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 
Alice, “not many” allows for some, so citing just one is hardly a knockout blow. Also, did you not realise that declaring victory on blog threads is a classic sign of insecurity?
…and you consistently agree with Buffett, then? Nice to hear.
More seriously, though – check out the smiley face above.
@Andrew Reynolds
Ok Andy and Jarrah – how about Mark M Zandi who founded economy.com and sold out very handsomely to Moody’s Investor Services in 2005 putting his net worth to eight figures… By the way, despite his considerable net worth, Mr Zandi doesnt agree with your liberal views. In 2006 he stated….
“Our tax policies should be redesigned through the prism that wealth is being increasingly skewed,” Mr. Zandi said, arguing that higher taxes on the rich could help restore a sense of fairness to the system and blunt a backlash from a middle class that feels increasingly squeezed by the costs of health care, higher education, and a secure retirement.”
I quite agree.
What smiley face?
Alice,
That’s two – and both from the USA. On the tax thing – you still have not read Carney, have you?
If Zandi believes that he is perfectly free to donate some of his eight figures to the government. I think Pres. Obama would accept a cheque (oops – check).
.
The smiley face in a comment generally indicates a gentle dig and/or a joke. You seem to have fallen for this one – or maybe your browser can’t show them. Get FireFox if so.
It was on the prev page…Not only Zandi Andy. Prof Q gets a mention page 18 SMH today… and when you consider this..
“Seventy-five percent of the chief executives in a sample of 100 publicly traded companies had a net worth in 2004 of more than $25 million mainly from stock and options in the companies they ran, according to a study by Carola Frydman, a finance professor at the Massachusetts Institute of Technology’s Sloan School of Management. That was up from 31 percent for the same sample in 1989, adjusted for inflation.”
Zandi was right and he made his comment before the GFC Andy. Wealth has been skewed towards the rich over twenty or thirty years of tweakings of the tax system. Frydman also notes
“The growing use of options as a form of pay helps to explain the sharp rise in the number of very wealthy households. But so does the gradual dismantling of the progressive income tax, Ms. Frydman concluded in a recent study.”
The dismantling of tax progressivity under liberal policies clearly needs to be reversed. This is an key essential reform.
PS another wealthy economist? John J Moon, MD of Metalmark Capital (Private Equity Firm).
Andy give up on that one (Few economists make it to the top)…all sorts of individuals and all sorts of qualifications can end up wealthy.
Alice,
Which is one of the great benefits of capitalism. 🙂 (smiley face there too, in case you missed it).
Alice – if advocates of high taxes for the wealthy actually focused those taxes on people with a net worth in the 8 figures then they would cause nowhere near as much harm or protest. However our top income tax rate cuts in around $180k and this typically represents somebody with a career who has got there mostly on the merit of their labour skills not via invested capital. The relativity between their income and those that sit below them in career path isn’t usually extreme.
Personally I’d be supportive of a land tax which is a tax on one form of wealth. Of course “supportive” presumes that the purpose of the revenue is to reduce the tax burden elsewhere. Perhaps we could increase local land rates and abolish state payroll taxes.
@Andrew Reynolds
_ _
o o Andy this is the best I can do! No benefit if rich end up in Wall St casino!
^^
Alice,
Yes – there is. If they succeed and make money out of it then the wealth has been used well by productive businesses to drive improvements in the broader economy. If not, the wealth has been transferred to others who may make better decisions.
.
To go OT for a while (apologies, PrQ) that reminds me of what one of my history teachers taught me about the Rum Rebellion. Macarthur and friends are normally portrayed as the villans of the piece as they rebelled and also treated many others harshly. He said this is correct, they did and they deserve to be castigated for that – but the capital they accumulated and their entreprenuership also drove the development of the sheep industry in Australia that made many, many others wealthy and created a lot of employment.
On balance, then, were they good or bad for Australia?
