Paul Krugman’s piece on “Why did economists get it so wrong” has attracted a vitriolic response from John Cochrane, reproduced here. Krugman’s piece was strongly worded, but the reply ups the ante, and I expect further escalation. Economics conferences in the next few years are going to be interesting events.
Given that, as Krugman himself notes, disagreements between economists were notably mild until the crisis erupted, what is going on here?
I’m visiting Berkely at present and just had a chat with Brad DeLong. These are some of the thoughts I had about the great macroeconomics wars as a result.
One important element that can’t be ignored is the effect political partisanship, which is much more bitter in the US now than in most other places. It’s not so much Republicans vs Democrats as Republicans vs anti-Republicans. Krugman has been a leading figure in rejecting the idea that the Republican party represents a serious viewpoint that should be accorded respect, even in disagreement. Not surprisingly, the members of the intellectual class still associated with the Republican Party (relatively few, these days, but still dominant in the Economics Department of the University of Chicago) intensely dislike Krugman’s writing for the NYT.
But more important, I think, is the hole in the intellectual landscape opened up by the crisis. As regards macroeconomics, the pre-crisis near-consensus described by Krugman included a lot of “freshwater” macroeconomists whose intellectual roots go back to the New Classical/Real Business Cycle literature of the late 1970. This literature initially suggested that there was no possible role for monetary or fiscal policy unless people had mistaken expectations and drew the implication that a sufficiently credible and determined government could eliminate inflation without any serious cost in terms of output and employment, a theory tested to destruction by the Thatcher government.
Given the empirical difficulties encountered by strong forms of these views, most of the freshwater economists were prepared to make some concessions. As regards monetary policy, they were willing to accept some use of interest rates to target inflation, while arguing against “fine tuning” designed to stabilise the economy – during the Great Moderation it was easy enough to conclude that macro instability was a problem of the past, a claim made explicitly by Robert Lucas.
Similarly, it was easy enough to accept the implication that, in certain extreme circumstances like those of the Great Depression, the standard tools of monetary policy might prove ineffective necessitating direct use of fiscal policy to expand the money supply. In the absence of any perceived risk of a Depression, it was easy enough to make this concession while arguing against any use of active fiscal policy.
In the wake of the crisis, this position was untenable. If you supported fiscal policy at all, it was clear that a massive stimulus was needed. In fact, the arguments of Barro and others that Keynesians had overestimated the multiplier effects of fiscal stimulus implied that the required stimulus was even larger than Keynesian estimates would suggest.
Moreover, there is, as Brad DeLong and others have pointed out, no coherent position under which fiscal policy is totally ineffective while monetary policy is at least partly effective. And the only plausible conditions under which policy is totally ineffective is if the macroeconomy is always in (or close to) equilibrium. So, it’s essentially impossible to believe in recessions and unconditionally oppose fiscal policy.[1]
So we see Cochrane forced all the way back to Say’s Law, the claim that it is logically impossible for (planned) supply to exceed (planned) demand, since willingness to supply, say, labour implies willingness to demand goods. Cochrane accuses Krugman of wanting to scrap the macroeconomics of the last forty years[2] but then makes it clear enough that he wants to dump Keynes and everything that has been written since.
Arguments about Say’s Law are unlikely to be resolved by logical disputation. The only way to address them is to look at the historical record of the economy over the last couple of centuries. If you see stability, interrupted only by the occasional ill effects of government policies, you’ll accept Say’s Law. If you see regular crises, except for a few exceptional periods when macroeconomic stabilization policies have appeared to work, you’ll reject it.
fn1. Except for those who can always find some government program or another to blame, even for a case as clear cut as the 1890s Depression in Australia.
fn2. This charge is broadly correct, but I think the correct answer is the one anticipated by Cochrane. Economics did indeed take a wrong turn in the 1970s, responding to the breakdown of (one version of) Keynesianism. We need to find a new and better response, and much of the work of the past 40 years will have to be be discarded or reinterpreted as a result.
