Re: Tom Palley on AS/AD

[Jim Devine <jdevine@xxxxxxxxxxxxxxx>]

Michael Perelman forwarded a letter from Tom Palley to me concerning AS/AD,
IS/LM, etc.
> Thank-you for your kind words about my book on PK Economics. Some
> observations:
>
> (1) Romer's AD schedule is in fact the IS schedule. His model is IS-LM
> with a horizontal LM. The monetary authority is just setting the interest
> rate - something lots of PKs have maintained for a very long time.

I don't think Romer cares about what Post Keynesians think (though he
should). His horizontal LM is based on the Fed's current policy stance,
which is to target the Fed Funds rate.

> (2) You are right to observe that in a "static" context, the endogenous
> money debate does tend to reduce to a debate over the slope of the LM
> curve. Horizontalists/Accommodationists believe that the LM is always
> flat. Structuralists believe that the LM is positively sloped, and that
> interest rates have a tendency to rise as output rises relative to normal
> levels.
>
> There are many reasons for this related to issues of financial
> intermediation and changing risk positions. The monetary authority may
> also contribute to the extent that it adopts a "leaning against the wind"
> policy stance.

My favorite PK perspective is Minsky's, i.e., that if the Fed "leans
against the wind" and raises interest rates to fight or prevent inflation,
that induces financial innovation, which leads to lower money demand, which
counteracts the Fed's policy initiative (and is ignored by Brad deLong's
Krugmanite faith in the powerful Fed).

> (3) Despite this, even a static conception of endogenous money yields
> insights and is of value. (i) It firmly introduces credit into the
> analysis, thereby leading to a focus on the macroeconomic consequences of
> debt. (ii) It discredits monetarist claims about the ability to control
> the money supply. The money supply is endogenous and can't be controlled.
> The monetary authority can only control the monetary base and the shortest
> of short term interest rates. Beyond that, all else is endogenous. (iii)
> This recognition of endogeneity then leads to a concern with optimal
> regulation - i.e. what are the best structures for managing it?

right! I would add the clarification that it's the "economically relevant"
money supplies and interest rates  that are endogenous.

> (4) But the real pay-off to endogenous money comes when it is located in a
> "dynamic" context. I have explored this issue in a business cycle model
> [Journal of Economics/ Zeitschrift fur Nationalokonomie, 1997, vol.65].
> The bottom line is endogenous money amplifies the business cycle.

That makes sense to me. Another side of this is that the endogenous money
supply implies increasing debt ratios in an economic boom, which then can
feed back to intensify the recession if and when it occurs.

Jim Devine jdevine@xxxxxxx &  http://bellarmine.lmu.edu/~jdevine