Friday, March 11, 2011

Another post on Yglesias and the Liquidity Trap

Here I go again. Yglesias refuses to recognise that a nominal interest rate of zero is special. He refuses to notice that some economists think it is crucial. I get irritated as always.

He wrote

much like the voters themselves, many politicians and political staffers are not that savvy about New Keynesian macroeconomic models.

I comment

One doesn't need any familiarity with *new* Keynesian economics to understand the views of Black, DeLong, and Krugman, since they are clearly explained in "The General Theory of Employment Interest and Money." On the other hand, the key point (which is not stressed in that book) has largely been lost in the New Keynsian literature. Also I think you don't get it.

He wrote

Black, Paul Krugman, Brad DeLong, and I all believe that with unemployment high and interest rates and inflation low that a larger short-term deficit will help post real output and reduce unemployment.

I comment

Sorry to be rude, but Krugman does *not* believe that when nominal interest rates are "low" then fiscal stimulus is in order. He believes that when the monetary authority can't push nominal interest rates any lower, then, and only then, fiscal stimulus is a good idea. If nominal interest rates wer exactly what they are, and the FOMC thought GDP and unemployment were fine and dandy, then there would be no point in fiscal stimulus, since the FOMC would cancel its effects on GDP and unemployment by raising interest rates.

The key condition (according to Krugman who explained it all very clearly) is that the monetary authority is constrained by the zero lower bound. That means that interest rates and inflation do not have similar roles in the argument. It means that low interest isn't enough. What is needed is a FOMC which won't cause an increase in the federal funds rate even if there is a fiscal stimulus but which can't reduce the federal funds rate, because it can't be below zero.

1 comment:

Anonymous said...

Do you not believe in links?