John Quiggin 
The results of the Australian stimulus package make it difficult to believe the various Keynes haters versions of the Great Depression and the ineffectiveness of a well thought out a fiscal stimulus when people are too scared to spend. The highly contrived ‘alternative’ explanations of the historic record seem nothing more than mathematical sophistry. Sure you can always fit sufficiently complicated models to past data if you have enough parameters, but where they fail is in providing effective policy responses. According to their Panglossian world fiscal policy shouldn’t have worked, but it did. In science that is the point at which you discard their theories.
What is surely suffering is public confidence in economics. It seems none of them have a very strong scientific outlook right now. Markets do break. Governments don’t know how to fix them without major crises in the wake such as debt and currency malfunctions. Whichever group of academics is declared the most righteous, surely the losers are those of us who must live with what seems more and more like quackery tied to political agendas, one side or the other.
Well JQ – here is some more news…on macroeconomics. It may have limited time as a subject for broad business students in many unis now. The CPA has apparently dropped the requirement for a separate unit of macro for professional accounting qualifications (and we all know the foreign students in first year choose accounting because of the points thingy…). It can now be combined with micro.
So expect more micmac subjects and only one economics unit required…of course its all about who gets the take of the foreign students dollar is my skeptical view..if they get through undergrad… faster.. the CPA gets more (and unis get less). I can see the Macro RIP signs being made…who will continue these important debates in the future? Someone needs to straighten out the immigration points system for particular subject choices or all else will be begging on the roads that lead to Accounting.
JQ – this comment intrigues me. “Economics did indeed take a wrong turn in the 1970s, responding to the breakdown of (one version of) Keynesianism.”
I question whether Keynesianism (or one version) really break down at all in the 1970s. Or did Governments misapply inappropriate policies even earlier in the 1960s that had nothing to do with what Keynes would have suggested…the key is in those arguments that raged back in the 1970s when the fault lines emerged…
The freshwater frustration seems to be their inability to offer any solutions. The saltwater frustration with them is they deny any solutions exist or there is even a problem to solve.
Maybe they were romantics rather than economists? 😉
oops Ode on a Grecian Urn …
“Economics conferences in the next few years are going to be interesting events.”
H*rs*sh*t. They’re going to be the same as they always were, only now Krugman, too, will get the Stiglitz treatment.
At least in the States; YMMV.
I think you’re misreading the balance of opinion, Ken. As the recent G20 summit showed, outright opposition to stimulus is a pretty marginal position in policy circles in most countries, and this is also true in the Australian economics profession. The RBC/freshwater crowd are stronger in the US, but they’ve lost a lot of ground, and I would say are in the minority now.
Disagreement over the validity of Says law seems to keep quite regular company with disagreement about the meaning of Says law.
Where is Steve Kates when he is needed?
Alice – why do accountants need to know macroeconomics? I can appreciate that they need to be able to adjust for inflation (a shift in the value of the unit of account) but do they really need to know much about the origins of inflation. It’s Martin Place, Sydney, but knowing this doesn’t help them in the counting of beans. Surely macroeconomics is for economists.
JQ – sorry this is off topic but I know you are interested in the debate about old media versus new media. Tim Andrews (writing from the USA) has posted an interesting article on this topic on the ALS blog. He outlines three major news breaks in the last month that the mainstream media has missed or ignored. One lead to a high level resignation and another to congress making funding cuts, in both cases before the old media had even noticed. Another entailed a million people marching in the streets with only footnote references from the old media.
http://blog.libertarian.org.au
What is going on here?
Agree with Cochrane about needing to be really looking at all the reasons for the 08 recession (peak oil may be helpful-but probably not on Cochrane’s radar), and at possible solutions other than inflationary money supply. There are other ways to get money circulating other than printing it or giving it away. Wasn’t it Keynes who wrote that we have more to learn from Gesell than from Marx?
TerjeP (say tay-a), the truth is Obama’s overall approval rating now stands at 63%, the same as last month.
