Fish don't feel the water they swim in. (I've heard that's false, but it's too good to check). Paul Krugman does not feel the Monetarist hegemony he swims in. The only part of Monetarism that he does feel, and that he now identifies with Monetarism, is that one small part of Monetarism that failed to achieve hegemonic status. Milton Friedman in 1970's believed that M2 growth ought to be kept small and constant – the k% rule. Milton Friedman lost that battle. But he won every other battle. He won the war.
Here's Paul:
"I’ve always considered monetarism to be, in effect, an attempt to assuage conservative political prejudices without denying macroeconomic realities. What Friedman was saying was, in effect, yes, we need policy to stabilize the economy – but we can make that policy technical and largely mechanical, we can cordon it off from everything else. Just tell the central bank to stabilize M2, and aside from that, let freedom ring!
When monetarism failed – fighting words, but you know, it really did — it was replaced by the cult of the independent central bank. Put a bunch of bankerly men in charge of the monetary base, insulate them from political pressure, and let them deal with the business cycle; meanwhile, everything else can be conducted on free-market principles." (my bold).
(I'm picking on one small part of his post, by the way, and the rest of it is well worth reading.)
There's a lot more to Monetarism than the k% rule.
Paul Krugman, like nearly all of us, forgets all the battles that Milton Friedman won. "That's not Monetarism, that's just normal economics; everyone believes that!" We don't feel the Monetarist water we swim in. Only the Post Keynesians, who took a different path in the 1970's, can feel the Monetarist water, because they don't spend their whole lives swimming in it.
As a Post Keynesian blogger (help me out someone, because my memory has failed) recently said, the canonical New Keynesian model is Monetarist. Well, it isn't exactly Monetarist, but it's very close. A Keynesian Rip Van Winkle who fell asleep in 1970 would certainly see it as much more Monetarist than Keynesian. And if he woke up and saw independent central banks targeting inflation, with flexible exchange rates, no price and wage controls, and fiscal policy relegated to the sidelines for emergency use only, he would know that Milton Friedman had won his war.
The canonical New Keynesian macro model has three equations:
1. An expectations-augmented Phillips Curve with long-run neutrality at the natural rate of unemployment/output and short-run non-neutrality. Pure Friedman. The vertical (or near vertical) long-run Phillips Curve was once controversial. Now it's the standard benchmark. It's part of the water.
2. An Euler-equation IS curve. This is nothing more than a way to translate Milton Friedman's Permanent Income Hypothesis into math. Unlike the Old Keynesian IS curve, current income does not appear as a constraint determining current consumption demand. Current consumption is part of an intertemporal optimisation plan against an infinite-horizon budget constraint. Again, it's the standard benchmark. It's part of the water. When you depart from this benchmark, as Paul Krugman and Gauti Eggertsson did in their recent paper, by introducing borrowing constrained consumers whose consumption depends on current income, that very feature is what makes your model stand out from the benchmark of Milton Friedman's hegemonic Permanent Income Hypothesis.
So far, it's pure Milton Friedman all the way.
3. Some sort of Taylor Rule reaction function for monetary policy. OK. Here's it's not pure Milton Friedman. It's not a k% rule for the money supply. But it's still very Monetarist in spirit. First because it is a monetary policy reaction function that closes the model, and not a fiscal policy reaction function. The model assumes that Milton Friedman has won the war: that monetary policy is in charge of aggregate demand, and that fiscal policy is relegated to handling micro stuff and so can be ignored. Which is what Milton Friedman wanted. Second, because that reaction function is built around a target level of inflation. That is one way to give expression to Milton Friedman's dictum "Inflation is always and everywhere a monetary phenomenon". It means that inflation is the responsibility of the monetary authority. It's not something you try to control with fiscal policy or wage/price controls, while monetary policy targets something else.
Looking at those three equations, I call it 2.5 out of 3 for Monetarism. From the standpoint of the 1970's, the canonical New Keynesian model is five-sixths Monetarist.
(Of course, it all looks different from the standpoint of today, and quasi-monetarists like me notice other ways in which the canonical New Keynesian model fails to do explicit justice to the use of money as a medium of exchange and nominal anchor, but that is by-the-by. And this leaves out the monopolistic competition underpinnings as well. The canonical New Keynesian model is the child of Milton Friedman and Joan Robinson, raised by its paternal grandfather, Knut Wicksell.)
Worthwhile Canadian Initiative 
Here’s a new tool for your balancing pole analogy. An articulated inverse pendulum. 3 degrees of freedom. Mainly cool video. From his comments, it appears that once it is up he uses a linearized model of the non linear system. I was thinking maybe you could consider the red one as expectations. You wanted to pull it off the wall. Also the control is focused on it, exogenous shocks to the red.
“If Beta is less than one, the Long Run Phillips Curve in that model would not be vertical.”
OK, that makes sense. I need B < 1 for the result to hold. All I am saying is that if mc_n goes to zero, then in the limit, as n goes to infinity, the arithmetic mean of expected future inflation over the next n periods also goes to zero (and therefore the geometric mean does, too).