@Andrew Reynolds
“In a former work [the Essay on Population] I endeavoured to trace the causes which practically keep down the population of a country to the level of its actual supplies. It is now my object to shew what are the causes which chiefly influence these supplies, or call the powers of production forth into the shape of increasing wealth.” T.R. Malthus, 1820 (Principles of Political Economy, Bk. 2,Ch.1,Sec.1.)
Which of these two works by Malthus “has been shown to be wrong many more times than . . . right”? And by whom?
it’s obviously true that skills in accounting and finance, law or many types of engineering are vastly more useful to the running of a business than is economic theory. how often does a business manager draw an isocost line through an isoquant map to determine production levels? I doubt that most microeconomics ever gets used by businesses. Micro would replace most of its current abstract, angels-on-a-pinhead content with practical techniques from Operations Research if it wanted to be a serious practical subject.
So Andrew is right, although he has no reason to single out ‘Keynesian’ economists. Keynesian economists at least make an effort to observe reality, unlike the neoclassicals who simply construct their own, besides which it’s micro and not macro that supposedly pertains to the running of a business.
jcb,
OK – Malthus did take many ideas from Say, Smith, Mill and Ricardo and in doing so he was right. The analysis he took from them, though, and ran with was wrong. He clearly misunderstood them all. Keynes, unfortunately, took that even further and (IMHO) was even more incorrect in his misunderstanding.
Malthus, though, in his Essay on Population was demonstrably wrong. Global population in 1820? Global population now? Oops.
“as Krugman himself notes, disagreements between economists were notably mild until the crisis erupted, what is going on here?”
I think I have an explanation. The freshwater models were and are much ‘prettier’ than the alternatives, and amongst (apparently) useless things, what other criteria is there to evaluate models than prettyness. The crisis has concentrated minds on less vacuous criteria (as crises often do). Old, but far less elegant, explanations have once more provided an effective remedy. The consequent loss of status for the freshwater ‘artists’ and their models may have been simply too much to bear.
In the aftermath, Cochrane and the other freshwater sleuth’s are now attempting to find the ‘real’ cause of the 08 GFC which reminds me of OJ’s life long quest to find out who really murdered his ex-wife. Give them time though, sixty years on they had managed to tell pretty good (real business cycle) stories about the ‘real’ causes of the Great Depression. But how many people back in the 1930’s would have believed those stories?
I have to agree with Krugman: “The math of real business cycle models is much more elegant than that of New Keynesian models, let alone the kind of models that make room for crises like the one we’re in; that makes RBC models seductive, but it doesn’t make them any less silly.”
My score Krugman v Cochran? 1-0
Terje, contrary to the claims in the post at ALS, the 9/12 rally was featured on the front page of the Washington Post, while a larger anti-war rally in 2002 was buried inside. I think you will find that the media is biased towards the interests of the people that own it.
To restate Terje, any word said by Fox, Drudge or the warblogosphere is a lie, including “a” or “the”. Sad to say, ALS is part of this circle of lies. For all practical purposes, libertarianism has been killed by the fatal embrace of the Repugs.
Economics ideology and “war” is silly anyway. Government tends to simply go with what works.
I will treasure this
@Andrew Reynolds
Andy – did you actually read that Krugman article?
You say “If they succeed and make money out of it (ie casino style gambling on Wall St) then the wealth has been used well by productive businesses to drive improvements in the broader economy.”
Andy billions just EVAPORATED ie went straight into the ether (all those savers funds, all those unemployed now, all those Mum’s and Dads hard earnt nest eggs, all those councils savings of rates, all those government’s savings of our taxes).
If anyone thinks that Wall st before the GFC was closer to an efficient market than Keynes Casino, they are living in denial land and this seems to be the defining feature of liberalism doesnt it? Bernanke virually denied there was a bubble in housing (bubble – what bubble? The one that just burst), other liberalist / markets economists suggested high unemployment is the result of workers choosing to go off on vacation… FAMA said he hated the word bubble and that “house buyers were very careful” meaning the US house prices were not a bubble and could be trusted. Now that is serious denialism Andy.
