Mark Thoma on the 2009-2015 Dark Age of macroeconomics: Weekend Reading

Weekend Reading: I would have said that the Dark Age is over. But the behavior of professional Republican economists formerly of note and reputation—and I am looking at you, Robert Barro, Harvey Rosen, Douglas Holtz-Eakin, Larry Lindsey, John Taylor, John Cochrane Glenn Hubbard, Michael Boskin, Charlie Calomiris, Jim Miller, Jagdish Bhagwati, and George Shultz: you know better. And, Marty Feldstein, you really should not have written your defense of Trump’s China tariffs. The 2009-2014 Dark Age looks to me, mostly, like a deliberate decision to be stupid and not think issues through. This one looks like a last, vain attempt to gain some influence on Republican policy: Mark Thoma (2009): “A Dark Age of Macroeconomics”: “Quoting an email [from Paul Krugman], economists who…

…have spent their entire careers on equilibrium business cycle theory are now discovering that, in effect, they invested their savings with Bernie Madoff…

I think that’s right, and as they come to this realization, we can expect these economists to flail about defending the indefensible, they will be quite vicious at times, and in their panic to defend the work they have spent their lives on, they may not be very careful about the arguments they make. I don’t know if the defenders of the classical faith have come to this realization yet, at least beyond the subconscious level, and the profession will most likely move in the same old direction for awhile due to research inertia if nothing else. But I think what has happened will have a much bigger impact on the profession and the models it uses to describe the world than most economists currently realize:

A Dark Age of macroeconomics… Paul Krugman: “Brad DeLong is upset about the stuff coming out of Chicago these days—and understandably so….

…First Eugene Fama, now John Cochrane, have made the claim that debt-financed government spending necessarily crowds out an equal amount of private spending, even if the economy is depressed—and they claim this not as an empirical result, not as the prediction of some model, but as the ineluctable implication of an accounting identity. There has been a tendency, on the part of other economists, to try to provide cover to claim that Fama and Cochrane said something more sophisticated than they did. But if you read the original essays, there’s no ambiguity—it’s pure Say’s Law, pure “Treasury view”, in each case…. Both… are asserting that desired savings are automatically converted into investment spending, and that any government borrowing must come at the expense of investment—period. What’s so mind-boggling about this is that it commits one of the most basic fallacies in economics—interpreting an accounting identity as a behavioral relationship….

So how is it possible that distinguished professors believe otherwise? The answer, I think, is that we’re living in a Dark Age of macroeconomics… knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed…. The knowledge that S=I doesn’t imply the Treasury view—the general understanding that macroeconomics is more than supply and demand plus the quantity equation—somehow got lost in much of the profession….

Given their understanding of… the basics not the hard stuff, it’s becoming a lot easier to understand how financial economists missed the developing bubble and the effect it would have…. One thing I’ve learned from the current episode is not to automatically trust that the most well-known economists in the field have done due diligence before speaking out on an issue, even when that issue is of great public importance, or even to trust that they’ve thought very hard about the problems they are speaking to.

I used to think that, for the most part, the name brands in the field would live up to their reputations, that they would think hard about problems before speaking out in public, that they would provide clarity and insight, but they haven’t. In fact, in many cases they have undermined their reputations and confused the issues.

People have been deferential in the past, myself included, and these people have been given authority in the public discourse-even when they are demonstrably wrong their arguments show up in the press as a “he said, she said” presentation. But, unfortunately for the economics profession and for the public generally, the so called best and brightest among us have not lived up to the responsibilities that come with the prominent positions that they hold…

Should-Read: Paul Krugman (2009): Economists, ideology, and stimulus: “Mark Thoma and Brad DeLong are both, in slightly different ways, perturbed by the state of debate over fiscal stimulus. So am I…

…This has not been one of the profession’s finest hours. There are certainly legitimate arguments against spending-based fiscal stimulus. You can worry about the burden of debt; you can argue that the government will spend money so badly that the jobs created are not worth having; and I’m sure there are other arguments worth taking seriously.

