Macroeconomic Theory, Policy, and the Crisis

I have written a piece over at TCS Daily that discusses macroeconomic theory, policy, and the financial crisis. Here is a tease:

The conventional wisdom on the current financial crisis is that macroeconomic theory has little to say. I am not sure where this idea originated, but there is much that can be explained from existing theory especially in regards to policy. The work of Robert Barro, Charles Plosser and John Long as well as Nobel laureates such as Milton Friedman, Franco Modigliani, Finn Kydland, and Ed Prescott have much to say about the impact of macroeconomic policy.

Unfortunately, with a few notable exceptions, the work of these economists has received scant attention during the current crisis. Nonetheless, their work remains important in explaining the futility of much of the current policy prescriptions. Equally disturbing is the return of self-professed Keynesians with policy prescriptions that are wholly inconsistent with both Keynes and modern macroeconomic theory.

Read the whole thing.

5 responses to “Macroeconomic Theory, Policy, and the Crisis

  1. This column is very well done, my applause for you!

  2. Catherine MacLeod

    I agree wholeheartedly.
    The hope is that the market will eventually punish / push policy makers into realising the mistakes they are making – if policy makers are able to realise the cause..

    For example, in the UK, CDS have blown out following the “stimulus package” announced in November. This package centres around a temporary VAT cut and significant tax hikes in the future. Simple Ricardian equivalence would suggest that this is meaningless in terms of stimulus – and CDS spreads have suggested the same.
    In the US, where faith in more permanent tax cuts and the govt’s willingness / ability to run higher deficits is greater, CDS spreads have increased.
    Too bad that they aren’t picking up on it yet.

  3. I’m sorry but I am now very confused. You seem to be saying that “modern” macroeconomics produces the same prescriptions as good old Keynes. Yet at the same time you also seem to divide the profession into one side (the general equilibrium types) who think there is little that government can or should do to fix unemployment (because it isn’t there!), and another side that regained their faith in simple 1936-era Keynesian tools just as the US economy tanked. I think the real “divide” is between those who model only with rationality, and the others who consider that irrationality is large and variable enough that it cannot be contained in a well-behaved error term. And where would you categorize the Minsky-type approaches, which also seem to make sense and would have uncannily foreseen the present crisis, except that the very top guys in the field don’t seem to listen to them.

  4. I am currently studying Intermediate Macroeconomics and I don’t precisely comprehend how this huge ” stimulus packages” that Washington and London are overzealous about is going to bring their economies back on track.
    On a different note though, how is going to get this menace when it grows worse day in day out?

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