"Paul Krugman says the state of macroeconomics is rotten. Steve Williamson disagrees. With apologies, I'll cut-and-paste most of Steve's post:
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...
Since the 1970s, it is hard to identify a field called macroeconomics. People who call themselves macroeconomists have adopted ideas from game theory, mechanism design, general equilibrium theory, finance, information economics, etc. to study problems of interest to policymakers and the public at large. Sometimes it's hard to tell a macroeconomist from a labor economist, from someone working on industrial organization problems. What are "freshwater" and "saltwater" macro? No idea...
The truth is that we have all moved on from the macro world of the 1970s. Methods that seemed revolutionary in 1972 are the methods everyone in the profession uses now. The nerds who had trouble getting their papers published in 1972 went on to run journals and professional organizations, and to win Nobel prizes. This isn't some "cult that has taken over half the field," it's the whole ball of wax... (emphasis mine)http://noahpinionblog.blogspot.com/2012/12/macro-what-have-you-done-for-me-lately.html
Economic science does an excellent job of displacing bad ideas with good ones. It's happening every day. For every person who places obstacles in the way of good science to protect his or her turf, there are five more who are willing to publish innovative papers in good journals, and to promote revolutionary ideas that might be destructive for the powers-that-be. The state of macro is sound - not that we have solved all the problems in the world, or don't need a good revolution.
Yes, nothing like between Milton Friedman and James Tobin. How about like between Stephen Williamson and Paul Krugman? There seems to be no little "animosity" at least on one side. For his part Krugman mostly ignores Williamson all together.
Noah Smith argues that Macro all uses the same basic models now. Krugman says that misses the point:
"So, Noah Smith weighs in on the state of macro and argues that there really isn’t that much disagreement in the field, because both saltwater and freshwater macro use the same set of techniques. (For newbies: saltwater is the kind of macro practiced at MIT, some of Harvard, Princeton, etc., macro that still finds Keynesian ideas useful and argues that monetary and fiscal policy can be effective; freshwater is Chicago, Minnesota, etc. insisting that business cycles are optimal responses to real shocks)."
"I think Smith is missing the point here. Alchemists and chemists used similar equipment: retorts, beakers, and so on. That didn’t make them the same endeavor. New Keynesians and real business cycle theorists both do lots of intertemporal maximization — that is, they use similar equations to represent consumer and producer behavior. Again, this doesn’t make them the same endeavor.
http://krugman.blogs.nytimes.com/2012/12/20/on-not-seeing-the-forest-for-the-equations/
I don't know that alchemists and chemists all use the same equipment.
"The real test came when the financial crisis struck, and pretty much to a man freshwater economists not only argued against fiscal stimulus — which is a defensible position — but insisted that there was no possible way to justify stimulus, that such ideas had been refuted and that “nobody” believed in them anymore. The only way to understand these claims is to realize that the freshwater types simply didn’t accept the legitimacy of what the New Keynesians were doing — in fact, didn’t even bother to read any of it, because anyone who actually worked with that kind of model would know that fiscal policy can indeed have an effect in that framework."
"I’m not saying that the NK approach is necessarily right; but it’s a serious intellectual effort, undertaken by people who thought they were part of an open professional dialogue. Oh, and there’s a lot of evidence for the price stickiness that is central to NK models; again, maybe it doesn’t mean what the theorists think, but surely that evidence ought to be part of any discussion."
"So yes, the equations in one of Mike Woodford’s papers look a lot like the equations coming out of Chicago or Minneapolis. And a few years ago it was possible to delude oneself into believing that this represented a true convergence of thought. But recent events have proved that it just wasn’t true."
What Krugman seems to be arguing is that all that matters is what your policy is regardless of the model. However, it is notable that they all agree on the same models. I just recently read Skidelsky's book "Keynes: Return of the Master" and he-along with people like Steve Keen, whose book I am currently reading "Debunking Economics"-argues that for all the squabbles between the New Keynesians and the Real Business Cycle theorists, it is a family squabble. That they agree on the models would seem to vouchsafe this.
Actually, Skidelsky argues that RBCers ignore reality when it contradicts DSGE and NKers ignore DSGE when it contradicts reality.
In this sense you could say they're both half right. The question of Keen, Skidelsky and other heterodox economists is whether it's enough to usually get policy right-as people like Krugman and Delong do-even as the theory has grave shortcomings?
Or is there a need to move beyond the Neoclassical world altogether?
