Brad De long republishes a great piece of his arguing that Keynes Tract on Monetary Reform was a great monetarist document. As he concludes:
1rom our perspective today–in which the Great Depression is seen as a unique disaster brought on by an unprecedented collapse in financial intermediation and in world trade, rather than as the largest species of the genus of business cycles–it is far from clear that Keynes of 1936 is to be preferred to Keynes of 1924.
Besides, Keynes of 1924 writes better: his prose is clearer, less academic, less formal; his argument is more straightforward, linear, easier to follow; his style is as witty.
If you’ve not read it, go check it out. Friedman was a big admirer of Keynes.
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it is some twenty years since I read most of Keynes so on an uncertain memory I will agree with both Brad & Nicholas but I did think his piece on the Versailles treaty and effects there of was pretty good too.
Funny enough although the General Theory is his most influential I found it the hardest going
Keynes
Nicholas, I
James, I see the two as inseparable. In managing interest rates, central banks do so for the most part through changes to the monetary base. Put another way, they can manage either short term interest rates or the monetary base, but not both at once. Determining flow on effects to the wider money supply and credit markets is of course another matter entirely.
Having said that, my comment about leaning against the prevailing passions is perhaps more apt when used to describe his views on countercyclical fiscal policy.
Thanks Ingolf,
I think you put the issues very well – and also in a way that highlight’s one of Keynes’ great instincts summed up in the phrase “in the long run we’re all dead”.
We live now in an age of monetarism – not the exact kind required by Milton Friedman but of the kind prescribed by Keynes – that is great efforts are given over by an independent and skilled mandarinate to preserve price stability – interpreted as low steady inflation of 2-3% in this country and slightly lower elsewhere.
Now you regard this as ‘relentless inflation’ in the long run. Well, it sure is pretty relentless. But like a lot of economic distortions a reasonable approximation is to say that the cost of the distortion is proportional to the square of its measurement. (this is a rule of thumb from micro – for tariffs for instance.) With inflation perhaps the curve is more exponential as once you get above a certain level of inflation – 30-40% perhaps the costs skyrocket and the economy ends up pretty much imploding.
But small deviations from the right level have much lower costs for obvious reasons. Now there are some reasons for choosing a positive inflation. Most particularly people are hard wired to really dislike wage reductions, though if a company is in trouble they can come much more easily at wage freezes. If you want to have a look at the literature on this google [“akerlof” wages “low levels of inflation”]
There’s the further point that we can’t measure inflation all that accurately – and product quality improvement may account for a seizable fraction of a percent per annum. So averaging 1.5% inflation (a little lower than us but other countries do this) might be averaging less than 1% with product quality taken into account.
So I’m not sure why this age we are living in has so much worse monetary policy than the gold standard era. And in the gold standard era downturns were much more severe with bank runs and all the rest of it.
What’s happening now is a big experiment as you say. Markets are reacting pretty rationally to the apparent taming of the cycle. They’re borrowing more and gearing up. That is exactly what you’d expect with a debt equity premium as large as it is. In effect the debt is bidding down the debt equity premium and it will be bid down further if and when interest rates rise. Will this end in tears. I don’t know.
But assuming that it does end in a nasty downturn, the question must still be asked whether a long downturn – say of the magnitude of the Japanese stagnation might nevertheless be better than the alternative of several sharper recessions in the period before then. Here Keynes would say ‘well you may be right, but you’re not that smart. No-one is. So we do what we can to keep growth going, we don’t do anything that’s clearly silly, but we don’t refuse to head off a recession (with monetary expansion) on the grounds of some theory that says that they’re really the best we can do. Perhaps we’ll get to that point, but everything in life is an experiment – theory doesn’t give us anything like 20:20 foresight, so trying to avoid recessions is an experiment worth trying and we should do it and keep our eyes out for traps and try to avoid them.”
Further I think there are really two things rolled into one in your comment. The first is inflation – and the worth or otherwise of zero inflation and/or a specie based monetary base and the tradeoffs between the long and the short term.