What’s been disturbing, however, is the parade of first-rate economists making totally non-serious arguments against fiscal expansion. You’ve got John Taylor arguing for permanent tax cuts as a response to temporary shocks, apparently oblivious to the logical problems. You’ve got John Cochrane going all Andrew-Mellon-liquidationist on us. You’ve got Eugene Fama reinventing the long-discredited Treasury View. You’ve got Gary Becker apparently unaware that monetary policy has hit the zero lower bound. And you’ve got Greg Mankiw — well, I don’t know what Greg actually believes, he just seems to be approvingly linking to anyone opposed to stimulus, regardless of the quality of their argument.

Needless to say, everyone I’ve mentioned is politically conservative. That’s their right: economists are citizens too. But it’s hard to avoid the conclusion that all of them have decided on political grounds that they don’t want a spending-based fiscal stimulus — and that these political considerations have led them to drop their usual quality-control standards when it comes to economic analysis.

Has there been any comparable outbreak of mass bad economics from good liberal economists? I can’t think of one, although maybe that’s my own politics showing. In any case, what’s happening now is pretty disturbing…

Should-Read: Paul Krugman (2011): It’s Not About Welfare States: “Whenever a disaster happens, people rush to claim it as vindication for whatever they believed before. And so it is with the euro…

…As an aside, the interesting thing about the euro from a political point of view is the way it cut across the ideological spectrum. It was hailed by the Wall Street Journal crowd, who saw it as a sort of milestone on the way back to gold, and by many on the British left, who saw it as a way to create an alliance of social democracies. It was criticized by Thatcherites, who wanted to be free to move Britain in an American direction, and by American liberals, who believed in the importance of discretionary monetary and fiscal policy.

But now that the thing is in trouble, people on the right are spinning this as a demonstration that … strong welfare states can’t work.

So, just to say what should be obvious, the countries in trouble are not in any way marked out by having especially generous welfare states. You can use a number of indicators; here’s the OECD measure of “social expenditure”, measuring (separately and together) both public spending and private spending that is channeled and regulated by public policy, like US employer-based health insurance.

Sweden, with the largest social expenditure, is doing just fine. So is Denmark. And Germany, which is the up side of the pulling-apart euro, has a bigger welfare state than the GIPS.

Not that the facts will convince anyone on the right, but the blame-the-welfare-state meme is nonsense…

Should-Read: Mark Thoma (2009): “Can Economists Be Trusted?” “Are There Ever Any Wrong Answers in Economics?”: “Let’s ask another question. Does Greg Mankiw believe in the classical model he is using to defend Fama (in the classical model, the LM curve is vertical, and a vertical LM curve leads to a vertical supply curve, and to the result that demand side policies such as a change in government spending or taxes cannot change real output)?…

…I disagree … that the LM curve is vertical… Introspection is not a particularly reliable way to measure elasticities. There is a substantial empirical literature on money demand that demonstrates that it is interest-elastic…. According to Ball, the interest semi-elasticity of money demand is -0.05: This means that an increase in the interest rate of one percentage point, or 100 basis points, reduces the quantity of money demanded by 5 percent.

How far off is the vertical LM case as a practical matter? One way to answer this question is to look at the fiscal-policy multiplier. In chapter 11 of my intermediate macro text, I give the government-purchases multiplier from one mainstream econometric model. If the nominal interest rate is held constant, the multiplier is 1.93. If the money supply is held constant, the multiplier is 0.60. If the LM curve were completely vertical, the second number would be zero…

Greg has been pretty good at saying there is a lot of uncertainty about the fiscal policy multipliers, and about explaining why estimates differ across studies, and why he favors one set of estimates over another, so I don’t want to come down too hard on his disagreement with the 1.93 figure in his “favorite textbook”, but it does seem like he is defending Fama with a model that he does not believe in…

Should-Read: Paul Krugman (2010): The Instability of Moderation: “Brad DeLong writes of how our perception of history has changed in the wake of the Great Recession…

…We used to pity our grandfathers, who lacked both the knowledge and the compassion to fight the Great Depression effectively; now we see ourselves repeating all the old mistakes. I share his sentiments.

But watching the failure of policy over the past three years, I find myself believing, more and more, that this failure has deep roots–that we were in some sense doomed to go through this. Specifically, I now suspect that the kind of moderate economic policy regime Brad and I both support–a regime that by and large lets markets work, but in which the government is ready both to rein in excesses and fight slumps–is inherently unstable. It’s something that can last for a generation or so, but not much longer.

