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Levine on the Keynesian Illusion

Author(s): John Cochrane

In support of the "Keynesian Illusion"

From the Grumpy Economist:

David Levine has a very nice post on the Keynesian Illusion.

David Levine's analogy for Stimulus

Some big themes: Standard Keynesian economics violates budget constraints. He explains it well, but it is sure to occasion the usual venom from with the "Say's law fallacy" brigade that has a lot of trouble understanding the difference between budget constraints and equilibrium conditions.

David does a lot without equations. That broadens the appeal, but equations can be useful. For example equations clarify that crucial difference between budget constraints and equilibrium conditions. Equations can put to rest silly controversies. We might not still be writing papers, books, and blog posts about what "Keynes really meant," 80 years after the fact, or using "Say's law" as rotten tomatoes, if Keynes had written some equations.  Cynically, maybe the lesson is that lack of equations -- or even an equations appendix or citation -- keeps debate going and your name in the papers.

I also fear that his lovely anecdote about people each of whom wants what others produce will lead readers a bit astray. Keynesian economics is about lack of "demand," sticky prices not absent prices. It's not about absence of money, double coincidence of wants, and so forth.

David goes beyond the usual IS/LM formalism, to explain some of the "coordination failure" interpretations of Keynes. He also references Axel  Leijonhufvud's "great and famous work" describing a mismatch between saving, a desire for generic future consumption, and the demand for specific goods that firms need to invest.

He has a nice personal story of his Keynesian upbringing, which reminds me of my own. And

Knowledge of Keynesianism and Keynesian models is even deeper for the great Nobel Prize winners who pioneered modern macroeconomics - a macroeconomics with people who buy and sell things, who save and invest - Robert Lucas, Edward Prescott, and Thomas Sargent among others. They also grew up with Keynesian theory as orthodoxy - more so than I. And we rejected Keynesianism because it doesn't work not because of some aesthetic sense that the theory is insufficiently elegant.

The constant refrain that critics "don't know" Keynesian economics is an ingorant (I mean that not an insult, but in its literal meaning, ignoring the facts) calumny. Sargent's first book "Macroeconomic Theory" is a great example of a modern economists wrestling hard with Keynes.


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