The second is the idea of leaning against the wind of the cycle which all modern monetary authorities do to some extent. If we are successful in doing this then we remove a major source of risk for investors – short-term systemic risk. This would occur whether we aimed for 2.5% inflation in the long term as we do in Australia or if we aimed for zero inflation. That would create pretty much the same kind of pressure on the equity premium it seems to me – entrepreneurs would borrow to invest. Debt would rise relative to equity and the equity premium would likewise start to diminish. And that might end in the same tears too. But it hasn’t been low levels of inflation that has caused it, it has been the central bank being able and prepared to lower systemic short-term risk.
As a conservative in these things I’d feel more comfortable taking this bet than the radicalism of going back to the gold standard – with all its arbitrariness and short term risks to the stability of the money supply. But of course I might be wrong . . .
James, I missed your exchange with Ingolf while drafting my comment above. I hope I’ve made myself clear that I regard Monetarism broadly as the emphasis on monetary stability seen as a policy in which “great efforts are given over by an independent and skilled mandarinate to preserve price stability”. I realise this is not how it was preached by Friedman (though his emphasis at the time was in minimising the cost of getting inflation down something we’ve not proven to be much good at), but his basic message has triumphed it seems to me even if the means he proposed did not. But if you want to preserve the word Monetarism for Friedman’s proposed approach then well and good – Keynes wasn’t ever a Monetarist.
Regarding Friedman’s views on Keynes, here are some quotes – all by Friedman and extracted and quoted by Friedman in his essay on Keynes in the Economic Quarterly, Vol 83, No. 2 Spring 1997.
This in an essay which is in fundamental disagreement with Keynes’ policy conclusions and predilections.
If that’s the definition of a monetarist, I wonder who isn’t one. Robert Mugabe?
As for Friedman’s praise quoted above, well, it doesn’t sound that sincere to me. I think he’s buying insurance againts charges of prejudice, which he knows is expensive in his case. But I’ll have a look at the whole article.
James, I presume that’s what Brad means by monetarist – together with the downplaying of fiscal policy in leaning against the economic cycle. Do you think Brad means anything more by it?
Nicholas, price stability as a policy aim certainly beats the hell out of the growth oriented approach of the 1960s and 70s. Nevertheless, its very amiability and seemingly irreproachable reasonableness can at times obscure serious problems.
In its 1998 annual report, the Federal Reserve Bank of Cleveland devoted a lengthy essay to the topic
Thanks Ingolf.
You may indeed be right. I’m not sure that there are any failsafe ways through the various perils we are trying to navigate however. (In the meantime I’ve been selling assets!)
Amen to that, Nicholas. If ever anything fitted Churchill’s description of Russia, it’s the current international financial architecture.
Brad De long also has a very interesting article (pdf) he wrote a while back sketching a reasonable ‘liquidationist’ position on depressions – not that he concedes that liquidationism made any sense in the great depression. The arguments against it are very strong in that case.
Also this post outlines in a lot more detail his argument not just that “modern Keynesians are (in many respects) monetarists” but also that “modern monetarists are really Keynesians–even though they like to admit it even less.”
Interesting article, Nicholas (the first one that is), but not one that I find particularly convincing.
De Long contends that “The Federal Reserve did not push reserves into the banking system during the 1929
Ingolf,
Whatever you think of De Long’s argument, are you endorsing ‘liquidationist’ recipes for dealing with the Great Depression? I’ve not studied this, but it certainly seems far fetched. Where was all this over-investment in the 1920s that needed to be liquidated by a prolonged depression?
Come to think of it, you argue that there’s been a lot of misallocation of investment lately. Well there has been in dwellings due in substantial part to tax lurks, some excess animal spirits and to some extent the ‘leaning against the wind’ of the central bank. That’s been unwinding here somewhat and unwinding more in the states. So where else is there massive misallocation of investment illustrating the kind of misallocation of capital goods investment that the liquidationist view requires to make sense?
In many ways I would have thought the trend was in the opposite direction – towards consumption whereas the theory I take it you are appealing to is one in which there is an investment in excessively long chains of production implying over-investment in capital goods.