It is truly a very odd religion.
MoSH – thats nice. But why are you telling me this? Is it relevant to something that I’ve said. Because I don’t think I’ve ever had much to say (good or bad) regarding Obama. Is Obama an opponent of Says Law or some such thing?
why does mr andrews think that 9/11 was perpertrated by the Arab/American community? Is that another scoop?
from the article-
“On September 11, 2001, the Ella Baker Centre issued a statement that “Community-based organizations led by people of color will hold a ‘Solidarity Gathering’ and candlelight vigil on Wednesday night to support the Arab-American community”. Let this sink in for a moment. The day of the worst terrorist attack on U.S. soil, and Van Jones’ organization expresses solidarity not with the innocent victims, but with the perpetrators.”
Nanks – Your point is valid. I had the same thought myself when I read that passage. But you’re knit picking. Van Jones was forced to resign following an online inquiry into his past(including his advocacy of the view that the US government deliberately permitted 911). A major scalp was taken due to a major controversy. Yet that controversy wasn’t even reported let alone unearthed by the traditional media (until after he resigned).
The article is Tims not mine. I just think it is interesting and topical and I agree with the general thesis that new media is changing the rules of the game.
Does the media have a left wing or right wing bias? Personally I think it has a mainstream bias? And personally I think that’s a problem. I would rather it was representative of all view points across the spectrum rather than some sort of averaging machine.
TerjeP (say tay-a), really, I wonder who said ‘I don’t buy the idea that Obama is some terrible socialist menace’. Not that I disagree.
I agree with the point about the mainstream media being past its use-by, but I think many people gave up on MSM as a source of quality information years back. We get a bit of a biased impression here in Aus (and maybe the US is similar). The UK still had good mainstream press the last time I lived there.
MoSH – I presume you’re quoting me from another context. Even if I did say that I’m still wondering what your point is.
@TerjeP (say tay-a)
Terje – Accountants do all sorts of things which I would consider a macro understanding essential…how about accounting for exchange rates or even accounting for any hedge instruments. Its not all finance that does that.
No TerjeP (say tay-a), I am not misquoting you they are your exact words.
Terje, you need the same reality check given to Sukrit a little while ago. All credible estimates of the crowd in Washington are below 100 000. The Van Jones stuff was standard rightwing Swiftboating – the proponents immediately moved on to the impeccably centrist Cass Sunstein. The ACORN stuff was run endlessly on Fox. (BTW, I didn’t need to check any of these, and I’d already blogged one)
If you think these pathetic efforts by the Republican slime machine (+Rathergate!!) represent the future of journalism, you’re sadly misled. The same people pushing this stuff went right along with the MSM in peddling lies about weapons of mass destruction, covering up the catastrophe in Iraq, making excuses for torture etc etc. They actively promote delusionism on climate change, DDT, stem cell research, evolution and so on.
Alice,
Just FYI – accounting for exchange rates is not done. Exchange rates are used in assessing a value for some assets (like assets held overseas or forward contracts). In those cases a macro understanding is not needed – you use the prevailing market rate on the relevant day(s) from a source like Bloomberg.
On the hedge instruments – again, no understanding needed. Use the relevant market price and/or exchange rate on the relevant day(s).
The standards essentially dictate (in descending order of preference) three possible sources of prices:
1. The sell price (less costs to sell) in an active market (as defined in the standards)
2. The value assigned in a recent transaction, or
3. A modelled value using a model that is “generally accepted” for valuing items of that type.
No macro knowledge needed. It is probably better to leave most accountants out of that area.
MoSH – I don’t memorise everything I ever say but I’m happy to assume you have quoted me correctly (a link might still help). I do identify with the position expressed in the quote. However I’m still left wondering what your point is given that you agree with the quote anyway.
JQ – thanks for looking at it and for sharing your assessment.
p.s. you know my position on the war, WMD and torture. For those that don’t I opposed the war, actively criticised claims of significant and meaningful WMD in Iraq and I’ve never supported torture. On foreign policy I think the GOP backed a looser in GWB, although before he was elected President he made all the right noises.
