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Monday, February 17, 2014

Comment on Krugman

Commenting on Smith, Krugman wrote

"real business cycle theorists ... aren’t like French generals getting ready to fight World War I in 1939; they’re still working out how to repel cavalry charges."

(my thought but put eloquently)

"I think it puts Keynesians (of all stripes) in a better light than Noah grants."

and "Bottom line: I am not a French general!"

I comment.

I agree that you aren't a French General. You are, however, fighting an old war. You are fighting the Japanese stagnation of the 90s. Not a mistake (or a reflection on you) since it is the rich world wide problem of the 10s. History doesn't repeat itself but sometimes it rhymes.

But what about "I think it puts Keynesians (of all stripes) in a better light" hmm alll stripes ? It seems to me that new Keynesians are a war or two back (in 39 figuring out how to defeat the Prussians). In NK models, real variables are assumed to be stationarily distributed around an exogenous long run equilibrium. They didn't explain the European unemployment problem of the 80s and 90s. They decided that Europe wasn't a proper market economy so it is irrelevant to the mainstream of macroeconomics. Then reform made it OK. Now (without reversal of reform) there is extremely high unemployment for a long time without deflation (well maybe deflation in Greece).

Even you have had some intellectual discomfort. You tentatively forecast deflation and later noted that downward nominal rigidity was much stronger than you thought. Existing new Keynesian models can't deal with downward nominal rigidity, because they work in minus expected inflation space. It is easy to add downward nominal rigidity to an adaptive expectations augmented Phillips curve. The slow recovery (so far) creates no problems for old Keynesians. It creates a whole lot of problems for anyone who claims that new Keynesian economics is an advance on old Keynesian economics.

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