The (failed) state of macroeconomics (crosspost from Crooked Timber)
When econbloggers aren’t arguing about cyborgs, they spend a fair bit of time arguing about the state of macroeconomics, that is, the analysis of aggregate employment and unemployment, inflation and economic growth. Noah Smith has a summary of what’s been said, which I won’t recapitulate. Instead, I’ll give my take on some of the issues that have been raised (what follows is inevitably
The main issues at stake are
* Is there a consensus ? [1a]
* If not, what are the main points of disagreement ?
* What, if anything, has macroeconomics achieved in the last 40 years
* Where should we go next?
I’ll post today on the first of these, then come back for more later
Is there a consensus?
- Clearly there was a consensus as of early 2008. The differences between “saltwater” (former New Keynesian) and “freshwater” (former New Classical/Real Business Cycle) economists had blurred to the point of invisibility. Everyone agreed that the core business of macroeconomic management should be handled by central banks using interest rate adjustments to meet inflation targets. In the background, central banks were assumed to use a Taylor rule to keep both inflation rates and the growth rate of output near their target levels. There was no role for active fiscal policy such as stimulus to counter recessions, but it was generally assumed that, with stable policy settings, fiscal policy would have some automatic stabilizing effects (for example, by paying out more in unemployment insurance, and taking less in taxes, during recessions). It was generally agreed that this approach to macroeconomic policy, combined with financial deregulation had produced a ‘Great Moderation’ in the volatility of economic activity, as well as sustainably low and stable inflation. In the academic macro literature, this convergence was represented by Dynamic Stochastic General Equilibrium models, constructed with all the rigor and elegance of a haiku as Olivier Blanchard observed at the time
- This broad consensus was destroyed by the Global Financial Crisis and the Great Recession, but it wasn’t replaced by anything resembling a real debate. Rather, different groups have gone off in different directions
Academic macro went on more or less as before, except that the inclusion of financial sector shocks in DSGE models has now become a hot topic. So, from the viewpoint of someone like Stephen Williamson, everything in the garden is rosy.
This is actually a relatively tranquil time in the field of macroeconomics. Most of us now speak the same language, and communication is good. I don’t see the kind of animosity in the profession that existed, for example, between James Tobin and Milton Friedman in the 1960s, or between the Minnesota school and everyone else in the 1970s and early 1980s. People disagree about issues and science, of course, and they spend their time in seminar rooms and at conferences getting pretty heated about economics. But I think the level of mutual respect is actually relatively high.
As you might expect from someone who thinks that economic theory has no implications, and that this is a good thing, Williamson doesn’t even raise the issue of whether this internal tranquillity is problematic given the chaos in the actual macroeconomy and the absence of any agreement on how to respond to it.
Central banks have, in effect, treated the entire period since 2008 as a Schmittian “state of exception”, during which normal rules cease to apply. They have used the crisis to push governments to adopt “reforms” favored by the financial sector, such as cutting welfare benefits and other areas of public expenditure. But their central concern has been to restore the status quo ante, and the exclusive primacy of monetary policy, as soon as possible. From the central bank viewpoint, the restoration of low and stable inflation after the shocks of the 1970s is their crowning achievement and one to be maintained at any cost.
So, there is virtually no debate going on in academic macroeconomics, or in the circles where policy is actually being made. What debate is happening largely involves people like Krugman (and, much less notably, me) arguing against his Chicago opponents (Cochrane, Fama, Mulligan) who are mostly not macro specialists and therefore (as Williamson points out in his piece) “not really up on what is going on in macroeconomic research” but who do have something to say about macro-economic policy. Although most of the participants are academics, and both sides can boast Nobel prizewinners, this argument is, just like most things in the US today, part of the general war between parallel left and right universes, encompassing issues like climate change, tobacco, gun control and so on. There’s no way in which New Classical or RBC models can explain a sustained depression occurring in many countries at once, and they don’t even try. Instead we get absurdities like Casey Mulligan’s claim that the Great Recession is caused by easier access to food stamps in the US (or, as one commenter put it, “Soup kitchens caused the Great Depression”). Note that Mulligan doesn’t even attempt to explain how food stamps in the US could cause a deep depression in, for example, the UK, where welfare benefits have been sliced by the Tories.
fn1. Broadly speaking, there’s a generally positive view among mainstream economists about the state of microeconomics. The general view is that the inadequacies of the Econ 101 model of competitive markets are being addressed by developments in behavioral economics, theory of asymmetric information, game theory and so on.
fn1a I thought it was obvious from the context but I’ll add that I’m referring to mainstream economists in this post, and that the 2008 consensus I describe was shared by policymakers and mainstream academic macroeconomists but not by all economists, or even all mainstream economists. In particular, I didn’t agree with it, and was writing about Minsky and asset bubbles in 2006, but that kind of work did not (and does not) get into mainstream macro journals.
fn2. The underlying assumption was that low and stable inflation is consistent with broadly stable output growth. Because it was presented first as a description of actual central bank behavior and then as a rule of thumb, it was acceptable to both saltwater and freshwater economists, and helped to blur the differences Saltwater types interpreted the Taylor rule as a mandate to pursue both objectives. In the freshwater view, central banks were supposed to focus only on price stability, but output fluctuations might provide information about future inflation, and could therefore be taken into account in setting policy.
fn3. I get this terminology at second-hand, so apologies if I’m misusing it, but it seems apposite to me.
fn4. Yes, yes, I know.