War Among the Economists

PK

[T]he ideas of economists and political philosophers, both when they are right

and when they are wrong, are more powerful than is commonly understood.

Indeed the world is ruled by little else. Practical men, who believe themselves to

be quite exempt from any intellectual influences, are usually the slaves of some

defunct economist. Madmen in authority, who hear voices in the air, are

distilling their frenzy from some academic scribbler of a few years back. I am

sure that the power of vested interests is vastly exaggerated compared with the

gradual encroachment of ideas. Not, indeed, immediately, but after a certain

interval; for in the field of economic and political philosophy there are not many

who are influenced by new theories after they are twenty-five or thirty years of

age, so that the ideas which civil servants and politicians and even agitators

apply to current events are not likely to be the newest. But, soon or late, it is

ideas, not vested interests, which are dangerous for good or evil.

Who cares what economists think? Keynes, conclusion ofThe General Theory of Employment, Interest, and Money:

When the Great Recession struck, and Obama proposed afiscal stimulus as a response, many economists were infavor – but there was also substantial pushback

This controversy had its roots in an economic debate thatbegan in the 1960s

Until the late 1960s, there was broad consensus that recessionsreflected a fall in aggregate demand.

There was dispute over why demand fell and what should bedone about it. Traditional Keynesians blamed unstable privateinvestment (“animal spirits”) and called for fiscal policy;monetarists, led by Milton Friedman, blamed destabilizingmonetary policy and called for a money growth rule

But why did money have real effects? The search for“microfoundations”

The “Phelps volume” view:sticky prices due to imperfectinformation

Also Friedman on natural rate

Big prediction: any attempt totrade off higher inflation forlower unemployment will cause apparent tradeoff todisappear

Unemployment versus inflation, 1959-68

The same, 1959-1980

But if it’s imperfect information, doesn’t this mean thatpolicy only works by fooling people? And in that case can activist policy ever be useful? Rise of rational expectations

Lucas, 1980:

“One cannot find good, under-forty economists who identifythemselves or their work as‘Keynesian’. Indeed, people eventake offense if referred to as ‘Keynesians’. At researchseminars, people don’t take Keynesian theorizing seriouslyanymore; the audience starts to whisper and giggle to one another.”

Keynesian revival in the 1980s

Costly disinflationin the 1980s seemedat odds with rationalexpectations

Saltwater versus freshwater

Saltwater dominates policy positions:

Ben Bernanke, Ph.D. MIT 1979

Janet Yellen, previously at Berkeley

Mario Draghi (ECB), Ph.D. MIT 1976

Olivier Blanchard (chief economist of IMF), Ph.D. MIT 1977

Lawrence Summers, Ph.D. Harvard

But freshwater has a strong role in academics

Ken Rogoff, 2001:

The Chicago-Minnesota School maintained that sticky prices were nonsense and continued to advance this view for at least another fifteen years. It was the dominant view in academic macroeconomics. Certainly, there was a long period in which the assumption of sticky prices was a recipe for instant rejection at many leading journals. Despite the religious conviction among macroeconomic theorists that prices cannot be sticky, the Dornbusch model remained compelling to most practical international macroeconomists. This divergence of views led to a long rift between macroeconomics and much of mainstream international finance …

There are more than a few of us in my generation of international economists who still bear the scars of not being able to publish sticky-price papers during the years of new neoclassical repression.

Trends

The phony peace

And then came the crisis – and the stimulus

Robert Lucas: “Christina Romer — here’s what I think happened. It’s her first day on the job and somebody says, you’ve got to come up with a solution to this — in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.

“So she scrambled and came up with these multipliers and now they’re kind of — I don’t know. So I don’t think anyone really believes. These models have never been discussed or debated in a way that that say — Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics.”

The Booth School survey

The big issue: crowding out

Traditional crowding out: interest rates

“Immaculate” crowding out: John Cochrane

First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about “crowding out.”

Market confidence arguments