Morning Must-Must-Read: Noah Smith: What Causes Recessions?

Noah Smith: What Causes Recessions?: “Some people–the types who think the market is self-adjusting and wonderful and doesn’t need any government help…

…believe that recessions are a natural, even healthy process… responses to changes in the rate of technological progress, or to news of future progress, or even bursts of creative destruction. Others… believe that there’s something blocking the market from adjusting to the shocks that buffet it. The market adjusts by the price mechanism…. So if you want to show that the market doesn’t naturally self-regulate, the simplest and easiest way is just to show that prices themselves can’t adjust in response to events. This phenomenon is called ‘sticky prices.’… Greg Mankiw and Lawrence Ball wrote an essay for the National Bureau of Economic Research entitled ‘A Sticky-Price Manifesto.’…

The economic establishment reacted harshly…. ‘Why do I have to read this?’ fumed Robert Lucas, the dean of macroeconomics. ‘This paper contributes nothing.’ He went on to accuse the sticky-pricers of being opposed to science and progress:

But Lucas fumed in vain…. Sticky-price theorists proved that you didn’t need a lot of price stickiness to mess up the smooth working of the economy. Even the tiniest dash of stickiness would turn all kinds of theories on their heads…. Sticky-price models still have their dogged opponents here and there throughout the macroeconomics world. Steve Williamson of the Federal Reserve Bank of St. Louis dismisses sticky prices on his blog, saying that the Great Recession went on too long to have been caused by price stickiness, and that sticky-price models have conquered central banks mainly due to slick marketing…. The moral of the story is that if you just keep pounding away with theory and evidence, even the toughest orthodoxy in a mean, confrontational field like macroeconomics will eventually have to give you some respect.

People should read Robert Lucas’s unhinged discussion of Ball-Mankiw:

Robert E. Lucas, Jr. (1994), “Comments on Ball and Mankiw,” Carnegie-Rochester Conference Series on Public Policy 41, pp. 153-155….

Why do I have to read this? The paper contributes nothing not even an opinion or belief–on any of the substantive questions of macroeconomics. What fraction of U.S. real output variability in the postwar period can be attributed to monetary instability? Cochrane’s paper addresses this question, as have Barro, Kydland and Prescott, Shapiro and Watson, and many other recent writers. It appears to be a very difficult one. Ball and Mankiw have nothing to offer on this question, beyond saying, trivially, that they believe the answer is a positive number and suggesting, falsely and dishonestly, that others have asserted it is zero. Yet monetary non-neutrality is the intended subject of their paper!

One can speculate about the purposes for which this paper was written–a box in the Economist?–but obviously it is not an attempt to engage other macroeconomic researchers in debate over research strategies. The cost of the ideological approach adopted by Ball and Mankiw is that one loses contact with the progressive, cumulative science aspect of macro-economics. In order to recognize the existence and possibility of research progress, one needs to recognize deficiencies in traditional views, to acknowledge the existence of unresolved questions on which intelligent people can differ. For the ideological traditionalist, this acknowledgement is too risky. Better to deny the possibility of real progress, to treat new ideas as useful only in refuting new heresies, in getting us back where we were before the heretics threatened to spoil everything. There is a tradition that must be defended against heresy, but within that tradition there is no development, only unchanging truth. Research that was in fact directed at difficult questions becomes trivialized, no matter which side it is on. Hume, Friedman, Schwartz, Keynes, Hicks, Modigliani become merely interchangeable spokesmen for a fixed set of ideas.

Why does it matter that Friedman and Schwartz carefully assembled and examined data on U.S. monetary history, if the real effects of changes in money were evident to Hume, who had no systematic data on either money or production? Why does it matter that Hicks and Modigliani showed us how to distill intelligible equation systems out of the confusions of Keynes’s Genera/ Theory? Why does it matter that theorists today are developing new models of pricing? If work like this represents progress, it must be because it contributes to resolving some difficulty or deficiency with earlier theory or evidence or both. If the IS/LM model as passed on to us by Hicks and Modigliani is all we need, why do I need to work through hard papers by Caballero or Caplin and Leahy? If these papers offer nothing more than debating points against heretics, I would rather do something else!…

For Ball and Mankiw there can be no real progress, so real business cycle theory is only a threat: It must be defeated, and then we can go back to where we were “a generation ago” (to quote from the draft given at the conference). The possibility of a synthesis of old and new ideas that might leave us better off cannot be envisioned. A few years ago, one of my sons used the Samuelson-Nordhaus textbook in a college economics course. When I visited him, I looked at the endpaper of the book to see if actual GNP was getting any closer to potential GNP than it had been in the edition I had used many years earlier. But the old chart was gone, and in its place was a kind of genealogy of economic thought, with boxes for Smith and Ricardo at the top, and a complicated picture of boxes connected by lines, descending down to the present day. At the bottom were three boxes: On the left, a box labelled “Communist China”; in the center, and slightly larger than the rest, a box labelled “Mainstream Keynesianism.” The last box, on the right, was labelled “Chicago monetarism.”

Times change. Accordingly, to Ball and Mankiw, Chicago monetarism (or at least Milton Friedman) now shares the middle, mainstream box, and there is a new group for the right-hand box, to be paired with the Chinese communists. But the tradition of argument by innuendo, of caricaturing one’s unnamed opponents, of using them as foils to dramatize one’s own position, continues on. I am sorry to see it perpetuated by Ball and Mankiw, and I hope they will put it behind them and return to the research contributions we know they are capable of making.

April 10, 2015

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