Must-Read: Lawrence Summers (2013): Reconstructing Macroeconomics

Must-Read: The view was that there was no harm done in modeling the Phillips curve as linear–that the inflation cost of having unemployment below the natural rate by 1%-point was offset by an equal inflation benefit to having unemployment above the natural rate by 1%-point. And the view was that inflation expectations were not “rational” in the Lucas but that there was no harm in modeling them as adaptive. But these–as Larry and I tried to argue back in 1988, without notable success–together synergized into a huge mistake that did a lot of harm:

Larry Summers (2013): Reconstructing Macroeconomics: “There is a central question: Should we think of macroeconomics as being about…

…as it was thought about before Keynes, and came to be thought of again in the 1990s–cyclical fluctuations about a trend determined somewhere else, where the goal if you were successful was to reduce [the fluctuations’] amplitude; or as centrally about tragic accidents where millions of more people were unemployed for millions more person-years at costs of trillions of dollars in ways that were avoidable with more satisfactory economic arrangements. Unless and until we adopt the second view, I think we are missing what is our principal opportunity to engage in human betterment. And as long as the question is conceptualized as ‘what friction should we insert into the existing DSGE model and we will have it?’, I don’t think we will get to the kind of perspective that I am advocating. Now it is easy to say this, it is easy to say this. It is much harder to provide a constructive vision of just how to do it. But there are a number of schools of work that to date… have been… abstract… multiple equilibria, fragile equilibria, and so forth… [that I think] have … [the] notion that… you have a very bad outcome that you somehow could have avoided without compromising the future…. It really is true that a little bit of avoiding what has happened over the past six years is worth a lot of making the amplitude of fluctuations around trend smaller. It seems hard to observe the past six years, which did not in fact achieve that much disinflation, and not think that it should somehow have been possible to avoid that waste.

August 13, 2015

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