It's fascinating to watch this debate take place within the mainstream of macro, where there is relative agreement that both sides are using the same models. Obviously this basic complacency ignores various sects of heterodox economics where other models are actually being considered and practiced. Keen and many others in the Post-Keynesian realm are very well educated in mainstream modeling, but I'm not sure the same can be said of the reverse.
ReplyDeleteMy issue is that while Krugman and some others have been more correct on policy since the crisis broke out, they were completely blind-sided by the crisis and weak recovery that followed. From my perspective, it's unclear how much of their policy accuracy stems from their models versus prior political leaning that happen to fit with this particular crisis (I'd lean towards the latter).
Over the course of this semester in school, I've come to see that neoclassical economics has made numerous advances in the past few decades. Having said that, there is still good reason to move beyond that world to one that acknowledges fiat currencies, private debt and the financial sector.
Joshua, I don't think it's fair to say that Krugman and others were completely blindsided by the crisis and weak recovery that followed. In fact Krugman did point out that the stimulus package was not big enough, and contained a significant amount of tax cuts, as opposed to direct transfers to consumers. On second thought, perhaps they were blind sided by the crisis.(financial.) Roubini was one of the few that saw it, along with some political insiders that were dismissed out of hand. And here we are now trying to avert a self made crisis by the very people that insisted then, as now, that the way to resolve the issue is to cut spending to levels that will most certainly lead us back into recession. This is mostly a political/ideological issue that fails to acknowledge factual reality. Whomever coined the phrase "epistemic closure", was clearly referring to the Republican Party policy makers and economic advisers for the most part.
ReplyDeleteJosh I think Nanute has a point about Krugman. He wasn't blindsided by the weak recovery if you check the archives.
ReplyDeleteI do think you're right that he's right more because he ignores his own models than because his models are correct.
That's more or less what New Keynesianism does. It has the same wrong models as RBC but with enough "frictions" to explain reality better.
I'm interested in what advances you think Neoclassicism has made. Do you see the Lucas Critique as such an advance?
I do thnk that Keen is right that the Neoclassical model is very one dimensional in it's notion of general equilibrium and comparative statics.
I think he's right that we need a model that incoproates the idea of dynamism into economics.
P.S. It's funny that Nanue mentions Roubini. I notice that people like Sumner now diminish his prediction by basically saying that as he believe in the Efficient Marekts Hpothesis, Roubini-or even John Paulson's profits going short in 2008-was just dumb luck, as no one can beat the market over time.
So before the crisis they said Roubini was wrong. After the crisis they said 'who cares anyway it wsa only luck.'
Nanute and Mike,
DeleteYou are both correct that Krugman was a proponent of much larger stimulus from the beginning. However, until recently he was still worried about bond vigilantes that would cause interest rates to spike on Treasuries. He seems to changing his views on that topic, which is positive, but when pushed to explain his views he remains tied to adding rigidity to New Keynesian models.
As for neo-classical advances, I do think New Keynesian models are an advance from the initial IS-LM and from RBC. Also, the behavioralists are an advance of original neo-classical views. That's not to say there aren't bigger and better advances outside of that regime, but it is moving forward within its own limits.
As for Sumner, his comment about bubbles and the EMH are constantly confusing and seemingly inconsistent. Roubini's prediction may have been partially luck, but the dynamics he outlined were pretty spot on. Since the crisis, he has had more trouble, which in part has stemmed from unique govt/CB action. Regarding Paulson, his gains on housing were probably even less due to luck. He effectively had inside information and was given special privileges by Goldman. Unfortunately for him and his investors, he's tried to apply the same principles to other markets where the dynamics of the housing bubble are not relevant.
Josh, I suspect you've misread Krugman on the bond vigilantes. He has stated on numerous occasions that the fear of the bond vigilantes was unfounded in the current zero lower bound climate. Here's an excerpt from DeLong on Mankiew's so called confusion in this regard: ....In 2003 the unemployment rate peaked at 6%, the employment-to-population ratio troughed at 62%, and short-term safe nominal interest rates never hit the zero lower bound. In this business cycle the unemployment rate peaked at 10%, the employment-to-population ratio troughed at 56.5%, and the short-term safe nominal interest rate has now been at its zero lower bound for four years and is now expected to remain at the bound for three more.