Now Andy, you tell me, is Denialism (capital D) written into the liberalist’s / markets / efficient markets / mathemagians / neo liberals economists handbook? Do they have to swear on the bible that they will deny all economic ills before they get to join? Some of these economists like Cochrane make themselves look totally and utterly stupid to the ordinary man on the street. There is no use having their precious and complicated maths if ITS NOT WORKING and not only is it not working, they cant even see its not working (or see the woods for the weeds).
My score – Krugman 1. Cochrane disqualified for using mathematics dishonestly.
I meant mathemagicians.
@gerard
Gerard – micro pertains to running a business (making sure you have the right quantities of meat and gravy in the pie). You are quite correct. Macro pertains to running the business through economic cycles and being able to recognise when people would rather buy plain meat pies rather than your gourmet duck filo pastry pies.
Micro pertains to unrealistic theoretical models about hypothetical rational all knowing humans (who don’t exist in real life). Macro consists of assuming these all knowing humans stuff up on such a regular and consistent basis that government (a collection of similar – but somehow different – all knowing humans) have to step in to bail out the rational micro humans.
No one explains why we assume economic agents are all knowing. No one explains why this doesn’t work at the maco level, requiring massive intrusion into the market by people even dumber than the market participants themselves – govt.
However if you shut up and repeat the models and graphs on a piece of paper at the end of the semester, you’ll pass. Which is all that really matters.
ABOM – I was being tongue in cheek with Gerard and you are (always) right, there is nothing rational about it except the P, C, D or HD on the paper.
ABOM, I don’t know what you do in life but this is complete tripe ‘…people even dumber than the market participants themselves – govt’? Who do you think sets macro-economic policies correcting market-failure?
“Market failure”??? Ha Ha Ha! How about “govt correcting central bank failure – which is itself a branch of govt.”
ABOM, explain yourself.
@ABOM
I don’t know how you were taught economics, but my professors always went to great pains to explain that the models that are studied in economics courses are always abstractions that aren’t meant to be completely realistic. The most commonly used example is the roadmap, which shows you how to get from point A to point B, but does not depict every pothole, tree, house etc, or the doctor who studies how a healthy human body works before discussing what can go wrong with it.
Assuming the omniscience and rationality of agents in all situations is a big assumption that obviously doesn’t translate into reality, but I don’t think any serious neoclassicals have ever asserted this is the case, at least not any I know. And Austrians definitely don’t.
Which brings me to Krugman’s latest disgrace. Much like Say’s Law, there seems to be a wilful misinterpretation of what the actual hypothesis states. Of course the market makes mistakes, and if the information at hand isn’t accurate its pricing won’t be accurate. But it also begs the question, how is government going to do a better job? Do they have some godlike genius working for them who can somehow divine the true market price? And if so, why isn’t he/she making millions of dollars elsewhere?
It is an abuse of deductive logic to say that since the current order (bastardised Keynesianism/Keynesianism by stealth/Militant Keynesianism, and yes, I will continue to assert we are dealing with one of the many guises of Keynesianism despite your kicking and squealing) has collapsed, we need to return to the “Old Keynesianism”.
You continually mention the 70s saying “Keynesianism works fine, yet something went wrong, and as soon as we can define the problem everything’ll be hunky dory” and yet you ridicule those who do not accept your version of events apropos the 1890s financial crisis (and that it is possible to unearth material that challenges your ‘official’ version shows that it’s not ‘clear-cut’).
Krugman is no longer an economist anyway. His work with trade was good, but now he is a hyper-partisan columnist for a newspaper whose days are hopefully numbered. While this article is meant to be satire, it could almost be true:
http://www.huffingtonpost.com/andy-borowitz/krugman-could-turn-into-m_b_134477.html
And that’s coming from the uber-liberal (as in social democrat) Huffington Post. Krugman is, quite simply, the Michael Moore of economics.
In short, how many versions of Keynesianism/”The One True Faith” do we need to go through before we can discard it?
