In his blog post yesterday, Paul Krugman claimed: “We have a pretty good model of aggregate demand, and of how monetary and fiscal policy affect that demand. … And it remains true that Keynesians have been hugely right on the effects of monetary and fiscal policy, while equilibrium macro types have been wrong about everything.” Were that true, why have the Fed’s and CBO’s own Keynesian models, for example, so over-predicted the recovery?
In Unintended Consequences: Why Everything You’ve Been Told about the Economy is Wrong, I identified two structural problems facing the economy: no near-term alternative use for risk-averse savings other than subprime consumption and a dial-back in risk-taking after banks proved more unstable than expected. As a consequence, I predicted slow growth and little, if any, price inflation despite what has now amounted to $5 trillion of fiscal stimulus and unprecedented monetary stimulus and that excess liquidity would sit idle until after the economy recovered.
Keynesians, like Krugman, the Fed, and the CBO, were right that monetary policy would not produce price inflation but only because they were wrong that fiscal and monetary policy would stimulate growth. Six years after the financial crisis, it’s just dawning on Krugman and Larry Summers that the problems are structural.