DeleteThe rule of thumb has two parts. First, unless you hit the zero lower bound on interest rates the business cycle should be handled by monetary policy, and fiscal policy should be conducted upon "classical" principles: set tax rates and spending programs so that the debt-to-GDP ratio converges to a sustainable target level, where the target takes into account the fact that you will want to run large budget deficits in (a) wars, (b) depressions in which interest rates hit the zero lower bound, and (c) other national emergencies.
Second, when you do hit the zero lower bound, "Keynesian" principles should govern fiscal policy: borrow and spend to boost production and employment as long as inflation expectations remain anchored.
There is nothing to puzzle over here....http://delong.typepad.com/sdj/2012/12/in-which-greg-mankiw-pretends-to-be-puzzled.html
nanute - I may have misread Krugman at times, but I think this excerpt from DeLong actually displays my disagreement perfectly.
DeleteMy critique is that both Krugman and DeLong are still tied to a theory that includes a "liquidity trap." As stated above, monetary policy should be the main level except when interest rates hit zero and it is at that point "that the fear of the bond vigilantes was unfounded." I'm arguing that as long as the US is a currency issuer, bond vigilantes will remain invisible regardless of the current interest rate. Further, I would argue that monetary policy is not well suited to handle business cycles at all.
Related to the above, I think it would be a mistake to target a debt/GDP ratio since any level is potentially sustainable (i.e. Japan ~220%).
Josh, OK. So what should the Feds role be? It would seem that under current circumstances it might try the employment part of the mandate. All the effort thus far, (QE's) have not had much of an effect on raising interest rates.(Not saying this is the intent, but if deflation was the main concern, you'd think re-inflating would be the goal). It would seem that lawmakers have been too focused on debt and unwilling to use fiscal policy to stimulate demand. Thus, the Fed is left with the difficult task of trying to manage monetary policy, while at the same time, attempting to implement fiscal policy. I will say one thing: Past history of Fed policy would seem to validate your argument regarding business cycles.
DeleteJosh, Right after posting my comment I head over to the Economist View and see this post on exactly what we're discussing here. http://economistsview.typepad.com/economistsview/2012/12/fed-watch-missing-the-big-japan-story.html
DeleteBy the way, I appreciate your taking time out of your very hectic schedule to respond to the neophytes. I have zero background in economics/finance, I'm just an interested observer. Thanks again.
nanute, Thanks for engaging in discussion. Most of my knowledge, to date, comes from pleasure reading/researching as well (economics/finance background only goes so far).
DeleteAnyways, if the Fed is to maintain a role, a few options are:
1) research institution
2) regulator (need to remove bank members from the boards)
3) Lender of last resort (Bagehot style, not what the Fed did in 08-09)
At this point I think the Fed should be doing very little aside from maintaining ZIRP. The other actions merely increase capital gains (largely for the wealthy) at the expense of interest income. The Fed's primary way of targeting employment was through a housing bubble, which hopefully will not occur again.
If the Fed were not pursuing its current actions, its entirely possible the fiscal side would do more. The fiscal side has unfortunately been very inefficient in its own efforts, which makes the problem more difficult. Ultimately I don't think encouraging households to leverage up again will lead to sustainable growth.
As for Tim Duy's story, he's generally been a big supported of monetary stimulus. Many people are hoping Japan will move toward NGDP targeting now. The BOJ can maintain rates on sovereign bonds at any level it wants. If the fiscal side steps up deficit spending, then I would expect to see at least a temporary boost in GDP and decline in the Yen. However, given Japan's demographics, if inflation picks up without a subsequent rise in rates than a majority of voters will quickly become very unhappy.
DeleteThere are also efficiency problems with fiscal spending in Japan being directed towards privileged companies and households. I think many people in Japan like the sound of higher growth and inflation without fully recognizing how getting there will affect them.
Josh, Those are all good ideas for what the Fed's role should be. The problem is that the changes are most unlikely without some major shake up from the legislative side of things. And this approach might end up being worse than trying to effect Fed policy change from within the finance/econ construct. Whether or not NGDP targeting is a good policy, (I don't think so), the Fed has moved in that direction as a result of constructive criticism from "inside the club." The larger issue is in fact the lack of meaningful fiscal side policy initiatives. This is a direct result of the ideological rigidity of the freshwater school, and the significant influence they've had on policy since the 80's. Chicago School and the like have been dominant in policy with the exception of the neo-liberals, or New Keynesians if you like, that held sway during the Clinton years. In both cases, the emphasis has been on monetary policy, with fiscal policy taking a back seat to most policy initiatives. As Krugman has said in the past,(I'm paraphrasing here), "we don't know if true Keynesian fiscal stimulus policies work, because we've never tried it." Not even during the Great Depression.
