George Osborne, New Keynesian
Pretend you have been appointed Chancellor of the Exchequer in May 2010, and you want to find out what what “bleeding-edge” macro research says you should do.
What do you find out?
If you’ve read New Keynesian Lars Svensson, you might be sceptical about the efficacy of deficit spending in boosting aggregate demand. Like Svensson, you’ve watched Japan run large deficits for two decades, and seen that that the level of Japanese nominal GDP is unchanged after that all time, yet public sector debt has soared. You don’t want to go down that route. You might like the idea of a “Foolproof Way” to exit the ZLB, a price level target and currency devaluation, but you can see the UK CPI is already above target, and you are worried about the global politics of engaging in “currency wars”.
If you’ve read New Keynesian Ben Bernanke, you would be a strong believer in the unlimited power of the printing press in raising UK aggregate demand.
You would surely listen to New Keynesian Mervyn King, who is one of the UK’s most prestigious macroeconomists, and also happens to run your central bank. He tells you in no uncertain terms to get the deficit down and let him get on with running AD policy. He tells you he tried out his printing press in 2009, and it worked very well indeed. He’s got your back.
If you’ve read New Keynesian Paul Krugman, you’ll consider raising the inflation target to 3% or 4% as the best policy choice at the ZLB… but you get shot down by Mervyn King who thinks that’s a really bad idea, which might herald a return to the 1970s.
You’ll also believe that under New Keynesian inflation forecast-targeting, the central bank will internalize whatever fiscal policy decisions you make, and steer an appropriate course for UK aggregate demand. Your new friend Mervyn has promised to print enough money to keep things ticking along nicely.
So maybe you get on with running fiscal policy to cut the deficit, and let the Bank take care of AD policy for a year, or two years, or three years. Inflation stays well above target, and the jobs market, well, it could be much worse. The printing press is duly deployed when necessary.
But bizarrely, all this time another bunch of “New Keynesian” economists are baying for your blood, admonishing you for making some kind of policy error. They don’t seem to believe a word Ben Bernanke wrote. They don’t believe in inflation forecast-targeting. They tell you that monetary policy doesn’t work, and you’re an idiot for thinking it ever would. They have nothing much to say about Japan. And they have strange ideas about how fiscal policy can be used as a “magic money tree”, with “self-financing” deficits. They tell you that increasing borrowing will reduce borrowing, yet reducing borrowing will increase borrowing! They are hard to understand.
You also get advice that tells you maybe the central bank has been screwing up all along. You find another New Keynesian, Dr. Escape Velocity – he tells you he can fix things if you let him loose with that printing press and give him room to move. But another bunch of “New Keynesian” economists, the ones who are running the central bank, tell you in no uncertain terms that UK AD policy is working just fine.
Who do you believe? The Bernanke/Svensson New Keynesians? The
New Crude Keynesians who think fiscal policy is all that matters at the ZLB? The New Keynesians at the central bank who are screaming at you that everything is just fine?
You bet the farm on Dr. Escape Velocity… and throw in some interventionist fiscal policy for good measure. Nobody’s very happy with you.
I must say I’d almost feel sorry for you after all that. It’s a tough job at the top, isn’t it, when all you have is conflicting New Keynesian macro policy advice?