This is not our grandfather’s recession

Scott Sumner wrote a post that the Keynesian model could not explain the recession we were in recently. Although I fully agree with Sumner, I intend to emphasize a few points.

Let’s first look at this graph showing PCE and disposable income:

The Keynesian models we have do not show that NGDP will drop 33% in a quarter when disposable income is actually rising. What’s more, disposable income is rising, not just a little, but by an astounding 42% on an annual basis.

What is the importance of disposable income? In fact, (Keynesian) models that simply predict that fiscal stimulus will stimulate the economy have a mechanism that extends from more fiscal stimulus to more disposable income and from there to more spending. So the Keynesian models do not explain why NGDP fell so sharply in the second quarter. In fact, according to the Keynesian model, we must now be in a period of an extraordinary explosion that is rare in history.

One might reply that people are afraid to shop because of the epidemic. Of course, it is a reasonable explanation. But as far as I know, we have no model that predicts financial stimulus will be effective when people are afraid to go shopping. Frankly, I view the implementation of such a huge stimulus package as a loss because of people’s unwillingness to spend. Strangely, the recession we are in maybe the only recession where it is reasonable to delay the fiscal stimulus(to 2021, for example).

If this winter vaccine is developed, as experts predict, naturally people will be more willing to shop in 2021. And so the fiscal stimulus can be effective, at least if you believe the basic Keynesian model. However, the monetary stimulus will be more effective in stimulating the economy at a much lower cost in 2021. Does not consume monetary stimulus ammunition; it actually creates ammunition by raising the natural interest rate. Financial stimulus consumes ammunition.

Sumner is right, this isn’t our grandfather’s recession.

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