So it seems that Boehner is going to pull a Gingrich. Both the president and the House Republicans’ plans cuts are relatively minor. But the question is why cut spending now. The only reason spending cuts are necessary, if you agree that the crisis was caused by collapsing demand (not a supply shock) is because there is too much demand recovery. That would be signaled by full capacity, rising interest rates, and/or rising prices. In the first case, industrial capacity utilization was in January 2011 at around 76%, below the average for the 1972-2010 of close to 80%. In the case of interest rates, both short term and long-term rates are incredibly low. So if the economy is not at full capacity price pressures are not driven by demand. The US government can, contrary to you, borrow at low rates. The question is not so much if it should do it, but for what purpose. I would suggest that they give me more money, but I’m sure most people will be bitterly opposed!
The ISLM model persists in most undergraduate textbooks, and even though it has vanished from graduate courses*, it remains central to the way economists think about policy issues. The main reason it survives is not so much that it allows a relatively simple intro to policy issues to undergrads, as some argue, but the fact that it captures the interaction between real and monetary phenomena which was central for Keynes’ General Theory (still worth reading), and is flexible enough to accommodate divergent views, often reflected in different inclinations of the curves.
It is also true that the conventional interpretation of the ISLM is fraught with problems. But the ISLM model is incredibly flexible and can accommodate most critiques. For example, a few years back a reader asked Mankiw why he still taught that the Fed controls money supply, rather than control the rate of interest, which would be more relevant. His reply was not particularly good (just an ad for his book), but the …
Two economists at the Federal Reserve Bank of San Francisco (FRBSF) have written a paper in which they claim the natural rate of unemployment (i.e. the one consistent with price stability) is not around 5% anymore. Now it is close to 6.7%. It reminds me of a talk given by Solow at SCEPA in 2000, in which he said at the beginning that the natural rate did not exist, and by the end he suggested it was 5.2%.
There are several ways of trying to measure the unobservable natural rate. One is to use the inverse relation between vacancies and unemployment (the so-called Beveridge Curve). The idea is that if there are more vacancies than regularly observed for a given level of unemployment, then the normal level of unemployment must be higher. Further, the idea is that job vacancies are completely driven by supply conditions (this is often omitted in explanations of the curve).
If that is the case, supply changes drive the vacancies up, and the level of unemployment consistent with price…
So last year, during our ongoing battle on Keynesianism and common sense, a Fox News' bobblehead doll coined the term Naked Keynesianism. It was an attack on Jamie Galbraith's views on deficits and debt, and on the need for fiscal stimulus. The full video and commentary are here. So Jamie is corrupting our youth, and as far as I know I am too. You'll find here a few posts that should help those interested to understand why Naked Keynesianism is like Naked Logic. If you are against logic or facts, just go here.