Holiday Reading: The State of Macro
What´s with the numeral 8?
(The “Holiday reading” idea was borrowed from Steven Kirchner). This one is from 10 years ago.
Early on in the ‘Great Recession’, Robert Gordon argued that 1978-era macro is more relevant than modern (DSGE) macro to the understanding of the current crisis:
The paper resurrects “1978‐era” macroeconomics that combines non‐market‐clearing aggregate demand based on incomplete price adjustment, together with a supply‐side invented in the mid‐1970s that recognizes the co‐existence of flexible auction‐market prices for commodities like oil and sticky prices for the remaining non‐oil economy. As combined in 1978‐era theories, empirical work, and pioneering intermediate macro textbooks, this merger of demand and supply resulted in a well‐articulated dynamic aggregate demand‐supply model that has stood the test of time in explaining both the multiplicity of links between the financial and real economies, as well as why inflation and unemployment can be both negatively and positively correlated.
On Christmas Day David Glasner argued that macro went off track in 1968, and Milton Friedman´s “natural rate hypothesis” was the culprit:
But it’s interesting to note that, despite his Marshallian (anti-Walrasian) proclivities, it was Friedman himself who started modern macroeconomics down the fruitless path it has been following for the last 40 years when he introduced the concept of the natural rate of unemployment in his famous 1968 AEA Presidential lecture on the role of monetary policy.
Now John Quiggin comes along and says that things went wrong after 1958 with the advent of the Phillips curve:
My own view is even more pessimistic. On balance, I think macroeconomics has gone backwards since the discovery of the Phillips curve in 1958 [1][2]. The subsequent 50+ years has been a history of mistakes, overcorrection and partial countercorrections. To be sure, quite a lot has been learned, but as far as policy is concerned, even more has been forgotten. The result is that lots of economists are now making claims that would have been considered absurd, even by pre-Keynesian economists like Irving Fisher.
Further along he states:
The main response was New Keynesianism which showed that with plausible tweaks to the standard micro assumptions, some Keynesian results were still valid, at least in the short run. New Keynesianism gave a rationale for the countercyclical monetary policies pursued by central banks in the inflation targeting era, whereas the classical view implied that a purely passive policy, such as Friedman’s money supply growth rule, was superior. Broadly speaking the pre-crisis consensus consisted of New Keynesians accepting the classical position in the long run, and most of Friedman’s views on short-term macro issues, and abandoning advocacy of fiscal policy, while the New Classicals acquiesced in moderately active short-term monetary policy
How you evaluate this consensus depends on your view of the period from 1990 to the crisis. Noah Smith, quoting Simon Wren-Lewis says
macro did produce a policy consensus (basically interest rate targeting by the Fed, with a Taylor Rule type objective function balancing growth stability and price stability), and yes, that policy consensus did help the world, by giving us the Great Moderation, which wasn’t perfect but was better than what came before
Implicit in this view is the idea that the Great Moderation was a policy success and that the subsequent Great Recession was the result of unrelated failures in financial market regulation. My view is that the two can’t be separated. In the absence of tight financial repression, asset price bubbles are regularly and predictably [3] associated with low and stable inflation. Central banks considered and rejected the idea of using interest-rate policies to burst bubbles, and the policy framework of the Great Moderation was inconsistent with financial repression, so the same policies that gave us the moderation caused the recession.
It appears that economic stability – low and stable inflation, low unemployment and close to potential growth – requires “financial repression” to be “sustainable”. What sort of world we live in indeed! Furthermore, I think that saying that “the same policies that gave us the moderation caused the recession” borders on the “lunatic”!
But it seems that what Quiggin really wants is to bring fiscal policy back as the premier stabilization tool. Keep wishing Mr. Quiggin.
There´s more on the numeral 8. At the time of Paul Samuelson´s death in late 2009 Krugman wrote:
But here’s Paul Samuelson, from pages 353-4 of his 1948 textbook:
Today few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle. Purely monetary factors are considered to be as much symptoms as causes, albeit symptoms with aggravating effects that should not be completely neglected.
Forgetting to note that in the 1985 edition Samuelson wrote:
Money is the most powerful and useful tool that macroeconomic policymakers have, and the Fed is the most important factor in making policy.
There´s also 1998, the year the Greenspan Fed reacted to “other shocks” in the words of the late William Niskanen, bringing about economic instability after 10 years of very high economic stability. These other shocks were the productivity shock and the Russia crisis (and LTCM).
And then there is 2008, the year Bernanke´s Fed decided that reacting strongly to price shocks (from oil and commodities) was the right thing to do!
If only C-19 had come along in 2018!