By “unstable” I don’t just mean Minsky-type financial instability, although that’s part of it. Equally crucial are the regime’s intellectual and political instability.


Intellectual instability: The brand of economics I use in my daily work–the brand that I still consider by far the most reasonable approach out there – was largely established by Paul Samuelson back in 1948, when he published the first edition of his classic textbook. It’s an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasizes the way the economy can develop magneto trouble, requiring policy intervention. In the Samuelsonian synthesis, one must count on the government to ensure more or less full employment; only once that can be taken as given do the usual virtues of free markets come to the fore.

It’s a deeply reasonable approach–but it’s also intellectually unstable. For it requires some strategic inconsistency in how you think about the economy. When you’re doing micro, you assume rational individuals and rapidly clearing markets; when you’re doing macro, frictions and ad hoc behavioral assumptions are essential.

So what? Inconsistency in the pursuit of useful guidance is no vice. The map is not the territory, and it’s OK to use different kinds of maps depending on what you’re trying to accomplish: if you’re driving, a road map suffices, if you’re going hiking, you really need a topo.

But economists were bound to push at the dividing line between micro and macro – which in practice has meant trying to make macro more like micro, basing more and more of it on optimization and market-clearing. And if the attempts to provide “microfoundations” fell short? Well, given human propensities, plus the law of diminishing disciples, it was probably inevitable that a substantial part of the economics profession would simply assume away the realities of the business cycle, because they didn’t fit the models.

The result was what I’ve called the Dark Age of macroeconomics, in which large numbers of economists literally knew nothing of the hard-won insights of the 30s and 40s–and, of course, went into spasms of rage when their ignorance was pointed out.


Political instability: It’s possible to be both a conservative and a Keynesian; after all, Keynes himself described his work as “moderately conservative in its implications.” But in practice, conservatives have always tended to view the assertion that government has any useful role in the economy as the thin edge of a socialist wedge. When William Buckley wrote God and Man at Yale, one of his key complaints was that the Yale faculty taught–horrors!–Keynesian economics.

I’ve always considered monetarism to be, in effect, an attempt to assuage conservative political prejudices without denying macroeconomic realities. What Friedman was saying was, in effect, yes, we need policy to stabilize the economy–but we can make that policy technical and largely mechanical, we can cordon it off from everything else. Just tell the central bank to stabilize M2, and aside from that, let freedom ring!

When monetarism failed–fighting words, but you know, it really did—it was replaced by the cult of the independent central bank. Put a bunch of bankerly men in charge of the monetary base, insulate them from political pressure, and let them deal with the business cycle; meanwhile, everything else can be conducted on free-market principles.

And this worked for a while–roughly speaking from 1985 to 2007, the era of the Great Moderation. It worked in part because the political insulation of central banks also gave them more than a bit of intellectual insulation, too. If we’re living in a Dark Age of macroeconomics, central banks have been its monasteries, hoarding and studying the ancient texts lost to the rest of the world. Even as the real business cycle people took over the professional journals, to the point where it became very hard to publish models in which monetary policy, let alone fiscal policy, matters, the research departments of the Fed system continued to study counter-cyclical policy in a relatively realistic way.

But this, too, was unstable. For one thing, there was bound to be a shock, sooner or later, too big for the central bankers to handle without help from broader fiscal policy. Also, sooner or later the barbarians were going to go after the monasteries too; and as the current furor over quantitative easing shows, the invading hordes have arrived.


Financial instability: Last but not least, the very success of central-bank-led stabilization, combined with financial deregulation – itself a by-product of the revival of free-market fundamentalism–set the stage for a crisis too big for the central bankers to handle. This is Minskyism: the long period of relative stability led to greater risk-taking, greater leverage, and, finally, a huge deleveraging shock. And Milton Friedman was wrong: in the face of a really big shock, which pushes the economy into a liquidity trap, the central bank can’t prevent a depression.

And by the time that big shock arrived, the descent into an intellectual Dark Age combined with the rejection of policy activism on political grounds had left us unable to agree on a wider response.

In the end, then, the era of the Samuelsonian synthesis was, I fear, doomed to come to a nasty end. And the result is the wreckage we see all around us…

#weekendreading #shouldread

April 21, 2018


Brad DeLong
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