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Saturday, November 16, 2013

Krugman and Delong Show Lucas that the Death of Keynesianism is a Little Exaggerated

     Delong really went after Megan McArdle and Lucas here and I wonder if Lucas here isn't something of a surrogate for Sumner to boot.. Sumner declares Keynesianism in its death throes every few posts.

    http://diaryofarepublicanhater.blogspot.com/2013/11/there-sumner-goes-again-announcing-that.html

    McArdle, however, went Sumner one better, outright wondering why it's so hard to kill Keynesianism?

    http://www.bloomberg.com/news/2013-11-12/why-it-s-so-hard-to-kill-keynesianism.html

    What she finds puzzling she tells us is that Keynesianism-at least in the sense of a belief in a multiplier-was proven to be false by professional economists 30 years ago and yet it's still believed in among policymakers/ She appeals to John Cochrane:

    "How many Nobel prizes have they given for demolishing the old-Keynesian model? At least Friedman, Lucas, Prescott, Kydland, Sargent and Sims. Since about 1980, if you send a paper with this model to any half respectable journal, they will reject it instantly."

     "But people love the story. Policy makers love the story. Most of Washington loves the story. Most of Washington policy analysis uses Keynesian models or Keynesian thinking. This is really curious. Our whole policy establishment uses a model that cannot be published in a peer-reviewed journal. Imagine if the climate scientists were telling us to spend a trillion dollars on carbon dioxide mitigation -- but they had not been able to publish any of their models in peer-reviewed journals for 35 years."

     As Krugman points out, this is the argument from authority approach. After all, if the peer reviewers in respected economic journals reject Keiynesian ideas out of hand ,it must be because their false. After all, peer reviewers are simply incapable of error at least on matters of macroeconomics. 


     The whole idea of killing Keynesianism-or as Sumner puts it, driving a stake in its heart-is first of all, very silly and overwrought. I mean talk about grandiose. Miltron Freidman once said we are all Keynesians now-this was back in the 60s before a conservative counterrevolution that seemed to suddenly lead to no one admitting to being a Keynesian any more-one remembers Lucas' claim that in the early 80s no one was taking Keynesian ideas seriously anymore but when someone tried to discuss them would all laugh and giggle. 

    Yet, the reality is that we are all living in Keynes shadow to such an extent that vanquishing Keynes is far beyond what is achievable. While Lucas may talk about macroeconomists summarily rejecting Keynesianism, the very fact that there are macroeconoimsts at all point to us living in a terminally Keynesian world. 

    Meanwhile we all use macro aggregates do discuss the economy and the President and Congress deal with all this macro data for the budget, labor market etc. which didn't exist before Keynes wrote General Theory. Even Sumner's favorite measure-NGDP-is a macroeconomic aggregate-and so a Keynesian one. 

    So yes, Lucas earns Delong's scorn by basing his whole anti Keynesian argument on 'the peer reviewers don't like it so it must be false.'

   "What to do? Part of the fashion is to say that all of academic economics is nuts and just abandoned the eternal verities of Keynes 35 years ago, even if nobody ever really did get the foundations right. But they know that such anti-intellectualism is not totally convincing, so it's also fashionable to use new-Keynesian models as holy water. Something like "well, I didn't read all the equations, but Woodford's book sprinkles all the right Lucas-Sargent-Prescott holy water on it and makes this all respectable again." Cognitive dissonance allows one to make these contradictory arguments simultaneously."

    Strange argument-it's anti-intellectual to even question the judgement of peer reviewers. Questioning them is anti-intellectual- total credulity in whatever they say is a serious and intelligent?Lucas' argument suggests that whatever the peer reviewers say must be right-impossible to believe otherwise. Yet what he sounds like more than anything are the scholastics of the Middle Ages when they were faced with Galileo. This same argument was made then-after all, Church authority had believed this for centuries-is it possible that Representatives of God could have been wrong? Lucas even refers to his own Critique as Holy Water!

     Lucas argues that even NKers don't do so well with the peer reviewers and that in any case they've wholly given up on the multiplier-which he and his friends conclusively debunked 30 years ago for all time. 

      "Except new-Keynesian economics does no such thing, as I think this example makes clear. If you want to use new-Keynesian models to defend stimulus, do it forthrightly: "The government should spend money, even if on totally wasted projects, because that will cause inflation, inflation will lower real interest rates, lower real interest rates will induce people to consume today rather than tomorrow, we believe tomorrow's consumption will revert to trend anyway, so this step will increase demand. We disclaim any income-based "multiplier," sorry, our new models have no such effect, and we'll stand up in public and tell any politician who uses this argument that it's wrong."

      Krugman-and Delong-point out that Lucas' ground has shifted from in 2009 where he argued that nobody believes in stimulus now it's nobody believes in the multiplier-in 2009 he hadn't even been aware of the NK literature. Yet, Krugman points out that the NK model doesn't use a multiplier not because it's been disproved but that it 'deliberately gives hostages'-is makes its case with microfoundations, rational expectations, optimizing agents, etc. 

      Krugman also points out that Lucas has kind of exaggerated the idea that these arguments can't get by a peer reviewer anywhere-there was actually a major paper from the IMF-of all people; if you want to argue from authority it's hard to imagine any more prestigious institution than them-had a major paper that suggested there is a 1.5 multiplier in the EU and an even bigger one in the U.S.-by implication as the U.S. economy is relatively more closed than the EU.

     Krugman:

      "it is true that there has been a divergence between what gets published in the journals and what people in policy-related positions believe. Keynesian models — even New Keynesian models — remain hard to get past referees. Meanwhile, places like the Federal Reserve and the International Monetary Fund continue to do economic analysis with a strong Keynesian flavor. (There was plenty of Keynesian storytelling at last week’s big IMF event, and I did not exactly get laughed out of the room …)"

     "But look at who we’re talking about here. We’re not talking about dumb politicians who still do sort of Keynesian stuff. We’re talking about people like Olivier Blanchard and Janet Yellen — smart economists with plenty of technical knowledge and credentials, who continue to find Keynesian concepts useful even as such concepts are rarely published in academic journals. And it’s not just the people at the top: there’s a lot of Keynesian stuff going on in the research departments of these institutions."
      "So consider two hypotheses. One — which Cochrane appears to believe — is that being inside the Beltway has rotted Janet’s and Olivier’s brains, not to mention that of all their researchers, causing them to revert to primitive concepts that “everyone” knows are false. The other — which is what I hear from young economists — is that there is an equilibrium business cycle claque in academic macroeconomics that has in effect blockaded the journals to anyone trying to publish models and evidence that stress the demand side."

       Delong then really nails McArdle for appealing to the authority of Lucas:

       “Where to start?” he asks himself, sitting at a table in the warm 72F Roasterie drinking a $6.89 large mocha with two extra shots and contemplating the 24F temperatures of Kansas City, MO outside…
Would it be by noting that were I to head north on Main St. from here, in the four miles it would take me to reach the Federal Reserve Bank of Kansas City I would pass eleven check-cashing, car-loan, title-loan, and payday-loan emporia, all of them offering people loans at interest rates of 25%/year or more? There are a huge number of people in this economy who very much look like they are liquidity constrained–and for them it is simply stupid to model their consumption spending as if they were satisfying some intertemporal Euler equation that shifts spending from year to year at a 2%/year real mortgage or BBB bond rate…"
     "Would it be by noting that Milton Friedman’s original Permanent Income Hypothesis thought of “permanent income” as a three- or five-year average of income, not as some infinite-horizon forward-looking optimization exercise? And that whenever I would ask Milton Friedman what he thought the Old Keynesian MPC was, he would say “0.2 or 0.33–but falling as our distribution of income becomes more unequal and as homeownership and thus home equity loan availability expands”?…"
     "Would it be by noting that as Fazzari, Hubbard, and Peterson taught me long ago, principal-agent problems in corporate finance create a very large financial accelerator that makes investment spending depend powerfully on current corporate profits?…"
      "Would it be by noting that Michael Woodford does not think that the government should spend money on totally wasted projects, but instead on useful stuff, that at current government borrowing rates an enormous amount of expanded government expenditures right now pass cost-benefit tests even if you do not include short-term multiplier and long-term hysteresis effects in your model?…"
     "Would it be by noting that Keynes was not really advocating that government should in a Great Depression undertake useless expenditures? That Keynes’s remark that government could improve things by putting banknotes in bottles and burying them in the ground–the passage to which Cochrane is referring when he talks of economists who say “government should spend money, even if on totally wasted projects”–was actually a critique of those (like von Mises) who hoped to see the economy rebalance itself via an expansion of gold mining? That Cochrane has been told that he should read Keynes in context many times, and that he continues to refuse to do so?…"
       So the death of Keynes has been a little exaggerated. While Delong nails Lucas, I'd like to think that he also had Sumner in mind just a little. 

     
     

   

     

3 comments:

  1. Why do you keep saying Lucas? All of those quotes are from John Cochrane, not Lucas.

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  2. Does the argument change based on which one said it? You're saying Lucas doesn't think that Keynesianism was proved wrong 30 years ago?

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  3. "Meanwhile we all use macro aggregates do discuss the economy and the President and Congress deal with all this macro data for the budget, labor market etc. which didn't exist before Keynes wrote General Theory. Even Sumner's favorite measure-NGDP-is a macroeconomic aggregate-and so a Keynesian one"

    You nailed it here. Policymakers use established Keynesian national accounting, built through decades of painstaking negotiations between experts.

    Monetarists have none of this -- instead relying on bizarre concepts such as "hot potatoes" and "Chuck Norris effect" (and let's not forget the completely hopeless claim of trying to figure out which monetary aggregate is best for policy purposes)

    Very important point

    ReplyDelete