[UPDATES in the middle and then at the end.]
Once again, Nick Rowe has argued that according to the very model that Paul Krugman claims to be using–and I mean here, the full-blown model with intertemporal optimization, not the cruder IS/LM model that Krugman thinks gives surprisingly good policy recommendations, using the full-blown model as the benchmark–it is actually NOT true that the government needs to increase spending today, in order to restore aggregate demand and hence full employment.
On the contrary, Nick argues, the crucial variable in Krugman’s formal model is G(t)/G(t+1), which must increase in order to help the economy today. In other words, what’s important to get people today to spend more, is that the expected growth rate in government spending goes down.
[UPDATE: In a follow-up post, Nick spells out the situation much more clearly. You can see that I’m not misreading him.]
So, notice that a sudden surge today in government spending (which will subside once the economy is fixed) will achieve that goal.
But, Nick’s crucial point is that another way to make that ratio increase, is to today cut the expected level of government spending in the future. That’s a different way to get the growth rate in government spending (gauged today) to decrease.
Can New Keynesians chime in? Is this true?
If so, then we should all be able to agree on a plan for the government to slash spending in, say, 2016 by, say, 10 percent compared to the current baseline level. That will–assuming Nick is correct–put a lot of people back to work today. The Fed will be able to boost NGDP growth even as it scales back its asset purchases. And of course, the size of government will (in a few years) be much lower than it is now.
So Keynesians, market monetarists, and Austrians should all prefer this policy to the status quo. Agreed?
Now let’s get Krugman, DeLong, Sumner, et al. to get on board. The first two guys in particular are the ones who really care about helping the unemployed, and really want to ground policy proposals in formal models.
UPDATE #2: From Brad DeLong’s response to John Cochrane, I’m guessing the way DeLong gets out of this one, is to say he does not believe in New Keynesian models. OK fair enough. But do self-described New Keynesians believe their models? After all, this is a School of Thought, isn’t it? It would be weird if no Austrian economists believed the implications of Austrian business cycle theory, right?