Cochrane: 1, Krugman: 0
At the risk of getting banned, I just wish to clarify that not all the above post was addressed to ABOM – only the first 2 paragraphs.
John – I do appreciate you responding to the article by Tim Andrews that I linked to. However I think dialogue is generally more persuasive than statements (especially ones that claim that “the” is a lie). So perhaps if you commented directly on the ALS blog or directly at Tim Andrews personal blog where the original version of his article resides or even if you carved out a spot on your own blog for a fullsome discussion we might get further. Otherwise I have to hassle Tim to follow up here in the midst of a macro economic discussion and I suspect that it would get tedius.
Just sayin.
Sebastian, in reference to ‘….is government going to do a better job? Do they have some godlike genius working for them who can somehow divine the true market price? To answer YES, for it seems the RBA has made a ‘mozza’ from buying and selling in the market-place.
MoSH,
Of course – how silly of me. The government is all wise and perfectly capable of stepping in and correcting any and every little mistake the market makes.
The government is all wise and can see the future, in the full knowledge of all of the probable and possible consequences of its actions.
.
(AR then backs away slowly, looking for an exit)
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. ”
2. “Arguments about Say’s Law are unlikely to be resolved by logical disputation.”
JQ, you may be right regarding 2. above if one considers the endless and, IMHO, useless disputations in macro-economics involving ‘school of thought’.
Isn’t Cochrane aware of Radner’s 1972 model of a competitive private ownership economy with a sequence of commodities and share markets with rational expectations (defined a little different from Lucas)? In Radner’s model with incomplete markets the outcome is an equilibrium that has the property of minimising the value of excess supply (ie Say’s Law does not hold). Radner called this equilibrium a pseudo equilibrium. Some call it now a Radner equilibrium.
I suggest, those familiar with Radner’s and subsequent work in math econ are less surprised about the empirical evidence than the ‘school of thought’ people.
I know I’ve made this point many times on your blog. It seems not often enough. Interestingly, you’ve always allowed my posts to get through despite the obvious repetition.
Andrew Reynolds, you obviously underestimate what government’s can and cannot do. Just read up on what is happening in Germany and the government’s threat to fully nationalise banks unless they pick up their game.
MoSH,
I have no doubt that governments can do some very silly things. Was that your point?
@Sebastian
ABOm – yu have one thing completely and seriously wrong (and you are letting your adherence to free markets cloud your vision) – Krugman is more honest and right and less of a lying bastard than Cochrane. I might agree with you on the gambling banksd but you can at least acknowledge defeat on the fact that the dominant schooln of neo lliberlaism has run into a brick wall – you said it yourself…so why dry foul on Krugman? There is no rationality. He is saying what you said so what is your objection ABOM?
You cant be in Andy’s team and mine at the same time and you are smarter than that.
For christ sakes ABOM. You are not an idiot. Dont damn Krugman because its against your creed. Damn Cochrane …. because he is a liar – a mathematical liar. You know it and I know it.
@Sebastian
Let me just get one thing staright for Sebastian
The idiots from the Chicago Booth school dunmped Kenesianism (but worse thn that they dumped Friedman). They decided, in their wisdom they would dump the greatest and second greatest econmists of this century. Keynes was great because he provided a solutionto the great depression. Friedman was great because he provided a solution to command economies that had grown stagnant under State rule. Both offered something positive when it was needed.
The offspring who have distorted Friedman’s ideas have provided no solution to any crisis and instead have created crises and have pretended they were better than than those economists that offered a solution.
To those at Chicago booth I say…go back to your models, admit failure, get over your egos and get on with the job.
Alice, no mention of Mises or Rothbard? Or Ron Paul?
After all we’ve shared, all I’ve done for you (I tried to save you with gold but I don’t know if you took my mad rant seriously).
You are still in the thrall of the mainstream. You still think JQ has the answers. He’s a govt stooge like MoSHie.
I love you too much to allow you to be led toward superficial zombie Keynesianism, which is nothing but a deadend of war and world govt. Come into the light. Don’t be afraid of anarchy. Freedom works. Order without law is possible.
