Morning Must-Read: Paul Krugman: That 80s Show

Paul Krugman: That 80s Show: “The pivotal role of the 1980s in the development of economic thought….

The 70s have taken on mythical status, and are constantly invoked by inflation worriers, while the 80s get mentioned, if at all, as somehow proving the truth of supply-side economics. But what really happened in the early 80s…. Chicago’s Robert Lucas made an extremely influential case against any kind of activist policy… [because] only unanticipated changes in monetary policy had real effects. As soon as people understood that… the central bank had targeted a lower rate of inflation, prices and wages would adjust, without the need for sustained high unemployment. What actually happened in the 80s… was that… inflation did indeed come down–eventually. But along the way there were deep recessions and soaring unemployment, which went on much longer than you could justify with any plausible story about the monetary shock being unanticipated. This was very much a vindication of more or less Keynesian views about the economy…. But many economists had already dug themselves in too deep…. Unable to backtrack, they went even deeper, insisting despite all appearances that monetary policy had no real effects whatsoever, that it was all technological shocks….

For the rest of us the 80s were just as important as the 70s in setting attitudes toward policy…. The 70s showed the limits of policy, but the 80s showed that there were limits to those limits–that monetary policy (and fiscal policy, under some conditions) remained powerful…. And that insight has stood the test of time…