Tyler Cowen lists a number of economic propositions which he formerly believed, but has abandoned in the light of contrary evidence. Most of these propositions were elements of the economic orthodoxy of the 1980s and 1990s, variously referred to as Thatcherism, neoliberalism, the Washington consensus and, in Australia, economic rationalism. They include the efficacy of monetary targeting, the beneficence of free capital movements and the desirability of privatisation in transition economies.
Following in the same spirit, I thought I’d list a couple of propositions on which I’ve changed my mind in the face of empirical evidence. These are elements of the Keynesian orthodoxy of the 1950s and 1960s, on which I was trained. Following Cowen, I’ll list them as false claims I used to believe
* There is a long-run trade-off between unemployment and inflation
* Keynesian fiscal policy is a powerful and reliable instrument for stabilising aggregate demand
On both these issues, I’ve come to accept that Milton Friedman was largely right, and his Keynesian opponents largely wrong.
On the first, I think Friedman’s victory was total, although the supposed implication that there exists a “natural rate” of unemployment at which inflation remains stable has proved equally unreliable.
On the second, Friedman was absolutely right in talking about “long and variable lags” and rejecting the idea that it is possible to “fine-tune” the economy. This doesn’t mean that fiscal policy is of no value. In particular, the fact that budgets naturally go into deficit when the economy turns down provides a measure of automatic stabilisation. And when a deep recession lasts for more than, say, a year, there’s time to bring discretionary fiscal policy into play. The suggestion, by Nick Gruen and others, of some form of independent body to manage discretionary fiscal policy, analogous to that of the Reserve Bank in monetary policy, has a lot of appeal for me. Still, this is a long way from the kind of mechanical Keynesianism I was taught a few decades ago.
Combining my concessions and Tyler Cowen’s, it’s evident that there is some process of convergence in the beliefs of economists, though with a lot of oscillation. The breakdown of Keynesian economic management during the crisis of the 1970s, and the general ‘fiscal crisis of the state’ that occurred at the same time, validated many of the criticisms made by Friedman and others of the Keynesian and social-democratic orthodoxy of the postwar period. But it produced an overreaction, most notably in the extreme claims made by advocates of rational expectations macroeconomics, but also in overblown claims about the merits of privatisation and deregulation. These have gradually lost favour as their empirical weakness has been exposed by events.
fn1. Jason Soon has also noted this piece