Must-Read: It is indeed very gratifying at some level to look back and recognize that my macro economics teachers in Cambridge in the early 1980s have indeed helped me to understand the world. What is not so gratifying is how limited they reach and their influence has been. It was not George W. Bush but, rather, Barack Obama who said in January 2010–wholly inappropriately–that:
families across the country are tightening their belts and making tough decisions. The federal government should do the same. (Applause.) So tonight, I’m proposing specific steps to pay for the trillion dollars that it took to rescue the economy last year…. Starting in 2011, we are prepared to freeze government spending for three years. Spending related to our national security, Medicare, Medicaid, and Social Security will not be affected. But all other discretionary government programs will. Like any cash-strapped family, we will work within a budget to invest in what we need and sacrifice what we don’t. And if I have to enforce this discipline by veto, I will…
It wasn’t Hank Paulson, but Tim Geithner of whom Zach Goldfarb reported:
Once, as Romer pressed for more stimulus spending, Geithner snapped. Stimulus, he told Romer, was “sugar,” and its effect was fleeting. The administration, he urged, needed to focus on long-term economic growth, and the first step was reining in the debt. Wrong, Romer snapped back. Stimulus is an “antibiotic” for a sick economy, she told Geithner. “It’s not giving a child a lollipop.” In the end, Obama signed into law only a relatively modest $13 billion jobs program, much less than what was favored by Romer and many other economists in the administration. “There was this move to exit fiscal stimulus a lot sooner than we should have, and we’ve been playing catch-up ever since,” Romer said in an interview…
Return heard some things from Peter Orszag about how he misjudged the situation and appropriate fiscal policy in 2010 and after. We have heard nothing from Tim Geithner, from Jack Lew, or from Barack Obama.
The M.I.T. Gang: “showed how small deviations from perfect rationality…:
…can have large economic consequences; Mr. Obstfeld showed that currency markets can sometimes experience self-fulfilling panic. This open-minded, pragmatic approach was overwhelmingly vindicated after crisis struck in 2008. Chicago-school types warned incessantly that responding to the crisis by printing money and running deficits would lead to 70s-type stagflation, with soaring inflation and interest rates. But M.I.T. types predicted, correctly, that inflation and interest rates would stay low in a depressed economy, and that attempts to slash deficits too soon would deepen the slump. The truth, although nobody will believe it, is that the economic analysis some of us learned at M.I.T. way back when has worked very, very well for the past seven years….
There have been some important monetary successes. The Fed, led by Mr. Bernanke, ignored right-wing pressure and threats–Rick Perry, as governor of Texas, went so far as to accuse him of treason–and pursued an aggressively expansionary policy that helped limit the damage from the financial crisis. In Europe, Mr. Draghi’s activism has been crucial to calming financial markets, probably saving the euro from collapse.
On other fronts, however, the M.I.T. gang’s good advice has been ignored. The I.M.F.’s research department, under Mr. Blanchard’s leadership, has done authoritative work on the effects of fiscal policy, demonstrating beyond any reasonable doubt that slashing spending in a depressed economy is a terrible mistake, and that attempts to reduce high levels of debt via austerity are self-defeating. But European politicians have slashed spending and demanded crippling austerity from debtors anyway. Meanwhile, in the United States, Republicans have responded to the utter failure of free-market orthodoxy and the remarkably successful predictions of much-hated Keynesians by digging in even deeper, determined to learn nothing from experience….
Being right isn’t necessarily enough to change the world. But it’s still better to be right than to be wrong, and M.I.T.-style economics, with its pragmatic openness to evidence, has been very right indeed.