Terje, I do know your position which is why I was surprised to find you endorsing this stuff. The Fox News/warbloggosphere attacks contributed to making the MSM even worse than they already were, and these cases are prime examples, where the author is complaining that lies/tabloid video exposes/ginned up political scandals didn’t get even more attention than they did.
Complicity in this stuff has pretty much killed off libertarianism as a plausible contender for the support of anyone interested in freedom.
TerjeP (say tay-a), I think JQ has said it all.
JQ – I don’t think it is accurate to say I was “endorsing this stuff”. I said it looked interesting and I solicited feedback. I sometimes do the same with articles you have written and we have quite a few areas of disagreement. I certainly don’t claim to know the facts of these cases beyond what Tim has reported. Part of why I seek comment in a left leaning blog such as yours is to flush out any obvious deficiencies in the thesis. Plus you have commented on new media old media previously.
p.s. It was quite exciting to learn from MoSH that Obama is popular. Who would have thought that you could be President of the USA and also popular. 😉
TerjeP (say tay-a), the truth is Obama the socialist was already popular before entering politics and what a difference a clean skin like Obama is making to the highest office in the land.
Before he entered politics he was obscure.
TerjeP (say tay-a), your ignorance is showing. Do some reading.
I’m addicted to reading. Your not helping.
p.s. I don’t know why you get off being so rude. Perhaps you’re nicer in person.
@TerjeP (say tay-a)
I thought about your question before as to why accountants need a unit of macro. A) it was dumb question Terje and b) my answer was equally dumb.
People with accounting qualifications often do end up running firms or in senior exec positions…and understanding of macro would / should be de rigeur…it helps.
@Andrew Reynolds
Andrew – what can I say but dumber and dumber – the Chicago Booth school shows us that models and over reliance on math models is myopic and inward looking…Krugman is right. Cochrane is dummy spittingn and incredibly wrong. Where oh where has Greenspan gone? Why dont we ask him??…he came the closest to admitting his models were stuffed.
And here is Andy telling me that accountants should just buy someone else’s computer model and learn to push the appropriate statistical buttons…
The world moves on but the models dont Andy or not fast enough – hence the GCF (oops) investment in new robot technology lags todays human intelligence…thats why. What is this? Push button Accounting managers welcome to apply?
Andy – what a disgrace you are for selling your soul to automatrons…I dont know quite what to do with you!
@Andrew Reynolds
The point is to see it coming Andy…..not to just bean count it when it arrives.
You see…thats the tragedy of Cochrane…he only has his narrow like minded friends at Booth to prop up his ego now…he virtually even says as much. I think Cochrane imploded actually.
One robot down…and keep it up Krugman!!
So do people with engineering degrees and science degrees. However we don’t teach macro economics in engineering degrees and science degrees.
Could we say that irrantional exuberance has been replaced by irrational irritability brought on by having all of life’s certainties eroded and credibility trashed.
We have seen increasing levels of strange behaviour from the Liberal/Nationals over the past few days where behaviour is far from mild. Not only have those who espouse right wing ideology lost economic credibility they have also lost power in other ways. No wonder they are lashing out at those they feel are responsible for their angst. The credo is that attack is the best form of defence – although even that belief is difficult to sustain. Economics conferences will be interesting in the future as new paradigms are debated and the right wing attempts to regain credibility.
Alice,
Anyone who saw it coming would be able to count things of a lot more worth than beans.
Terje,
Fortunately not many Keynesian economists get there.
🙂
Andrew – I don’t think that’s true. A lot of business execs think the government stimulus was both necessary and effective.
