I wrote:
>>... The key classical assumption that pervades economics (and, seemingly,
>>Al Gore's mind) is not the assumption of continuous full employment but
>>rather the version of Say's Law that says that increased saving (nowadays
>>in the form of an increased government budget surplus) leads to increased
>>investment.
Brad interjects:
>...Because the Federal Reserve makes it so: the Federal Reserve targets
>the unemployment rate and acts inside the decision cycle of the fiscal
>authorities.
I don't understand this Krugmanite adulation (if not worship) of the
all-powerful Federal Reserve; "fine-tuning" of this sort has been rejected
by serious macroeconomists for quite awhile. Faith in fine-tuning was very
common in the period of High (Bastard) Keynesianism, but it was criticized
severely and correctly by monetarists and sophisticated Keynesians (like
Martin Neil Baily, chair of the US President's Council of Economic
Advisors, last time I checked).
First, the Fed controls the short-term nominal rate, while it's the
long-term real rate that's relevant to monetary policy's effect on the
economy. We can't assume that either the expected inflation rate or the
maturity premium is constant in a way that automatically facilitates the
attainment of the Fed's goals. For example, in 1992, the maturity premium
rose steeply, meaning that the Fed's efforts to stimulate the economy by
lowering short-term rates (seemingly to help George Bush reelected) mostly
encouraged refinancing of existing debt rather than borrowing to finance
new investment. Second, even the long term rate isn't a total summary of
the supply-side of the financing decision, since banks engage in credit
rationing and can change the collateral necessary for loans. On top of
that, the demand side depends strongly on expectations -- on what Mr.
Keynes called "animal spirits." These long-term expectations can and often
do affect investment in ways that contradict the goals of the Fed. Further,
there's the very-unpredictable accelerator effect, i.e., the way in which
current changes in sales affect expected profit rates. Even if we make the
assumption that expected profit rates are in the long run determined by
actual profit rates, the latter is not a variable that the Fed controls. If
the profit rate is low, as it was during the 1970s and 1980s, that limits
the Fed's ability to target any given unemployment rate without suffering
from inflation. Most serious studies of the effect of interest rates on
total spending suggest that the effect is pretty small, which limits the
Fed's ability to fine-tune. In econ-jargon, the IS curve is quite steep.
Further, the Fed does not control the international economy. It can thus
end up in a dilemma where domestic goals conflict with international goals.
Finally, it's very clear from the history of the last 4 to 8 years that the
Fed doesn't know what unemployment rate to target. The Fed has been very
lucky that the apparent NAIRU fell, because the Fed was groping in the
dark, not knowing what the NAIRU was.
>If you're in a liquidity trap, or your central bank is headed by potted
>plants or madmen, then things are very different. (At least, that's the
>way I teach it.)
Do you think that followers of Ayn Rand are mad? since Alan Greenspan is
one of those. BTW, I think that the liquidity trap is overblown. The key
problem in a recession is that a mutual interacting and reinforcing
combination of excess capacity, pessimistic expectations, and excessive
indebtedness makes spending even more unresponsive to low interest rates
than it usually is. This vertical IS curve makes monetary policy impotent,
in addition to the effects of the liquidity trap.
Jim Devine [EMAIL PROTECTED] & http://bellarmine.lmu.edu/~JDevine