Let’s compromise. Let’s both read Minsky together. In bed.
ABOM, I suggest you read a simple book by Peter Kennedy called Macroconomics for starters to get some idea about economics otherwise you are one poor lost soul who says muchado about nothing.
While there is certainly no need to worship him, Keynes recognised that humans are not automatons (and that he could be wrong). There is and was no need to wait for ‘Behavioural Economics’ to get to the point of being an aesthetic masterpiece (as Cochrane seems to suggest) before using insights about human behaviour (that many people have) when analysing economic problems. Besides, the psychology literature is not undeveloped and even if it is not particularly aesthetic psychology makes a better claim to being science than many parts of economics. Components of the success of the Australian stiumulus package were probably due to the speed with which the package happened. The package didn’t allow time for the fear to set in. After the initial shocks people were scared. After the government said it was going to do something big and the cheques started rolling out, people were thinking maybe it won’t be so bad, some probably even thought ‘the government will save us’. Then retailers did better than they were anticipating and they were thinking likewise. If the fear had been allowed to set in, if the initial package was started, say, three months later, it probably would have been much less effective. Roubini’s approach suggests that, as well as understanding and using models, a modest amount of thinking combined with a knowledge of history can be worthwhile when analysing economic problems.
Freelander, maybe you should have included some unknown unknowns like the fear of being spooked by an uncertain future making many pay off credit debt at a faster rate.
@ABOM
Lol ABOM. All is forgiven…until next time..
There are more important arguments than ours…Sebs out of the sin bin on early release! Trust me ABOM, Cochrane is a zombie economist robot of the very worst variety….
(I bet I get moderated for using the phrase “early release”)
No I didnt…amazing.
@Freelander
Freelander….so you acknowledge animal spirits can be herded? Sounds Keynesian to me.
@ABOM
ABOM – there are decent governments and then there are crooks and criminals posing as governments. Look at State Labor. We need a more effective way to get governments and ministers out before their time is up (with severe penalties). Look at the way a succession of NSW Labor governments have been handing out free taxi plates to Mr Cabcharge (SMH today) and look at the mess taxis are in (and thats just a drop in the ocean of how State Labor has been feeding its members from the taxpayers purse). Criminals ABOM. Yet until we disconnect them ALL from the donations trough we will vote in another colour much the same.
@Alice
Ive come to the conclusion its time to end the farce of State Governments altogether.
“the success of the Australian stiumulus package”
What success? What causal link have you identified?
“The package didn’t allow time for the fear to set in.”
This is basically the only positive I can think of, as the GFC was as much a crisis of confidence as anything else. Of course, that implies that any further stimulus is redundant, since measures of confidence have rebounded.
Or even remotely realistic. My micro professor instructed everybody: “Don’t think too much, or this all becomes nonsense”. For anybody who has experience in the hard sciences, the lack of rigor in economics is pathetic. If one admits that the models only work under assumptions that are patently false, then that is an admission that the model itself is false. The Pythagoreans asserted that all numbers were rational, by “assuming” away the existence of the irrationals, despite knowing that they existed.
@Sebastian
Says…”Krugman is, quite simply, the Michael Moore of economics.” That is actually a great compliment. I have no doubt Michael Moore assisted the US people to get rid of the republican government and the mad views rampant within the Bush Admninistration.
“We need a more effective way to get governments and ministers out before their time is up ”
Recall elections. Which I’m glad to see the NSW Liberals considering, though they stole it as a policy from the LDP.
“Look at the way a succession of NSW Labor governments have been handing out free taxi plates to Mr Cabcharge (SMH today) and look at the mess taxis are in”
Taxi plates are a rort on the public to begin with, and are now (predictably) exposed as a magnet for corruption. Solution – get rid of them, free the market for taxis.
Alice, re States, my preferred option is to dissolve States and local councils and replace them with regional governments that are in between in size and number, boundaries based on watershed geography. Never gonna happen, but one can dream.