It
Ingolf,
For me anyway, I think we’ve ended up where we started – in a productive rather than a repetitive way. I think you’re building far too much on some arguments which are perfectly reasonable but which could be quite wrong. Like Keynes I’m a (Burkean) conservative in this.
We know the economy is full of positive (destabilising) feedback in this area. That’s essentially the justification for governments leaning against the wind. Now if this is justified then leaning against the wind does diminish the magnitude of the business cycle and this generates large efficiency gains which grow over time. It is possible I grant you that it may end in something nasty, but we’ve got an aweful lot of growth out of the current system.
Your arguments would be stronger if we were protecting people from ‘real’ or ‘natural’ risks that we can’t mitigate socially – like the risk of fire to their houses or the risk that a technology won’t work. But the systemic risk that macro-economic management protects against is something that is not necessarily ‘natural’ or at least can be minimised. It can be minimised by social action – by the policies we pursue now. I see leaning against the wind as a trade in risk between parties poorly placed to bear it (individuals and corporations) and a party that is well placed to bear it – (the same parties acting collectively as the government).
When things are going well the state withdraws from risk sharing and when they threaten to get worse it extends it – into territory which we know no-one else will. (Better to batten down the hatches and wait till the expenditure of others gets things back to normal).
So far so good. Fundamentally I never really understand this penchant for thinking that recessions are natural and healthy. It’s not as if there isn’t a healthy evolutionary process in the economy sorting our the good and bad investments – it’s called competition. Even when we (successfully) protect people from recessions good investments generally continue to return more profits to their investors than bad ones. So the bad ones just go broke or get smaller slower. So what’s the problem – why do recessions improve on this mechanism? Why would removing them make things worse?
Now you argue that in the long run there’ll be some reckoning for all this. Perhaps, but I doubt it will outweigh all the benefits we’ve accrued so far and there could be some awfully big reckoning with what you’re suggesting and I think you agree that even without that there would almost certainly be quite substantial costs in moving to the new regime (recessions). I doubt the reckoning is likely to be on a scale that could outweigh the gains that the new approach has given us.
And in the long run we’ll all be dead.
Most interesting, Nicholas. I think I see a bit more clearly now why we differ. We
In the long run we’re all dead is not a fatuous comment. It’s an aphorism true enough. So it has to be read as a pithy (and to that extent improperly qualified) statement of a truism about a particular perspective – that of Burkean conservatism. It is full of import about the way Keynes thought. I don’t know if you’ve read Skidelski’s marvellous biography but he brings out Keynes’ Burkean conservatism particularly around this point. He sought amelioration, not revolution and what you’re suggesting is a (monetary) revolution. It’s hubristic about the powers of rationality to engineer some revolution.
Of course you can say that you’re arguing for the status quo ex ante circa WWI. But was that such a great system? What were growth rates then? And every decade or so you had a depression. As you know we had one in the 1890s which was very savage – up there but not as bad as the Big One of the thirties. Once you get bank runs it seems to me you’re stuffed – a bit like hyperinflation (though admittedly not so bad) you lose your monetary system – and the massive public good that comes with public confidence in the payments system.
We’ve not had bank runs or a depression since governments either through monetary or fiscal policy ‘lent against the wind’. EVER. Perhaps we will one day. It’s hard to imagine it being much worse than the Japanese experience which seems to have been a decade of near zero growth. That’s a lot better that a massive contraction wiping out a whole lot of perfectly good businesses and keeping all the entrepreneurs scared of ever investing in case the big one comes and wipes them out.
If what you’re suggesting is an improvement, can you point to one high growth country that has anything like it? Perhaps you could argue that countries that peg their currency to another are a bit like it, but where do we have high growth economies with banks that can fail?
And I’m mystified as to your comment about ‘classical liberals’ regarding the economy as a self-adjusting mechanism. Of course they regard individual markets as very close to this – as do it (unless there’s something wrong with the markets). But the monetary system itself is full of potential feedback all identified by Keynes and others. Expectations of future profit are a function of others’ expectations of future profit. Now you can argue that we’re destined to stuff up any centralised attempt to do better than the imperfect mechanism that would exist if we didn’t intervene centrally, but I can’t see how you can argue that issues of liquidity don’t involve collective action issues. This is commonsensical and confirmed both empirically and theoretically by the baby sitting co-operative used by Krugman to such good effect.
