Thursday, June 25, 2015

Nick Rowe shows us the prior

Fixed this (borrowed) graphic per the comment below.

Nick Rowe has a great post up today that really lays out the prior behind monetarism. He simply holds that the government may be good at providing some things, but progressively worse at providing more and more of the economy.

Why? That's just assumed as the prior before gathering evidence. The government is made of people just like businesses, but when a person works for the government, that person's marginal product is lower for some unexplained reason. My marginal product for the company I work for is X, but my marginal product in a government job is α X with  0 < α < 1 because reasons. Let's just cede that point to Nick. Maybe it's true.

However! Regardless of what my marginal product α X is, it simply must be greater than a position in what Matt Yglesias called the unemployment sector. That is to say α X  > 0 for all reasonable estimates of α.

And fiscal policy directed at companies (via e.g. government contracts to build stuff) to hire at full marginal product X > 0 also is better than people working in the unemployment sector. Therefore fiscal policy should essentially be directly correlated with the unemployment rate. The only way the unemployment sector should be large in a country is if you have simply run out of things to do -- everyone's marginal product is zero.

Nick's argument ignores the existence of a very unproductive sector of the private economy ... the unemployment sector.


  1. Shouldn't that be P(E|H) in the evidence section of the image?

    1. You're right. I borrowed the image from the internet (, but I should have noticed that!

  2. Jason: suppose that monetary policy did not exist, so the only way to increase AD was fiscal policy. Then you would be right.

    1. I'd agree -- contingent on assuming monetary policy is effective.

      However in that case you don't really need any assumptions about the size of government to discount fiscal policy. There is monetary offset, so fiscal policy does nothing regardless of the existence of an interior optimum.

      The assumption of monetary policy effectiveness is exactly what breaks down in the liquidity trap argument in favor of fiscal stimulus, though.

      I understand in the monetarist view "existence" = "effectiveness", but again this is what breaks down in a liquidity trap which is why there is a proposal to use fiscal policy in the first place.

    2. This comment has been removed by the author.

    3. Monetary policy tends to become ineffective for the same reason that discretionary fiscal policy tends to become ineffective.

      There is a severe supply side issue with Solomons.


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