, Peter, Tom and any others post here. There are some interesting dialogue happening here. I got to know EM over at NC and invited him to come here after he tried to explain the truth at NC. Mark threatened to toss me one time when I posted the timeline for 2008 and he called it a story. It was factul and pulled from another person who had kept the detail. Not much of an economist as my work guided me into supply chains, manufacturing throughput analysis, purchasing/inventory/production, etc. problems. That I can talk to you guys is a treat for me.
I would wander over to Econospeak and read Tom as he comes the closest to what I actually did in companies and still do to some extent.
Thank you for the complement. Dan and I work at it. Kind of wish Bruce would come back also. As to the trolls and stupid remarks? I try real hard to ignore them and just warn them. It works sometimes.
This topic is crucial
KELTON wants to reverse the instrument assignments
Go back to the macro of the early 1940s
Where the policy rate was pinned
And deficits allowed to go where war demands required
Seeing the green new deal as a kind of combo
Like the 30’s second new deal plus an arsenal of democracy
Project of existential moral purpose
Fighting Brown climate like FDR fought Brown shirts
It is not at all clear to me that Kelton wants to go back to the early 1940s. In particular, I haven’t read her proposal for wage and price controls rationing and a requirement that firms get permission to invest.
These were essential components of wartime economic policy. I think they were necessary then and, personally, do not recommend them now. But my point is that I don’t think Kelton does either.
Without that, WWII policy would have caused extremely high inflation. There was double digit inflation for a year when price controls were removed in 1946, and then an inflation fighting recession.
Again, one might advocate extreme stimulus and consider double digit inflation a minor problem. In fact, I considered it no big deal in the 1970s and didn’t at all agree with Volcker’s approach in the 1980s. But again, I don’t know whether Kelton thinks this.
She wrote (responding to Krugman) that she proposes that the Federal Government set spending levels so there is full employment. That means, she thinks the current level is about right with no room for a green new deal without taxes (notably she is not the same person as Alexandria Ocasio Cortez).
My reading is that she proposed that post 2008 government spending be increased until full employment is reach (exactly precisely what Krugman proposed) and now, her written answers imply that macro policy is about right.
That is I detect no trace of a hint of any disagreement about what macro policy should be now or should have been over the past 10 years.
Instead, I think Kelton insists that her non standard definitions of terms re the right definitions and every statement should be interpreted assumign otherr people use words as she does (even though they don’t) and insists that it is fundamentally important to decide which effect of a policy is its purpose (which is a statement about how the economy functions and not the aims and intent of policy makers).
I detect almost no disagreement about econmics or economic policy between Kelton and Krugman. There is a massive gigantic gap between what Kelton says Krugman has written and what he actually has written. Her claims about these matters of fact are demonstrably false (he provided the proof beyond all doubt in his tweet thread). There is also a semantic disagreement where Kelton insists that it is terrible wrong to use the standard definitions of words. She does not even argue that the choice of definitions affects predictions and proposals — her jargon can be translated into standard economic terminology — the dispute is purely semantic — I have asked her for some way to test with data whether she or Krugman is right on the natural gravitational effect of deficit spending. I have received no answer because the answer is there is no such test, because she is insisting on a distinction without a difference.,
Her assertions are not meaningful statements in social science, because her claim that something is true which is different from what Krugman writes is unfalsifiable, that is scientifically meaningless.
Onr exception is her assertion that high interest rates do not cause low aggregate demand (other things equal). This is a testable claim. It is false. By 1982 it was clear that Volcker could yank demand around and make GDP go up and down like a yoyo. Kelton isn’t the only macroeconomist who insists on ignoring this evidence (Edward Prescott does too).