Reply to “Coppola comment reflections on recovery and… 26/1/15

Peru 084An excellent and scholarly exposition of Keynes and some pleasing separation between Keynes and the Keynesians, but some implied misrepresentation of Quantity Theory and monetarism and some support by implication for the Keynesian interpretation of what Keynes said and no view of the alternative policies that might well solve the impending crisis.

I can only assume that you are aligning yourself with Keynes, but I know by extensive quotation you are giving yourself a get-out clause if you later feel unable to fully commit to the argument.

In paragraph 4 you quote that “an increase in output cannot occur unless by the operation of one or other of three factors”.  Each of these factors requires demand management and because the solution can only occur as the result of one of these three things you are ignoring any other solution. This is where Keynesians get their idea of deficient aggregate demand and therefore an assumption of cost push inflation at less than full employment. However as I explained to you in tweets all inflations are the result of excessive monetary demand and therefore this argument does not stand up. It has however been used as the basis for almost 50 years of fiscal deficits that have had no positive effect on output and employment and have arguably produced more unemployment and slower growth.

Now there is an alternative to demand-side policies that you do not consider and they are the only long term solution for the UK and Europe. These are the supply-side policies that can only work effectively with constrained government budgets and sound monetary policy.

This takes me to the second major point which is the misrepresentation of quantity theory and monetarism by you and your ghost writer: ”a crude economic doctrine” As a basis for monetarism quantity theory says nothing directly about being able to create jobs, increase output or kick-start growth.  It provides a framework for controlling inflation. All monetarism, as Friedman said, is based upon the simple proposition that there is a consistent though not precise relationship between the rate of change of money supply and the rate of change of nominal national income. Changes in monetary demand come first and changes in nominal national income come next. Any growth in monetary demand, which is not picked up by an increase in output, will filter through to inflation so that inflation, as described by Friedman, is always and everywhere a monetary phenomenon. So all that monetarism can do is provide a framework to control inflation and stable prices will then create a level playing field for free market capitalism to pick up the slack.

The road to recovery therefore does not look as Keynes said and you imply. It requires monetary discipline to achieve a 2% inflation target (QE/QT when necessary) and fiscal discipline so that the public sector does not inefficiently crowd-out the private sector`s ability to innovate and grow the economy.

There is no evidence that Keynesian demand management and fiscal deficits will support recovery. Moreover there is a lot of evidence that it is policy that has failed time after time and the only reason for doing it one more time is that it is what politicians, with a short term election horizon, want to hear. There is no sound economics to back it up.

John Hearn 26/1/15

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