DeleteI'm not proposing that households leverage up again to get us to a sustainable level of growth. I think that it would be much more effective, if there was a substantial debt forgiveness on the consumer/middle class side of the equation. We've seen massive amounts of indirect and direct debt forgiveness on the financial side of the ledger, but as you say, this has only led to an increased level of wealth for the group that needs it least. It's a perverse sense of rewarding bad behavior. The next major crisis that is going to hit the finance sector is the amount of student debt, that will never be repaid. This isn't a problem in and of itself. The problem is that the law of unintended consequences will be very bad for future growth. What I mean is, that by not making payments regularly, the debt keeps growing. And the rate of growth will outstrip the ability to repay the debt, as wages continue to stagnate or in real terms, decline. I'll leave the employment side of the Fed's mandate alone for the time being. I think I've rambled on a bit too long already.
Josh, And this from Krugman's blog: ...Oh, dear — does the president still believe that failure to reach a Grand Bargain will cause an attack by the invisible bond vigilantes, and that this is the reason we should fear the fiscal cliff? How many times do we have to show that this notion is wrong both in theory and empirically? America can’t run out of cash (except politically, if Congress refuses to raise the debt ceiling); it basically can’t experience an interest rate spike unless people see an increased chance of economic recovery and hence a rise in short-term rates. And the people who have been predicting an interest rate spike any day now for four years shouldn’t have any credibility at this point....
ReplyDeleteI'm glad you guys got some comments in yesterday-I've been without a laptop and couldn't get in yesterday. I agree with you on Krugma Nanute.
ReplyDeleteJosh I think for the most part, the problem that people llike Keen have with Krugman is theoretical. It's hard to argue that NK is an advance over RBC. It's intersting that you think it an advance over IS-LM. I'm intersted in which ways you think this is?
This is 1996 Krugman, from Lars P Syll's blog recently:
DeleteI like to think that I am more open-minded about alternative approaches to economics than most, but I am basically a maximization-and-equilibrium kind of guy. Indeed, I am quite fanatical about defending the relevance of standard economic models in many situations …
I may have more sympathy for standard economics than most of you. My criticisms are those of someone who loves the field and has seen that affection repaid. I don’t know if that makes me morally better or worse than someone who criticizes from outside, but anyway it makes me different …
To me, it seems that what we know as economics is the study of those phenomena that can be understood as emerging from the interactions among intelligent, self-interested individuals … Personally, I consider myself a proud neoclassicist. By this I clearly don’t mean that I believe in perfect competition all the way. What I mean is that I prefer, when I can, to make sense of the world using models in which individuals maximize and the interaction of these individuals can be summarized by some concept of equilibrium. The reason I like that kind of model is not that I believe it to be literally true, but that I am intensely aware of the power of maximization-and-equilibrium to organize one’s thinking …
One alteration from the initial IS-LM to the Mundell-Flemming version is the inclusion of a Balance of Payments line (moving from a closed to open economy version).
DeleteAs for NK vs. RBC, I think there are clear advances in thought though maybe not in the models. RBC believes no changes in the business cycle are foreseeable and that monetary factors have basically no real effects even in the short run. Disagreeing with those two views is a pretty big step up for NK in my view.
As far as your question about the Fed role, Nanute, I think the MMTers actualy want it to be absorbed back into the Treasury.
ReplyDeleteYou are correct about MMTers on that point.
DeleteIf it wasn't clear I think there's no question NK is better than RBC. That was a great quote from 1996 by Krugman. I have read that entire speech. Krugman admits he is a terminal Neoclassical there. The idea of general equilibrium-which is what DSGE stands for-is the whole problem for people like Keen and Skidelsky. Indeed, for Keen a "dynamic" general equilibrium model is a contradiction in terms.
ReplyDeleteStill, that quote from Krugman has no bearing on Nanute's point about Krugman during this crisis. Again, it's theory vs policy. On the level of policy Krugman has been mostly right since 2008.
Whether or not his model is sufficent is another question going forward. Keen and company make a persuausvie case that it isn't, I think.
Mike, I haven't read enough Keen and company to know if their assessment is correct. Krugman's model may be correct and still not be sufficient. Why, you may be asking yourself? For the same reason that we don't know if Keynes' model is correct. It's never been (or in Krugmans's case), been implemented.
Delete