“Economics did indeed take a wrong turn in the 1970s, responding to the breakdown of (one version of) Keynesianism. We need to find a new and better response, and much of the work of the past 40 years will have to be be discarded or reinterpreted as a result.” JQ
I wonder what such a reinterpretation would look like. It might have to go back further than the late-1970s. Even politically liberal post-WW2 American keynesian economists lived in a country with a world-dominant (and comparatively prosperous) economy. It’s tough to maintain skepticism under those circumstances, particularly when the profession enjoyed such growing prestige. In retrospect, a lot of what passes for Old Keynesian and New Keynesian in the US may in future seem to have been fundamentally “Classical” — at least in its acceptance of the natural tendency toward general equilibrium. Keynes was reinterpreted as an special case of classical principles, though an influential one, whose economic remedies were called upon under limited conditions — recessions, liquidity traps. Most of the skeptical keynesian impulse was diverted into the study of “frictions” or “imperfections” of the classical model. Even behavioral economics, so far, exists as a piecemeal critique of classical assumptions about rational behavior.
Perhaps the real distinction between contemporary economists ought to be between those who believe that economies naturally tend toward equilibrium (allegedly like physical systems) and those who believe that they are evolving, non-equilibrating systems (like biological, human, or historical ones). The distinction, then, would be between the descendants of David Ricardo, on one hand, and T.R. Malthus, on the other. Virtually every celebrated name in economics would fall into the first category, even Marx (a “Left-Ricardian” who believed the closed system would explode of its own accord, leading to a steady-state end of history). It would also include contemporary Freshwater (and many of the Saltwater) economists.
Malthus deserves to be re-discovered as the progenitor of an alternative to the contemporary classical version of economics, particularly his 1820 Principles of Political Economy (and especially Book 2). It’s on Google:
http://preview.tinyurl.com/le4gpu
Keynes did indeed write a well-known admiring essay, calling Malthus “the first of the Cambridge economists.” Not only did this work influence Keynes, but Malthus was the first (?) political economist to discuss the relationship of the distribution of wealth to economic growth (too much landed inequality is bad), and to suggest that getting a country out of a recession might require government sponsored public works. From this perspective, Keynes (and only a few of his self-proclaimed contemporary followers) would be seen as fundamentally a “Right-Malthusian” who tried to save capitalism. (Others of his self-proclaimed contemporary followers would be seen as fundamentally classical economists with only the faintest soupcon of eau de Keynes.) A “Left-Malthusian” would be someone who took Malthus’ analysis of the relationship between the division of landed property and economic growth (Bk.2, Sec.7) more to heart than his defense of security of property (and primogeniture) — and who extended his discussion of landed property to all forms of wealth.
“If only Malthus, instead of Ricardo, had been the parent stem from which nineteenth-century economics proceeded, what a much wiser and richer place the world would be to-day!” [Keynes, 1933]
@jcb
Says “I wonder what such a reinterpretation would look like. It might have to go back further than the late-1970s. Even politically liberal post-WW2 American keynesian economists lived in a country with a world-dominant (and comparatively prosperous) economy.”
The US launched a major war and kept it going for years…starting from a position close to or at full employment (Vietnam). Keynesians would / should know that would cause inflation. And that inflation got spread like a virus around the world and when the oil shock came BOOM! There was no Keynesian common sense in that. So tell me, did Keynesianism really fail or did the US govt stray from implementing any semblance of sound Keynesian policy in the management of their own economy in the 1960s (and of course, being so large an economy, the instability transmits to a lot of other economies notwithstanding those countries own good managements).
jcb,
Kates dealt with the Keynes/Malthus thing well by clearly showing that Keynes built on Malthus. Check out his “Say’s Law and the Keynesian Revolution”.
BTW – I do not treat that as a good thing. Malthus has been shown to be wrong many more times than he has been shown right.
Terje,
Most of those are accountants, lawyers or engineers. Not many economists in the upper ranks. I wonder why.
@Andrew Reynolds
You make broad sweeping statements like “not many economists in the upper ranks. I wonder why?” based on what Andy…your exceptional intuition? Groundless, factless and baseless observation. You may want to check Warren Buffets qualifications Andy. (knockout blow from Alice – yes!!)!