Mark Thoma: What Is Wrong with This Picture?
MIrror of Wildernesses Department: Fear your

Department of "Huh?!": Who Are You Calling "Keynesian", Kemosabe? Department

Stephanie Kelton:

Stephanie Kelton’s response to WaPo MMT article: It was very nice to see Dylan Matthews, who is a young journalist and not an economist, recognize the growing influence of MMT. The piece does get a number of things wrong…. While the Austrians screamed, “Zimbabwe”, we explained that QE is nothing but an asset swap and that idle reserves — whatever their magnitude — will not “chase” any goods. And while “Keynesians” worried about the impact that large deficits would have on US interest rates, we calmly explained the flaws in the loanable funds framework and insisted that rates would remain low as long as the Fed was committed to low rates (as the Bank of Japan has shown for decades)…

First, the whole point (well, not the whole point: there is a minor effect from quantitative easing to the extent that it takes risk off of the investor community and onto the taxpayers, thus reduces interest-rate spreads, and so moves us a small way down the IS curve via this "spreads" channel) of quantitative easing is to raise expectations of the price level in the future--to raise the money stock now to make more credible your statements that you will keep interest rates low and thus keep raising the money stock for a considerable period).

Second, "Keynesians" weren't worried about running large deficits in a liquidity trap--monetarists and Austrians and Austerians were. For example, from the spring of 2009, Paul Krugman:

Liquidity preference, loanable funds, and Niall Ferguson: Joe Nocera writes about Thursday’s New York Revie/PEN event on the economy, but fails to mention what I found the most depressing aspect of the whole thing: further confirmation that we’re living in a Dark Age of macroeconomics, in which hard-won knowledge has simply been forgotten. What’s the evidence? Niall Ferguson “explaining” that fiscal expansion will actually be contractionary, because it will drive up interest rates…. [T]his is really sad: John Hicks knew far more about this in 1937 than people who think they’re sophisticates know now.

In any case, I thought it might be useful to re-explain why our current predicament can be thought of as a global excess of desired savings — which means that fiscal deficits won’t drive up interest rates unless they also expand the economy…. Ferguson was thinking of the interest rate as determined by the supply and demand for savings. This is the “loanable funds” model of the interest rate…. What Keynes pointed out was that this picture is incomplete if you allow for the possibility that the economy is not at full employment…. [S]upply and demand for funds doesn’t tell you what the interest rate is — not by itself. It tells you what the interest rate would be conditional on the level of GDP; or to put it another way, it defines a relationship between the interest rate and GDP…the IS curve…. So what determines the level of GDP, and hence also ties down the interest rate? The answer is that you need to add “liquidity preference”…. Right now the interest rate that the Fed can choose is essentially zero, but that’s not enough to achieve full employment…. [W]e have an incipient excess supply of savings even at a zero interest rate. And that’s our problem.

So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending...