Wynne Godley: Hydraulic Keynesianism's Second Life?

     Krugman remarks on renewed attention the late economist is now enjoying.

     "A slightly belated reaction to Jonathan Schlefer’s interesting piece on therevived influence of Wynne Godley. There will, I’m sure, be a lot of argument about whether Godley’s approach was actually superior to somewhat more mainstream approaches. But I was struck by Schlefer’s characterization of Godley’s approach:

In mainstream economic models, individuals are supposed to optimize the trade-off between consuming today versus saving for the future, among other things. To do so, they must live in a remarkably predictable world.

Mr. Godley did not see how such optimization is conceivable. There are simply too many unknowns, he theorized.

Instead, Mr. Godley built his economic model around the idea that sectors — households, production firms, banks, the government — largely follow rules of thumb.

      "What you might not realize from this passage is that Godley’s notion that we should represent behavior by rules of thumb isn’t something new — it’s something old, which got driven out of macroeconomics. The “hydraulic Keynesianism” of the 1950s was all about viewing the economy as a kind of mechanism in which consumer behavior could be represented by an ad hoc consumption function, investment behavior by an ad hoc investment function, and so on. This produced a more or less mechanistic view of the economy, and AW Phillips famously represented hydraulic macro with aliteral hydraulic mechanism."

      "So why did hydraulic macro get driven out? Partly because economists like to think of agents as maximizers — it’s at the core of what we’re supposed to know — so that other things equal, an analysis in terms of rational behavior always trumps rules of thumb. But there were also some notable predictive failures of hydraulic macro, failures that it seemed could have been avoided by thinking more in maximizing terms."

     http://www.nytimes.com/2013/09/11/business/economy/economists-embracing-ideas-of-wynne-godley-late-colleague-who-predicted-recession.html?pagewanted=all

     It's funny. I was just having a discussion with Mark Sadowski over in the comments section of Interfluidity-Steve Waldman. Hme argued that Friedman proved that monetary policy can't set the employment rate in the long run. Here was my response:

    "Mark I admit I’m a bit of a cynic. Is it that the MP cannot do anything about U in the LR or simply that Friedman didn’t want it to do anything in the LR? That’s the way my mind works."

     http://www.interfluidity.com/v2/4706.html#comment-35590

     In Krugman's telling HK with it's 'mechanistic view' was rejected because Neoclassical economists felt that it diminished the importance of the individual. They much prefer to believe in a 'represenative agent.' So what drove the change was less because HK corresponded poorly with the fact than it offended the moral preferences of Neoclassical economists. Krugman finishes without taking a strong position for or against this Second Birth of NK but rather just remarking the irony as it's not a new idea but a return of an old-less pejoratively, we could say a 'previous idea'.

    "You could argue, and I would, that the rebellion against hydraulic macro went much too far. It’s not at all clear how much good the whole apparatus of maximizing behavior in New Keynesian models really does, and to the extent that such models do seem more or less to work, it’s only by making some ad hoc behavioral assumptions that are grafted on to the rest of the structure."

     "But it is kind of funny to see a revival of old-fashioned macro hailed, at least by some, as the key to a reconstruction of the field."

    What I tease out of this is that he's not thrilled by it necessarily but he's not going to publicly criticize it. He has after all been so critical of the current Macro status quo that it's natural there's going to be a search for something else.  

    If what matters is-as Sumner claims- not public opinion but the opinion only of economists-which makes some sense, we know since Thomas Kuhn that even scientific disciples are little societies-then Godley has gotten a real shot in the arm as his influence is being seen in some pretty mainstream places-not just some fringe MMTers poring over  Warren Mosler's site-not that there's anything wrong with that. 

    "If the economics profession takes on the challenge of reworking the mainstream models that famously failed to predict the crisis, it might well turn to one of the few economists who saw it coming, Wynne Godley of the Levy Economics Institute. Mr. Godley, unfortunately, died at 83 in 2010, perhaps too soon to bask in the credit many feel he deserves."

    "But his influence has begun to spread. Martin Wolf, the eminent columnist for The Financial Times, and Jan Hatzius, chief economist of global investment research at Goldman Sachs, borrow from his approach. Several groups of economists in North America and Europe — some supported by the Institute for New Economic Thinking established by the financier and philanthropist George Soros after the crisis — are building on his models."

     "In a 2011 study, Dirk J. Bezemer, of Groningen University in the Netherlands, found a dozen experts who warned publicly about a broad economic threat, explained how debt would drive it, and specified a time frame."

     "Most, like Nouriel Roubini of New York University, issued warnings in informal notes. But Mr. Godley “was the most scientific in the sense of having a formal model,” Dr. Bezemer said.

     "It was far from a first for Mr. Godley. In January 2000, the Council of Economic Advisers for President Bill Clinton hailed a still “youthful-looking and vigorous” expansion. That March, Mr. Godley and L. Randall Wray of the University of Missouri-Kansas City derided it, declaring, “Goldilocks is doomed.” Within days, the Nasdaq stock market peaked, heralding the end of the dot-com bubble."

     http://www.nytimes.com/2013/09/11/business/economy/economists-embracing-ideas-of-wynne-godley-late-colleague-who-predicted-recession.html?pagewanted=all

      It's not entirely clear where the econ profession will end up. What's clear is it won't return to the homogeneity of the Great Moderation were everyone song from the same song book. It doesn't look like it will be like 1936 or even in the 70s with Robert Lucas and a few others where things change overnight. Rather it seems that various disparate schools have risen up and each will contribute it's own broth to the soup. What this will get us remains to be seen-between Market Monetarists, Internet Austrians, Modern Monetary Theorists-now already splintered off from Monetary Realists-there will be a lot to absorb. How much from each school and what from each school remains to be seen. However, I certainly think this renewed interest in Godley is welcome.   

     It's clear that the dominant Neoclassical school will have a hard time absorbing the 'hydraulic' aspects like this:

     "Mainstream models assume that, as individuals maximize their self-interest, markets move the economy to equilibrium. Booms and busts come from outside forces, like erratic government spending or technological dynamism or stagnation. Banks are at best an afterthought."

    "The Godley models, by contrast, see banks as central, promoting growth but also posing threats. Households and firms take out loans to build homes or invest in production. But their expectations can go awry, they wind up with excessive debt, and they cut back. Markets themselves drive booms and busts."

     While a number of economists, analysts, pundits, et, al, predicted an economic threat most didn't have models but made the prediction informally. What many economists find attractive about Godely is he used a model to make his prediction. While others may use their superior intuition this can't be cloned. 

     Not that I want to give intuition a short thrift as much I use intuition in coming to conclusions. However, in econ there's no denying the importance of a model.