Sunday, December 7, 2008

Is Mankiw Throwing Keynes Overboard?

I am totally stunned.

Just over a week ago, Harvard Professor Gregory Mankiw wrote this as his lead sentence for a column which appeared in the NYT:

If you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes.
He then provided a classic overview of Keynesian thought, especially as it relates to an economic downturn.

He concluded this way:

It is hard to say how successful monetary and fiscal policy will be in avoiding a deep downturn. But as events unfold, you can be sure that policymakers in the Fed and Treasury will be looking at them through a Keynesian lens.

In 1936, Keynes wrote, “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slave of some defunct economist.” In 2008, no defunct economist is more prominent than Keynes himself.
Remarkably, a few days later, on his blog, he begins to diss Keynes (my bold):

The Keynesian model has some clear, practical insights about how to think about fiscal policy during economic downturns. But are those insights true?

One approach to answering this question is to examine the data using the techniques of time-series econometrics without imposing much a priori theory. For monetary policy, there is a large literature that does this; for fiscal policy, the literature is smaller but growing. The results from this exercise, however, do not always confirm the predictions from textbook Keynesian models...

For example, here is the conclusion of Andrew Mountford and Harald Uhlig (a prominent econometrician now at the University of Chicago) in an empirical study called "What are the Effects of Fiscal Policy Shocks?":

Our main results are that a surprise deficit-financed tax cut is the best fiscal policy to stimulate the economy

a deficit[-financed government] spending shock weakly stimulates the economy.

government spending shocks crowd out both residential and non-residential investment without causing interest rates to rise.

These finding are not consistent with standard Keynesian theory, according to which government spending multipliers are larger than tax multipliers and crowding out occurs through increases in interest rates.

An earlier, related paper by Olivier Blanchard and Roberto Perotti called "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output" reported similar anomalous results...Blanchard, incidentally, is now the chief economist at the IMF...

He continued with the Keynesian diss on CNBC (video here). He pointed out again that tax cuts may better for an economy than government spending during a recession, and also said that monetary policy will be the key to the direction of the economy from here, not fiscal policy.

What's going on? Why the sudden change?

My guess, it has to do with Obama's choice of Christina Romer to head the CEA. She is a former student of Mankiw's (He was also best man at her wedding--her husband is also an economist.) and he has to know she is sharp.

As I wrote on the day Obama named her:

Christina D. Romer, Director of the Council of Economic Advisors

A Keynesian, but actually appears to pay some attention to the money supply as an influence on the business cycle. See here....Best hope for economic sanity out of this group is from Romer.
What about Mankiw's new view on tax cuts as the best method for dealing with a recession?

Here's NYT in its profile of her:
...she has also found that tax increases cause the economy to contract. And her dissertation showed, to the great delight of free-marketers, that the federal government has not gotten much better at stabilizing the economy since the Great Depression.

Romer may already be having have an impact. What else can explain Mankiw's conventional recitation of Keynesian economics in NYT on November 28 and his abrupt change? [Note: Obama named Romer on Nov. 25, Mankiw put an NYT link to his conventional Keynes story on his blog on Nov. 27, so for all practical purposes, it must have been at NYT on Nov. 26 and thus the latest he could have written that column was simultaneous with the naming of Romer.] Read that NYT article closely, there is no talk of any failures in Keynesianism, no talk of tax cuts versus tax spending, in fact he says in the column:

That leaves the government as the demander of last resort. Calls for increased infrastructure spending fit well with Keynesian theory. In principle, every dollar spent by the government could cause national income to increase by more than a dollar if it leads to a more vibrant economy and stimulates spending by consumers and companies. By all reports, that is precisely the plan that the incoming Obama administration has in mind.
His back away from this stance starts after Romer is named.

But, as I also pointed out on my initial snapshot of Romer:

...when you are reaching into Berkeley, of all places, for economic hope, you are obviously not talking about a Milton Friedman protege.
I didn't even want to stretch it and say an Austrian protege. And in the NYT profile of her, they report:

...she has described herself as having “liberal Obama-heavy political views,”
But, it appears that we may have an honest economic broker on our hands, who will clearly state what she sees from the data, Keynes be damned. And Mankiw doesn't seem to want to butt heads with her. Impressive. Keep an eye on this lady.

1 comment:

  1. Hmm very perceptive, RW. I am still picking my jaw up from the first Mankiw column.