Saturday, April 11, 2015

Peter Temin explains the Great Recession and the slow recovery

A bit more on Peter Temin and David Vines book on Keynes. The explanation of the Great Recession is based on a traditional negative shock to the IS curve. Temin famously wrote the response Friedman and Schwartz Monetarist view of the Great Depression, his Did Monetary Forces Cause the Great Depression?, in which a contraction of consumption, and the IS, rather than the contraction of money supply and the LM was seen as the central story.*

 So the same is essentially at work now. They say:
“the IS curve in the US moved left a great distance after the Global Financial Crisis and the adjustments that followed. It moved so far that the new IS curve no longer crossed the LM curve at a positive interest rate.”
As can be seen below.
I can live with the representation of the Great Recession as a collapse of the IS (and yes the negative slope might be explained by other elements of demand, not investment, being inverse related to the rate of interest, like consumption or housing investment). I'm more troubled by the notion that the slow recovery is caused by the negative rate of interest, which in this case precludes the intersection of the IS and LM (note that, contrary to Krugman's negative rate, the equilibrium would not be the full employment one). But I do agree with the implied solution, not defended very forcefully, to my surprise, in the book, i.e. expansionary fiscal policy to bring the economy back to full employment.

In part, Temin and Vines do not defend fiscal policy strongly, because they bring the issues of an open economy to the forefront of the discussion, using James Meade's notion of internal and external balances. It's far from clear that they think this applies to the US, but in general their solution for a country with an external problem and unemployment, would be depreciation and austerity. In their words:
“The indebted country requires a combination of the two policies. Devaluation will increase exports and reduce imports. Austerity—just the right amount—will reduce home demand for goods and leave room for the production of extra exports and the home-produced goods that replace imports. The right combination of policies will move the economy to the intersection of the external balance line and the internal balance line, or even further down the internal balance line into the region of external surplus if the country is to begin repaying its debt.”
Note that without austerity the economy would overheat. That's a lot of confidence in the expansionary power of devaluation. As noted here several times, a devaluation can be contractionary, and it often 'solves' the balance of payments problem for that reason. Devaluation and austerity, by the way, were, and still are, the traditional policy measures imposed by the IMF on indebted countries. The implication seems to be that a combination of devaluation with austerity would produce, in the US too, a healthier recovery. The book is strangely positive on austerity, because of the external balance requirements, a position that, at least in this recession, other New Keynesians like Krugman and DeLong have temporarily abandoned.

And their analysis in the book about the post-war boom, the so-called Golden Age, is also not very good. Temin and Vines, even though they recognize the role of the Marshall Plan, emphasize the positive role of the IMF in promoting growth, and suggest that the IMF is an improved version of Keynes' proposal at Bretton Woods. In their words:
“The cooperation stimulated by American generosity in the Marshall Plan was a hallmark of postwar European progress... The IMF—an improved version of Keynes’ Clearing Union—eventually became a crucial policy-making institution... The IMF, which Keynes helped to design, was central to the restoration of growth.”
The Marshall Plan, which depended not just on generosity, but on fear of the Soviets, was clearly central. The role of the IMF in a global recovery of the 50s and 60s is hard to defend though. And Keynes Plan did not involve punishing indebted countries, which is what depreciation and austerity do, quite the opposite. In fact, Keynes was relegated to the debates on what became the World Bank at Bretton Woods, while Harry Dexter White was the central figure in the creation of the IMF. And the World Bank was, until the 1980s, a more benign instrument of US external economic policy, one might add.

But Temin and Vines also botch that one, and say:
“The World Bank, which was less central than the IMF, facilitated long-run growth. The World Bank was designed to help re-create the international pattern of productive trade that Keynes had described in The Economic Consequences of the Peace.”
Yes, the World Bank was created to recreate the pre-war pattern of trade, with the periphery selling commodities, and the center manufactures, and the British as the hegemonic... Oh wait. Yeah that makes no sense either.

* In later research Temin came closer to Eichengreen in putting the Gold Standard at the center of the Great Depression. For example, in his Lessons from the Great Depression. The seeds of his positive view on the role of depreciation are associated to his view that the abandonment of the Gold Standard was at the heart of the recovery. For a critique of that go here.


  1. Good post. I read the book too and had the same impression on the authors' reluctance to highlight explicitly the merit of expansionary fiscal policy.

    One quick clarifying question, why do you say the equilibrium rate here is the not the same as Krugman's negative rate?

  2. Sorry, I just noticed the link to Krugman's site...Yes, I agree his negative rate is different from the conventional IS-LM equilibrium rate, as in his framework he's drawing the supply and demand for savings that would prevail if the economy were at full employment.


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