Arnold Kling has a new article on modern macroeconomics. You may recall that I was somewhat critical of his previous piece on this topic. I think that this new piece is similarly off the mark as he continues to attack straw men (or, perhaps, he is attacking certain people who meet this criteria — of which I can think of a few — that are not representative of the discipline as a whole).
He begins with what he sees as evidence that there is some “new intuitive model” of the macroeconomy:
In the fall of 2011, the University of Chicago Business School, as part of its Initiative on Global Markets, created an expert panel of mainstream economists. The website states: “Our panel was chosen to include distinguished experts with a keen interest in public policy from the major areas of economics, to be geographically diverse, and to include Democrats, Republicans and Independents as well as older and younger scholars. The panel members are all senior faculty at the most elite research universities in the United States … a group with impeccable qualifications to speak on public policy matters.”
On March 6, 2012, the website reported on the results of asking this panel to agree or disagree with the following statement:
Because the U.S. Treasury bailed out and backstopped banks (by injecting equity into them in late 2008, and later committing to provide public capital to any banks that failed the stress tests and could not raise private capital), the U.S. unemployment rate was lower at the end of 2010 than it would have been without these measures.
The results were that 27 percent strongly agreed that the bailouts helped cushion the medium-term employment effects of the financial crisis, 51 percent agreed, 7 percent were uncertain, and the remaining 15 percent did not answer. Not a single panelist disagreed.
While I would grant that this represents the consensus today, one can imagine how the panel might have responded five years ago to a statement such as the following:
Monetary and fiscal policy tools are not sufficient for dealing with shocks to aggregate demand, such as asset market bubbles and crashes; these tools must instead be supplemented by other measures, such as injecting capital into banks and committing public capital to any banks that fail stress tests.
I would wager that many of the panelists, quite probably the majority, would have disagreed, even though this is basically the same statement as the one to which they voiced consensus agreement in March. For mainstream economists, the financial crisis has produced a new intuitive model of the economy which has yet to be articulated in any formal theory.
Does this mean that there is “a new intuitive model of the economy”? Despite Kling’s claim, I see no evidence. There are two very distinct questions being asked here and Kling seems to think they are exactly the same. They are not. One asks whether or not a particular policy helped. The second statement asks whether or not one thinks the policy is optimal (or at the very least necessary). I think that it is perfectly reasonable to assume that there are individuals who would agree with the first statement and disagree with the second statement. Thus, Kling’s main thesis is incorrect.
Thus, the mainstream view is that the financial crisis put the economy in such a deep hole that neither bank bailouts nor sizable fiscal and monetary policy could dig us out. However, this “deep hole” story is simply a way of reconciling a view that stimulus works with the fact that economic performance remains weak, particularly in terms of employment. There is little in the way of analysis that directly explains how the financial crisis put us into the “deep hole.”
Who is in the mainstream? This certainly doesn’t sound like the mainstream to me. In fact, Jim Bullard’s recent paper entitled, “Death of a Theory”, hammers home the point about what was mainstream prior to the crisis and how this consensus is beginning to emerge again. (I’m not going to re-hash the paper here, but I have discussed this paper previously.)
In addition, Kling claims that there is little in the way of directly explaining how the financial crisis put us in a deep hole. Where? There is an abundance of literature on banking and financial intermediation that existed before the crisis that can help us to understand the types of things that have happened and are going on. I don’t have time to write a survey in a blog post, but here are a few suggestions. Start with the work that Gary Gorton has done. His recent book summarized the events of the financial crisis in the context of the work that he and others have been doing over the course of the last couple decades. The initial work of Townsend and Williamson on costly state verification models and the extension of business cycle models to include these type of frictions such as that by Carlstrom and Fuerst as well as Bernanke, Gertler, and Gilchrist emphasize that endogenous changes in net worth amplify economic fluctuations. Franklin Allen and Douglas Gale wrote a book entitled Understanding Financial Crises prior to the crisis. In addition, see the work of Kiyotaki and Moore on liquidity.
Of course, one can quarrel with any of the work cited above, but one cannot claim that such work doesn’t exist!
Earlier this year, Bloomberg News had an article on the large number of graduates of the MIT economics department in charge of central banks or holding other important posts in Europe and elsewhere. The article delved into the outlook that MIT economists tend to share on the relationship between theory and policy. The article quotes from an essay by Paul Krugman.
The “MIT style,” according to Nobel laureate Paul Krugman, who received a doctorate from the university in 1977 and who is now a New York Times newspaper columnist, is the “use of small models applied to real problems, blending real-world observation and a little mathematics to cut through to the core of the issue.”
The article also describes the seminal role played by Paul Samuelson in the MIT economics department. Samuelson steered the department, and indeed the whole economics profession, toward using modes of analysis and discourse laden with mathematics, making it appear to resemble physics. Indeed, Samuelson was often accused of suffering from “physics envy.”
As with physics, the goal of many macroeconomists has been to predict and control economic phenomena on the basis of a minimal set of equations, the “small models” referred to by Krugman above. What I call the “modernist” view in economics is the view that small models give economists and policymakers the tools with which to explain, predict, and control economic growth and employment.
There are two points to make here. First, economists in general think that using mathematical tools helps to generate useful insights and explain economic events. This is correct. There is also nothing wrong with this practice. Math is a device that keeps our logic intact. Second, who thinks that these mathematical models are there to allow us to “control economic growth and employment.” I don’t see these statements in journal articles. Usually journal articles have statements like the following: “This paper demonstrates that X… Possible policy implications are …” I don’t know of any paper out there that purports to show how to “control economic growth and employment.”
Finally, Kling writes:
Now that we are experiencing another major downturn in the economy, the mainstream modernists will be doing another round of patching. (Note, however, that in part two of this series I described the “stubborn Keynesians” and “stubborn monetarists,” who would instead revert to the views they held prior to the round of patching that took place after the 1970s fiasco.)
There are some blogosphere-type Keynesians who think that we should go back to IS-LM. I don’t see the profession moving that way. In addition, “stubborn monetarists” don’t want to go back to the pre-rational expectations days of policy. Whether they are New Monetarists, Market Monetarists, and some brand of Old Monetarist, I think one would be hard pressed to find a member of these groups that want to throw out the last 40 years of macroeconomics — and those that do shouldn’t be taken seriously.
In short, Kling’s article seems to be an attack on a straw man. It seems that he is attacking some kind of caricature of what I would call “blogosphere Keynesianism.” But the blogosphere is a non-representative sample of the profession at large. And so are the views that Kling is attacking.