I’d also be interested in your reaction, if you’ve not read it to Krugman’s introduction to a re-issued Keynes’ General Theory. I thought it was very lucid. Brad De Long has a long excerpt here.
You
Well, the frustration was not really with you. I guess there are plenty of classical liberals that might argue against a role for leaning against the wind. But whereas their case is a strong one when it comes to micro markets, I think it’s absurd when it comes to macro-markets IF the argument is seriously put that there’s no market failure.
I guess there’s a perfectly good way to make it respectable which is to argue that govt failure is worse – that central banks mess things up and that therefore leaving it be is the best you can do. But the idea that there is a natural equilibrium rather than disturbance by positive feedback. Well I regard that as absurd – as demonstrated by the baby-sitting co-op. I have more time for classical liberals than that.
But I’m trying to get you to engage on those points. Surely you’d agree that there is strong positive feedback in an economy – through the monetary system.
Btw, I agree that money and credit is fraught. And it’s also a fertile field for nutters. I’ve always regarded it as somewhat magical. It’s certainly mercurial. I guess that’s partly my point. I don’t claim a deep knowledge, but I do believe that the idea of positive feedback is a big and simple idea that implies that leaning against the wind is a sensible policy. Anyway, I guess I’m repeating myself now. Again :)
Nicholas, it’s becoming clear to me that I may not properly understand how you’re using various terms and concepts. For example, what do you really mean by saying it’s absurd to argue there’s no market failure when it comes to macro-markets? Or that the idea that there’s a natural equilibrium in a free monetary system is equally absurd? Nor am I sure I understand how you’re using the term positive feedback. Or, come to think of it, what you really intend to convey with your usage of “lean against the wind”.
These matters seem to be important to you, for reasons that aren’t at all clear to me. As I guess was obvious, I was trying to tiptoe out of the conversation with my last post because it had started to feel a bit too much like a stoush rather than an amusing discussion on a fascinating subject. So, maybe if I better understand your argument — and in particular your use of terminology — we might be able to clarify things and either reach some agreement or happily agree to disagree.
Nicholas, going back to your #12, De Long’s characterisation of a specific school of ‘Keynesian’ thinking is accurate and helful. But he errs in equating this with ‘modern Keynesianism’ in general. ‘New Keynesianism’ is in fact essentially monetarist, by virtue of embracing the third plank in De Long’s menaifesto, namely:
But if you interpret ‘modern Keynesian’ neutrally as meaning contemporary Keynesians, they certainly don’t all subcribe to that, and needless to say Keynes wouldn’t either.
In any case, the cross fertilization of the last three decades doesn’t have much to do with your original post. What I objected to about that was the suggestion that the Tract on Monetary Reform contains some profound and original insights that Keynes subsequently lost sight of in the GT. It might have been more lucid, but it’s a much less ambitious book, and its adherence to the Quantity Theory framework, while completely understandable (everyone else did it), is a limitation rather than a virtue. I can’t see how anyone could agree with Krugman’s assessment and think otherwise.
As for the discussion with Ingolf, I suggest that one or other of you start a new thread, with as explicit as a statement as possible. This topic does lend itself to arguing at cross purposes.
Yes, fair enough James. I thought of your comments and this exchange with Ingolf when I read this exchange with Krugman on Krugman’s essay on Friedman.
Krugman agrees with you.
You pretty much word for word – though I think Krugman could have made his point more lively with a reference to Robert Mugabe.
Ingolf,
Apologies if you thought I was in for a stoush – not really my style. I was just hopping into the argument I thought on its merits. If you want to tip toe away please feel free, but I won’t bore others by following James’ suggestion and starting another post.
To answer your questions
1. what do you really mean by saying it
Nicholas, absolutely no need for an apology. Anyway, we could always just do a swap for mine from #19!
Thanks for the answers. I