Must-Read: Paul Krugman: Tobin Was Right

Must-Read: In retrospect, Robert Lucas’s solutions to the modeling problems left over from Milton Friedman and James Tobin–closing the model via specifying expectations, accounting for apparent wage and price inertia, and specifying the big business-cycle impulses–were, as Milton Friedman did warn, all intellectual value-subtracting. The three intellectual bets of requiring rational expectations first and above all, requiring market clearing second, and putting the Solow TFP residual on the right-hand side as a primitive third all force you into models that fail to fit the data and lack any true and useful implications:

Paul Krugman: Tobin Was Right:

Tobin’s 1972 presidential address to the American Economic Association…

That address was seen among my fellow grad students… as Tobin’s last stand, a desperate rearguard action in the debate with Milton Friedman over the natural rate hypothesis. And everyone knew that Friedman won that debate, vindicated by stagflation. Except if you read Tobin again now, he’s the one who looks vindicated…. The long-run Phillips curve… isn’t vertical at low inflation… downward nominal wage rigidity combined with churn… the framework [of] Daly and Hobijn… [and] Akerlof and Perry… the need to avoid

the empirically questionable implication of the usual natural rate hypothesis that unemployment rates only slightly higher than the critical rate will trigger ever-accelerating deflation….

Sure enough, the return of mass unemployment after 2008 didn’t produce much in the way of wage decline, except, finally, after years of Depression-level unemployment in Greece. When talking about the things an earlier generation got more right than all too many modern macroeconomists, I usually focus on the demand side… IS-LM…. But on the aggregate supply side, too, the oldies were goodies.