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Understanding Keynes: the data

‘New-Keynesian’ models use sticky prices and downward rigidity of nominal wages to get ‘Keynesian’ results: during slumps, low interest rates, money growth and additional expenditure (not necessarily government expenditure) can heal the economy and lower unemployment without inflationary consequences. The name ‘New-Keynesian’ is however a double travesty. Not because prices aren’t sticky (many are) or because downward rigidity of nominal wages does not exist (it exists). But because in the ‘General Theory’ Keynes argued that slumps can happen despite and even because of declining wage income and downward flexible wages. And because he had good reasons to do this: after 1921 english wages showed an unprecedented long-term decline while unemployment stayed way above historical levels and increased to unprecedented levels after 1929. An implication of (almost all) ‘New Keynesian’ models is that economies will bounce back to full employment if only labour and other markets are ‘flexible’ enough. The UK example shows that this isn’t necessarily the case. Keynes explained why. New Keynesian models don’t. As far as I’m concerned, data like those below should be part of any undergraduate introduction into Keynesian economics.

Churchill

Data: Bank of England.

Technical addendum: “The economic consequences of mr. Churchill” is a treatise by Keynes in which he lambasted the decision to rejoin the gold standard at a clearly overvalued rate. Until 1905 periods are from the year after a peak in unemployment until and including the next peak, after 1905 for obvious reasons the years 1913, 1929 and 1939 were used.

  1. originalsandwichman
    May 23, 2014 at 8:31 pm

    “The name ‘New-Keynesian’ is however a double travesty…”

    Triple travesty? Quadruple? See Sticky Wages of Sin

  2. May 23, 2014 at 10:36 pm

    While I agree with what you’re saying (I was making this same argument very recently), the spike in wages in the WWI era suggests to me that you are using nominal data. In New Keynesian models the wage that counts is real wages, not nominal wages.

    • merijnknibbe
      May 24, 2014 at 8:43 am

      Thanks for the remark, I’ll check out your argument. There is an obvious problem when you write a short blogpost about NK models: you can’t write about all of them. There are quite some NK models, all of them different (and, i.e., as many different implicit definitions of ‘model consistent’ rationality!).

      My default model is the ECB New Area Wide Model, arguably one of the most influential models around (for the uninitiated: this model states among other things that all EZ countries make the same 3 goods (actually there is (close reading:) 1 firm producing ‘the’ consumption good, 1 firm producing ‘the’ investment good (neat: no aggregation and 1 firm producing the government good, note that in reality the government produces much of this last bundle of goods itself (education etc.)) which *totally* ignores recent and not so recent findings about ‘global value chains’ and making the model by default unfit to analyse the relation between the Spanish housing boom and surplus German savings invested in Spain).

      About wages this model states:

      “Each household h supplies its differentiated labour services Nh,t in monopolistically competitive markets. There is sluggish wage adjustment due to staggered wage contracts `a la Calvo (1983). Accordingly, household h receives permission to optimally reset its nominal
      wage contract Wh,t in a given period t with probability 1 − ξW. All households that receive permission to reset their wage contracts in a given period t choose the same wage rate ˜Wt = ˜Wh,t. Those households which do not receive permission are allowed to adjust their wage contracts to productivity developments and inflation”

      As I read this, this is not just about ‘real’ wages, adjusted to inflation and productivity. By the way – the authoritarian streak of NK models becomes clear, too, with phrases like: ‘All households that receive permission’. As far as I’m concerned, this attitude is, thinking about Troika policies, not just a quirk of the model but an apt description of the mental state of Troika politicians just like the implicit idea that the government itself can’t be a producer.

  3. Philippe
    May 23, 2014 at 11:35 pm
    • merijnknibbe
      May 24, 2014 at 8:19 am

      Wren-Lewis is interesting indeed. He states:

      “In my second year lectures, I ask my students to think about a monetary policy that involved moving real interest rates in response to the output gap, but not to excess inflation. If that policy stabilised a closed economy, then what impact would the speed of price adjustment have on anything except inflation? Inflation aside, a world where price adjustment was quick would look much like a world where prices were much stickier. The ‘short run’ would have the same length, irrespective of how quickly prices adjusted.”

      I understand this as: if prices (except for the interest rate) are stickier just lower the real rate of interest more and faster and all will be fine. This is (look also at the comments) not about the possibility that downward flexible wages can actually be the problem (a possibility which ‘New Keynesians’ Krugman and Eggertson however underscore, in the post I use the phrase ‘almost all’ when talking about New Keynesian models).

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