Fighting the Last Macro War?: Friday Focus: February 28, 2014

Yes, there were grave failures of macroeconomic analysis, failures of surveillance, failures of organization, and failures of imagination at the Federal Reserve from 2003-2008. But once–*after* they had let Lehman Brothers go into its uncontrolled bankruptcy–those worrying about inflation and moral hazard on the FOMC got quiet and Ben Bernanke got out the financial crisis Bagehot-Minsky-Kindleberger playbook, what followed in dealing with the crisis was not a failure of economic analysis: it was not the case–then, after Lehman–that macroeconomists, reality-based macroeconomists at least, were like French generals in 1940 (or, for that matter, French generals in 1914, or French generals in 1870).

What was an enormous post-September 2008 failure was a complete failure of the policymakers and the public sphere to grapple with a persistently depressed economy in which monetary policy was constrained by the zero lower bound and hysteresis threatened–reality-based ex-Keynesian and ex-monetarist economies willing to mark their beliefs to market understood what was and is going on rather well…

Paul Krugman: Fighting the Last Macro War?: “Noah Smith… argues that macroeconomic theorists have been like French generals…

Always preparing to fight the last war–in the 80s they were working on finding solutions for the problems of the 70s, in the 90s they were working on the problems of the 80s, and so on….

I think it gives economists both too much and too little credit. First of all, a large part of academic macroeconomics is dominated by real business cycle theorists–and to the extent that their work is motivated by any real economic problems, it’s still about the stagflation of the 1970s, which is at least two wars back. Those guys aren’t like French generals getting ready to fight World War I in 1939; they’re still working out how to repel cavalry charges…. Second… what were the macro wars? First there was stagflation… the freshwater guys… stopped there… forever living in 1979…. They never reacted at all to the second macro war, the disinflation of the 1980s. The point there was that disinflation was very costly…. This reality, as much as clever new models, drove the Keynesian revival; the RBC guys paid no attention, and learned nothing.

It is, I think, somewhat fair to say that Keynesians spent a lot of time thereafter focused on price stickiness and momentum, on one side, and on monetary policy as the be-all and end-all, on the other. Did this leave them unprepared for the next war? A bit, but actually not so much…. Bank runs have been pretty well understood for a long time…. And policy responded pretty effectively, too: the financial crisis may have come as a shock, but it was more or less contained by the spring of 2009.

No, the real war involved dealing with a persistently depressed economy, with monetary policy constrained by the zero lower bound. And I just don’t see an intellectual failure there. A number of Keynesians… had studied the issue. The models rolled out… didn’t fundamentally change the approaches… the predictions those models made, about interest rates, inflation, the output effects of fiscal policy, were both counterintuitive to many people and reasonably on target. I just don’t see this as a story of economists unprepared to deal with new events….

Now, you might ask why, in that case, we haven’t solved the problem. But the answer there has nothing to do with lack of economic understanding; it has to do with ideologues who made up new doctrines on the fly (like expansionary austerity or doom by 90 percent debt) to justify policies that made no sense in the standard models. If politicians turn to climate deniers, that’s not a reflection on climate science; if they turn to crank macroeconomics, that’s not a reflection on Keynesianism.

Noah Smith: Noahpinion: Is macro doomed to always fight the last war?: “It seems obvious to most people that the Great Recession was caused by stuff that happened in the financial sector; the only alternative hypothesis that anyone has put forth is the idea that fear of Obama’s future socialist policies caused the recession, and that’s just plain silly.

Before 2009 there was very little finance in mainstream macro models (the biggest exception being these models by Ben Bernanke and coauthors). In 2009 and after, lots of people outside the field noticed this fact and got angry at macro. But macro, to its credit, was not nearly as tone-deaf as its critics made it out to be… as far as I can tell, “financial friction macro” is almost the only game in town…. But of course it would have been even nicer if macro had picked up on the finance thing more strongly before 2009…. Are macroeconomists doomed to always “fight the last war”?