Krugman’s blog, 4/13/16

There were two posts yesterday.  The first was “Why Monetarism Failed:”

Brad DeLong asks why monetarism — broadly defined as the view that monetary policy can and should be used to stabilize economies — has more or less disappeared from the scene, both intellectually and politically. As it happens, I wrote about essentially the same question back in 2010, inspired by the more or less hysterical pushback against quantitative easing. I thought then and think now that this was fated to happen, that Milton Friedman’s project was always doomed to failure.

To repeat the key points of my argument:

On the intellectual side, the “neoclassical synthesis” — of which Friedman-style monetarism was essentially part, despite his occasional efforts to make it seem completely different — was inherently an awkward construct. Economists were urged to build everything from “micro foundations” — which was taken to mean perfect rationality and clearing markets, not realistic descriptions of individual behavior. But to get a macro picture that looked anything like the real world, and which justified monetary activism, you needed to assume that for some reason wages and prices were slow to adjust.

Inevitably the drive for purism collided with the realistic accommodations, the ad hockery, needed to be useful; sure enough, half the macroeconomics profession basically said, “what are you going to believe, our models or your lying eyes?” and abandoned any good sense Friedman had originally brought to the subject.

On the political side, there was a similar collision. Right-wingers insisted — Friedman taught them to insist — that government intervention was always bad, always made things worse. Monetarism added the clause, “except for monetary expansion to fight recessions.” Sooner or later gold bugs and Austrians, with their pure message, were going to write that escape clause out of the acceptable doctrine. So we have the most likely non-Trump GOP nominee calling for a gold standard, and the chairman of Ways and Means demanding that the Fed abandon its concerns about unemployment and focus only on controlling the never-materializing threat of inflation.

What about the reformicons, who pushed for neo-monetarism? We can sum up their fate in two words: Marco Rubio. There is no home for the kind of return to realism they were seeking.

The point is that the monetarist idea no longer serves any useful purpose, intellectually or politically. Hicksian macro — IS-LM or something like it — remains an extremely useful tool of both analysis and policy formulation; that tool is not helped by trying to state it in terms of monetary velocity and all that. And if you want macro policy that isn’t dictated by Ayn Rand logic, you have to turn to a Democrat; on the other side, there’s nobody rational to talk to. Sad!

The second post yesterday was “Is Cheap Oil Contractionary?”

Low oil prices were supposed to be a big boost for the world economy; but it didn’t happen. Maury Obstfeld, my long-time textbook co-author and now chief economist at the IMF, offers an interesting argument about why: he suggests that it’s because of the zero lower bound. Falling oil leads to falling inflation expectations, and since interest rates can’t fall, real rates go up, hurting recovery.

Matt O’Brien is skeptical, and so am I — even though I am very much in favor of rethinking our usual assumptions when the economy is at the ZLB.

First, a priori, falling oil prices shouldn’t affect expectations for the rate of inflation of non-oil goods and services, or at least it’s not obvious that it should — and that’s the inflation rate that should matter for investment. Still, you could argue that oil is in fact driving those expectations, whether it should or not. What Matt does is question whether correlation is causation.

I’d make another point: even using market expectations, real interest rates have in fact gone down, not up, in the face of falling oil prices:

How is this possible, given the zero lower bound? It’s all about the term structure: long-term rates aren’t at zero, although they’re at least somewhat supported by the floor on short-term rates. And as it turns out, during the recent oil crash long-term rates fell enough to more than offset the decline in expected inflation.

Of course, Maury could be right in an other things equal sense. But my guess is that the oil-price disappointment comes less from expectational channels than from two facts: oil is now a big driver of investment, via shale, and oil exporters are actually cash-constrained these days, with an arguably *higher* marginal propensity to spend than oil consumers.

Anyway, interesting stuff.



One Response to “Krugman’s blog, 4/13/16”

  1. Paul from Norway Says:

    The question for oil traders is who will survive a sixty dollar barrel in 2020?

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