ISLMic fundamentalism

It goes easier if we show some faith in the other guy

A couple weeks ago, I took advantage of what struck me as a rare opportunity to point out a flaw in Paul Krugman’s work.  It seemed to me that he was somewhat late to the case against fiscal stimulus and was actually understating it.  I hadn’t much use for his “subtle” argument for fiscal “insurance.”

I can’t really tell if he has since dropped that argument: he seems to be oscillating. But there is no way I am going to pursue that discussion further. I must already seem like a stalker.

Anyhow, I had leaned on Krugman’s insights pretty heavily in the last five years of a job “on” Wall Street, so I was eager to demonstrate that I could distance myself from his “mistake.” I had actually been waiting a while for him to make it.

I don’t have many readers, so my piece did not provoke much response, but what response it did provoke came mostly from MMT.   The MMT crowd made two points, at least as I read them. First, they insisted there was a strong case for fiscal stimulus in the early part of the recovery and there  certainly remains one now. Krugman should not be shifting more quickly or more clearly. Rather, he should not be shifting at all.

Second, some of these MMT guys impugned motives, calling Krugman clearly partisan. He is for fiscal stimulus when there is a Dem in the White House, but against it when there is a Rep.

Those criticisms of Krugman applied even more so to me, given that I am to the “right” of Krugman on this issue, and so you can see why I was eager to defend myself Krugman.

But I have learned something fun in the process, which may strike you as super obvious, but might still helpfully be brought to the forefront.  One – if not the only — reason that people see political motivation here is that both sides are reasoning honestly from their own sense of the economic analysis but neither is assuming the other is acting similarly. It is not so much that guys are projecting, but that they are failing to.

I assume that Krugman, like me, sincerely believes that the case for fiscal expansion weakens markedly when the economy comes off the zero bound – or, as I would prefer, when the markets begin to correctly discount that  as a medium term prospect.

Krugman has chosen to express this perspective in the form of IS/LM analysis, which I concede is a strategic error.  IS/LM is not the only framework available to highlight the importance of the zero bound for fiscal policy. And if you brag on and overstate the value of IS/LM, then an attack on IS/LM – which is likely to be successful – is an attack on your entire world view.

To mitigate this particular problem, you could easily swap out the LM curve, which is dated relative to the Fed’s actual framework, and replace it with a Taylor Rule (TR) and longer-run Monetary Policy (MP) rule. That leaves you with the same apparatus, but it is a bit more realistic about how the Fed actually operates. I say a bit, in part because I am pretty sure the Fed has wisely chosen to avoid the Taylor Rule or any other reductionist policy rule in this environment.

I doubt swapping out LM for TR/MP  would fully satisfy many of the critics,  MMT or otherwise, and I can understand the skepticism. (One the one hand, the framework is ad hoc from a maximization perspective, and on the other it loses the spirit of Keynes.) I mention the TR/MP approach just to provide an example of another way to get to the importance of liquidity trap. There are others as well.

I would guess that Krugman is not really wedded to IS/LM, but I had earlier made the point that you have to assess people’s arguments as they are expressed rather than in terms of what they “really” mean.  Krugman has, in fact, bragged on the prescience of the IS/LM framework, even as he has thrown in the odd caveat. So I think MMT fairly forces him to own that.

If I read them correctly, members of the MMT school just totally reject that framework.  (Again, see Bill Mitchell’s post attacking Krugman for a particularly blistering example of that.)  MMT school members point out, pretty factually, that the LM curve is irrelevant if the Fed is targeting the overnight interest rate or if the Fed chooses, for any reason, not to target the money stock.  More fundamentally, they don’t accept that the Fed should using variations of interest rate policy in an attempt to hit “full employment”, which some view as a neo-liberal fraud. They also seem to challenge the conventional take on how/if interest rates deliver “crowding out” of investment in the presence of fiscal stimulus at what (others call) full employment.

I hope I have not mischaracterized anybody here. If I have done so slightly, maybe just cut me some slack. I am trying to make a broader point and doing so in what I think is, in this case, good faith.

The thing is, from the analytical perspective of MMT, Paul Krugman — and I — have no right to be changing our views about the appropriateness of fiscal policy here. Given that we have no such right, the timing of the shift sure does look partisan.  I know I am being Captain Obvious here, but maybe this idea should be in the forefront, just for emphasis.

With that in mind, maybe I could propose a partial truce here.  You guys can continue to disagree with the importance we place on the zero bound, but at the same time give us the benefit of the doubt that our motivation is sincere. To wit, we are not being partisan hacks. We are just wrong, by the lights of your world view.

And our side can do the same.  We may disagree with your claim that the MMT framework would make the US economy operate better, but we can respect that that is how you see it and that the timing of our view change may seem odd within that framework.

I can put this more bluntly. We can call each other morons, which seems to be standard practice in macro anyway.  Only a total moron would fail to see it my way. Christ, maybe you could start by learning some economics. * But we should hesitate before calling each other evil or political. 

And I need to stop writing about Paul Krugman. He is not the only economist out there. As a good post-Keynesian asked at least 15 years ago, who died and made him king?

* That is pretty much a direct quote from a prominent blogger who would view both sides in this discussion as completely out to lunch.