Post-Keynesians, Interest Rates & Monetary Policy

Steve Randy Waldman has a good post on Interfluidity in which he attempts to form a synthesis between New Keynesians (NKs), post-Keynesians (PKs) and Market Monetarists (MMs).

Waldman actually exposes a bit of a fault with post-Keynesianism: what exactly are the policy prescriptions? Or, more specifically: how should monetary policy be conducted? PKs generally want to channel bank’s lending to the right people; we’re generally in favour of fiscal stimulus during downturns; Steve Keen has a policy prescription for redefining shares that I’m not entirely sure I understand the implications of, but it would be hard to say anything about a shared stance on monetary policy.

Waldman fills this gap by assuming that PKs don’t have a problem with NGDP targeting in principle, though they may doubt its practicality at the zero bound. However, I have spoken before about how NGDP targeting ignores the role of interest rates in determining not only the rate but the type of investment that takes place – instead assuming that macroeconomic policy can only reliably influence nominal variables. Scott Sumner, in fact, appears to believe that under NGDP targeting, the interest rate would be irrelevant.

Sumner is actually incredibly vague about why NGDP is the correct indicator for monetary policy: he has previously refused to discuss transmission mechanisms, and appears to think the the general public understand what the monetary base is, a position that goes hand in hand with his emphasis on expectations. In fact, I’d go so far as to say the entire thing is becoming circular: the CB controls NGDP so it should target NGDP – we will judge this by the level of NGDP.

PKs & MMTers, contrary to MMs & NKs, view interest rate policy as exogenous, and the only monetary variable that the CB can reliably control. In fact, as Edward Harrison notes, this is probably the major difference between exogenous versus endogenous money.

The endogenous view lends itself to the views of Keynes himself, who saw low rates as the appropriate monetary stance. In this view, interest rates are a cost of investment and so if they increase it will have two effects:

(1) Net investment will decrease;

(2) Businesses that do invest will be forced to seek higher returns and therefore take more risk. This can lead to speculative bubbles.

However, evidence suggests that businesses making investment decisions do not look at short term interest rates – both because they are prone to changes, and because they are too, well, short term. The Radcliffe Report, for example, emphasises that business decisions are far more heavily influenced by long term rates of interest, and also by expectations over the future path of the long term rate of interest. Thus, successful monetary policy lies in a credible commitment to, and execution of, permanently low long term rates.  This also entails that monetary authorities have discretion over their jurisdiction, so capital controls would be a requirement.

As PKs & MMTers generally reject the IS/LM approach to the interest rate, generally sympathise with the views of Keynes himself and generally disregard ‘libertarian’ considerations when discussing international stabilisation, I do not see much of a reason that they should object to such a policy prescription.


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  1. #1 by wh10 on April 9, 2012 - 4:12 pm

    I don’t think PK agrees with NGDP in principle, and I do not think it has anything to do with the zero bound. Seems to me one idea PK rails against is the idea that monetary transmission mechanisms all of the sudden change drastically at the zero bound (for example they don’t agree with Krugman that QE hasn’t been inflationary because interest on bonds = interest on reserves at 0. They don’t see the situation as any different if interest rates were positive, and they don’t think it has anything to do with the equality of interest rates holding back some sort loan/money multiplier phenomenon, etc. Fullwiler covered this in his recent rebuttal to Krugman). I think “principle” includes plausible transmission mechanisms, and PK just does not see a plausible transmission mechanism backing NGDP. They are highly skeptical of expectations because they do not see any transmission mechanisms to back any expectations in the case of NGDP targeting.

    Anyways, my slightly informed take.

    • #2 by Unlearningecon on April 10, 2012 - 8:16 am

      QE could be effective in reducing long term rates if we had capital controls (as a side note, Market Monetarists generally do not support capital controls, suggesting to me that the approach is more about ideology than empiricism). However yes I do agree that it would never be inflationary.

      And re expectations: indeed. The average person doesn’t know what a Central Bank and NGDP are, and they won’t change anything based on its mandate (which they also don’t know/care about).

      • #3 by wh10 on April 10, 2012 - 9:49 pm

        What do you mean by your capital controls point? But even putting that aside, I do agree the Fed could lower long term rates, but that could be stimulative. You don’t think it could be stimulative? But in any case, that’s just a case of changing interest rates – can that tool be used to boost NGDP to whatever levels desired? That’s a question about the impact of interest rates on the economy. MM’s think you just need to do enough QE to increase money until it “hot potatoes” enough, but PK I think sees it more from the perspective of the impact of interest rates, not qty of money. On the other hand, PK (or at least MMT) would view fiscal policy more from the perspective of qty of money since it’s a net add of financial assets.

        Agree about the average person, but what about big business and finance? Assuming there was actually a plausible transmission mechanism, could their expectations impact the rest of the economy enough?

      • #4 by Unlearningecon on April 11, 2012 - 3:49 pm

        Without capital controls capital simply flows between different countries, so it’s difficult to use monetary stimulus precisely to affect one country’s interest rates.

        I believe it would be stimulative but not necessarily inflationary. This is because low rates encourage both more investment and ensure that investment is more sustainable, as companies do not have to seek excessively high returns.

        I don’t think the hot potato effect is a reliable guide to policy – it simply assumes mechanistic relationships between the monetary base, interest rates and expectations – we can make people spend more, we can’t determine exactly how that spending will filter into the real economy.

        Obviously the CB can impact the expectations of investors most effectively, and perhaps business. But NGDP? What business is going to be happy that nominal spending is increasing even if real spending isn’t? The MMs seem to think businesses don’t think in real terms, but they obviously do with product inventories, sales etc.

  2. #5 by Becky Hargrove on April 9, 2012 - 4:24 pm

    While I am not an economist, I have been studying economic issues for quite some time. Consequently, I think it does a world of good to think hard about the differences between the nominal and the real economies. So hopefully I can convey these thoughts about income in an understandable way. Long before taking part in Internet dialogue, I could see the difference between the real economy of products, and the tremendous, growing economy that was dependent upon that original wealth. This is why it is so helpful for me to see the world in the nominal terms which NGDP would at least reflect in income measurement. So my question would be, if it is not important to target income, do you think that overall equilibrium would be disturbed if (total) income grew to a substantial degree over already existing income? That would happen if low income individuals were employed in great numbers with other incomes remaining essentially the same. I would see this as dilution of productivity and think it is better to approach full economic access of lower income on a partially non-monetary set of terms with a sustainable base not equivalent to that of the middle class.

    • #6 by Unlearningecon on April 10, 2012 - 8:18 am

      I’m not sure that employing more people would necessarily entail a loss of productivity? Or have I misread you?

  3. #7 by Left Outside on April 12, 2012 - 5:20 pm

    First off, thanks for the envy! I like the idea of the Lucas critique, it just hasn’t been very useful.

    Secondly, I think I know the reason Scott thinks NGDP is the correct target variable.

    Money is long run neutral but can have short run effects.

    Why can it have short run effects? Because some prices are very inflexible.

    The most inflexible price is wages.

    Therefore, one of the main aims of monetary policy should be to stabilise the path of wages.

    A very close proxy for wages is NGDP: it also contains information on the general price level and production. It is also more politically palatable.

    Therefore target NGDP.

    So I think that is the logic.

    But I’m no market monetarist spokesperson.

    • #8 by Unlearningecon on April 13, 2012 - 1:50 pm

      That’s internally consistent but there’s still no discussion of transmission mechanism. That’s what puts me off – there’s a lot of handwaving.

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