Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 13 November 2013













  1. This is a very enlightening article, Professor Wren-Lewis. Your illuminating explanations of OK and NK and of how economists reconcile the two is much more valuable to me than the recent posts by DeLong and Krugman--I find their responses to Cochrane to be more to the wonkish "gotcha" side relative to your delightfully understandable rumination on the substance of Cochrane's argument.

    1. I second this! A very lucid explanation. Looking forward to reading the linked paper tomorrow, too!

  2. It is a fact that there are many new Keynesian models in the literature which have Ricardian equivalence ( say Smetts-Wouters). I hope no one takes the policy implications of such grossly unrealistic models seriously. It may be rude to call the analysis of such models insincere lip service to applied math dressed up as economics. However I see no other way to describe the phenomenon.

    Also you and Cochrane know more about this than I do, but I know of no evidence of superiority of the hybrid model over a model of complete myopia and habit formation. It is certainly true that all of the classical (e.g. Noted ny Friedman) evidence for the PIH fits a model of myopia and habit formation just as well. Since NK DSGE models all include habit formation (to fit the otherwise excess smoothness) the question of what of any empirical vlue is added by forward looking expectations is to my limited knowledge open.

    The fact that no one uses adaptive expectations is an appeal to authority not evidence. It is simply a fact that the variation TIPs breakevens can be explained in part assuming adaptive expectations R squared of 0.5 is the crazy period 2008-9 is excluded. I contrast thre is no hint of any trace of any explanatory power of forward looking expectations for the very boring reason that achieved inflation rates to maturity of the bonds have hppened to be almost constant since the introduction of TIPs (about 2.5%).

    Your post suggests that the NK glass is half full with useful insights from both NK and OK models. I am honestly not aware of significant evidnce that the NK glass isn't almost exactly empty.

    Data here

    1. do more modern NK models that include things like some proportion of myopic and/or credit constrained households really still "have Ricardian equivalence"?

      I'd have thought one wouldn't have to add too much to the more basic model to make Ricardian equivalence go away, and I'd have guessed such additions would be standard. But I don't know.

    2. Robert,

      I agree that the models are “grossly unrealistic”. But they keep academics employed, don’t they?

  3. When Krugman writes that:


    Does this apply only to US economic journals, or to ones in the UK as well?

  4. It seems to me that once you take on board issues like credit constraints and agents with limited horizons, you're not being both NK and OK, you're just being OK. I don't think that OK ever said that current income was the only thing that determined consumption, merely that it would have some effect.

    But labels shouldn't be the issue. The question is do we think that, in the real world, these factors will lead to there being some kind of multiplier effect via income. If we do, then we should be suspicious of any model that purports to demonstrate that there is no such effect by assuming away the things that cause it.

    1. I entirely agree.
      New Keynesians make me think of secret agents who believe they spy for one side, when they're in fact manipulated by the other side.
      When there are theoretical reasons why assumptions are "unlikely to be true and even better empirical evidence that [they are] not", such assumptions should be left to the use of the Chicago boys. They're doing economics for the sake of the art, not for answering crucial policy questions.
      Cochrane may not be so wrong about New Keynesians, but he just misses the fact that his critic applies to NeoClassical economists as well.

  5. A lot of non-economists like myself will be asking is there any room for context in this discussion and economies with different types of labour markets and financial systems. When we talk about "The coefficient on current income is something like ...", would this equally true in Japan in 2013 as the US in 1935? It just might be that the answers lie in the context - Keynes or Friedman or Cochrane could be completely right or not at all depending on it.

  6. Nicely put.

    Though, like Robert above, I do have misgivings about the net advantage of putting old wine in a new (methodological) bottle.

  7. Simon: fair enough. But let me give you another very big difference between Old and New Keynesian models in their fiscal policy recommendations.

    Assume there is an increased desire to save, that lowers the natural rate of interest, and that the central bank is unable or unwilling to lower the market rate of interest to match it. What is the policy recommendation for government spending if you want to increase the natural rate of interest to prevent a recession?

    Old Keynesian models say: increase the level of government spending.

    New Keynesian models say: reduce the expected growth rate of government spending.

    That is a substantive difference. (And I think that making half the agents hand-to-mouthers won't change that result, though I'm not 100% sure on that.)

  8. A keen implication is that distribution matters for demand. If income is transferred from those with little unmet demand to those who have large unmet demand, then net demand will increase. Wealthy special interests who cannot get past the idea of "zero sum" resent the redistribution as a dead loss. However, if the transfer increases demand and increases production (and wealth) in the system, then a transfer can be win-win. Many of the arguments against stimulus assume no resulting increase in output and denounce redistribution as zero sum in spite of overwhelming evidence to the contrary.

    -jonny bakho

  9. Forgive a simple question/observation..but isn't a critical aspect of Keyne's original work (maybe Original rather than Old) that Capital flows had to constrained..? And isn't the entire issue surrounding the Euro/EZ expirement, that it was precisely the surge in Capital Inflows that destabilized the Money/Fiscal relationship? And that this applies as much coming as going out?

  10. Prof Simon and the above commentators all assume that Keynsianism in its broadest sense includes just two possibilities: funding stimulus via borrowing and via tax.
    In fact Keynes was quite happy with a third alternative: funding stimulus by simply printing money. See 5th paragraph here:

    Certainly to impart stimulus by extra spending, and then negate or partially negate that stimulus by borrowing or raising taxes is on the face of it bizarre. That strikes me as making as much sense as throwing dirt over your car before cleaning it – or maybe AFTER cleaning it.