If you care about longer term rates, then you care about the mean of expected future inflation over many periods, since this would be the adjustment factor from real to nominal. Actually you would care about that adjustment factor for any long lived good that did not pay out every period but only at the end. But setting B = 1 means you can’t do your dynamic programming programming solution.
edeast: Wow! That was a really neat video! Now think of the logic that would be needed to make interest rate control work. Those engineers understand their inverted pendulum much, much better than we economists understand ours.
Nick: I think there is one element of Keynes’/Wicksell’s message that Friedman did not accept and that still matters. Keynes thought that changes in the natural rate would take output away from its potential level unless there were changes in the real money supply. Whether you think of this as happening “automatically” via flexible prices or requiring changes in M, this is a big innovation compared to classical thought, where the real interest rate is determined in the loanable funds market alone, so an investment slump would be corrected by a fall in the interest rate directly with no need for prices to fall. For a monetarist, sticky prices only cause fluctuations in output in response to monetary shocks. So if you think that sticky prices lead to output fluctuation in response to spending shocks as well, you have accepted part of Keynes’ message that is distinct from Classical and Monetarist ideas.
Kevin: initially, Friedman thought that the interest-elasticity of the demand for money (the interest-elsticity of desired velocity) was empirically too small to matter. (The LM is vertical, in Keynesian terms). As the empirical evidence came in, I think he abandoned that belief. (It’s still a puzzle, though, since most components of M2 do pay interest, and only currency has its nominal interest rate fixed at 0%, why the demand for money should be a negative function of the rate of interest).
I think that matters for the k% rule. For the k% rule to be optimal, you either have to believe that the natural rate of interest doesn’t change much, or else that the demand for money doesn’t vary much with the rate of interest.
There’s a Q=QD semi-equilibrium condition for the market in which consumption is traded for stones; a Q=QD semi-equilibrium condition for the market in which labour is traded for stones; but there is no such condition for the market in which consumption is traded for labour. Because that market does not exist. B&G is a model of a monetary exchange economy precisely because they assumed that market did not exist.
But the only two prices B&G refer to are the real wage, w, and the money price of commodities, P. So if there’s a missing market it’s actually the market for labour in terms of money! Really though, I don’t think B&G thought of any market as being missing. Given w and P, the money wage W=P.w and, since they assume that labour supply depends only on the real wage, there’s really no need to deal explicitly with W. If they had wanted the model to reflect Clower’s thinking the two prices would have been P and W, with the real wage being just a ratio of two nominal variables, like real balances. Notice that they explicitly consider the cases where w is stuck at an upper / (lower) limit, on the notional labour demand / (supply) curve. In those cases it wouldn’t matter whether barter was allowed or not, since only one side of the market would want to deal. Obviously B&G were interested in Clower’s approach but they stop short of introducing any kind of dual-decision hypothesis. They don’t need that. Ironically, given Barro’s later turn, they stay in the Old Keynesian mainstream.
I’m sceptical about your claim that the New Keynesian model is almost exactly the same, but I’ll leave that to Adam P since he knows that model much better than I do. I’m sure he knows the B&G model too, but I haven’t seen him object to the way you use it as a stick to beat Keynesians who aren’t as monetarist as you would like.
Kevin: B&G use the output good as the numeraire. That doesn’t mean it’s the medium of exchange. (It doesn’ even mean it’s the medium of account, because the modeller’s numeraire doesn’t have to be the same as the medium of account used by people in the model).
Yes, if the real wage is stuck at the upper limit (on the notional labour demand curve), or on the lower limit (on the labour supply curve) then allowing barter wouldn’t change anything. It’s only when w is between those two limits that barter can make a difference.
B&G actually say that money is the medium of exchange, the unit of account and the only store of value. But when you look at the details it’s just a Hicksian fix-price model with money in the utility function. They work it out more carefully than earlier writers, which is what makes the paper worthwhile.
Anyway, this is vaguely relevant and reminds me of my lost youth. Being a student I couldn’t cash cheques in the pubs but the system worked for most people. Partly thanks to that episode I became sceptical about economists’ claims concerning the importance of money, as opposed to credit.
In important ways Friedman is a Keynesian, as Roger Garrison explains in his essay “Is Friedman a Keynesian?”
http://mises.org/daily/4067
So perhaps a Friedman victory over 1960’s “Keynesianism” isn’t such a verbal problem after all.
Garrison has more on the deep scructural shared assumptions between Friedman and Keynes in his book Time and Money
K, No, Krugman did not say QE was our best shot at creating inflation, he said inflation targeting is our best shot.
I am quite certain that Krugman would be critical of the Fed as long as AD was below the level he thought appropriate, which I take as a tacit admission that the Fed does has the ability to raise inflation at the zero bound.
Adam, I think most people would interpret his work from the late 1990s as offering a recipe for creating inflation at the zero bound–although with Krugman (as with Keynes) there are as many interpretations as their are readers.
“No, Krugman did not say QE was our best shot at creating inflation, he said inflation targeting is our best shot.”
You’re right, I’m sure. But that wasn’t my point. My point was that he has explicitly said that there is no certainty that you can get out of this without fiscal intervention no matter what the Fed does. At least, that’s my reading of Krugman 🙂
“I think most people would interpret his work from the late 1990s as offering a recipe for creating inflation at the zero bound”
Then they’d be wrong. It is a recipe for maintaining full employment at the zero bound. The way you do it is by promising future inflation, you still don’t get inflation today.