09 May 2015

Keynesian Bask

Economics 3 Comments

I want to figure out how much a standard Keynesian thinks that holding interest rates 0.5 percentage points too high, will increase unemployment (in percentage terms).

For example, suppose a recession hits and that a Keynesian thinks full employment requires the Fed to set interest rates at 2 percent, but instead the Fed for some reason only cuts rates down to 2.5 percent. Instead of unemployment falling to the natural rate, it will be higher. But how much higher?

As always, if you actually know what you’re talking about when you give me your answer, that would be swell.

3 Responses to “Keynesian Bask”

  1. Transformer says:

    Not sure I meet the “if you actually know what you’re talking about…” criteria, but just to break the ice here’s my thoughts:

    Within the Keynesian framework the effects upon employment of an interest rate 0.5% above the full employment rate would depend upon many other variables – probably most importantly the interest elasticity of demand for investment, and the fiscal framework (automatic stabilizers etc) in place.

    I do not think that most Keynesian would claim that they could look at a given recession and say “ah – that requires interest rates of 2%” – they could only say which direction to move interest rates in, but perhaps some of the New Keynesian DSGE models used by CB might claim they could make that call, but the answers in that case would still depend upon the variables they feed into the model.

    • E. Harding says:

      Yeah, Transformer, I think you’re right; for Keynesians, it would depend on the stance of fiscal policy. As Sumner says, low rates aren’t easy money, so boosting deficit spending would help make the needlessly high rates more bearable for Keynesians, as higher deficit spending would lead to a higher natural rate of interest.
      I don’t know what I’m talking about, either.

  2. Daniel Kuehn says:

    Not satisfied with my answer eh?

    I think your whole approach was sound, I just didn’t know enough to know what to think of the exact estimates.

    See this on Taylor’s Taylor Rule vs. Rudebusch’s Taylor Rule: http://delong.typepad.com/sdj/2009/12/on-the-definition-of-a-taylor-rule.html

    That’s what I was alluding to about there being some disagreement on what the Taylor Rule would actually give you.

Leave a Reply