Wednesday, 8 February 2012

More on Schools of Thought

                The main task of this post is to try and answer the following question: why do schools of thought seem to fragment mainstream macroeconomics but not microeconomics? However before tackling that issue, I need to clear some ground raised by some interesting comments on my earlier posts on this issue.
                One point I did not make clear enough in my earlier discussion is a distinction between mainstream and heterodox economics. The latter might include neo-Marxists, post Keynesians, Austrians and others. My concern was about mainstream macroeconomics becoming fragmented into schools of thought. I can see why those challenging the mainstream might find schools of thought both convenient and useful. I also think it is very important that the mainstream should be continually challenged.
                I also may not have emphasised enough the downside of the microfoundations project. I do worry that it may help to exclude good ideas, as James Galbraith suggests, and have written about how this could be dangerous for policymakers who rely on the mainstream. However I still believe that microfoundations, if interpreted flexibly, bring net benefits. But that is not the focus of what I wanted to say on schools of thought.
                The success of the microfoundations project is also why I agree with Steve Williamson that academic work in macro is probably not as fragmented as it was in the 1970s. (I was not an academic at the time, so I cannot be sure.) In that sense, academic macroeconomists when doing academic work can still locate what they do within a common, mainstream framework. We all use models that abstract from many things to focus on what we think is important for some particular issue, and we receive criticism about whether those abstractions are valid or not. My concern about schools was more with the interface between academia and policy, which includes the advice academics give, what economic journalists write, and what politicians pick up.
                The kind of thing I had in mind here include politicians thinking that austerity would not increase unemployment, because those that worried that it would were from the same misguided Keynesian school that opposed Margaret Thatcher’s monetarism in 1981. Journalists who find it easier to slot every debate into one between schools rather than address issues on their merits. And academics who attempt to argue that certain views are not worthy of consideration because they were confined to the dustbin 30 years earlier. Jonathan Portes gave similar examples in his post.
                One of the interesting things about schools of thought in mainstream macroeconomics is that there does not seem to be anything similar in microeconomics. Now such a generalisation invites counterexamples. Some might point to the debate over the methodology of behavioural economics, for example. However most of my academic colleagues who I have road tested this idea on do agree that macroeconomics seems more prone to schools fragmentation than microeconomics. If this is true today, it is strange, because macroeconomics has become microfounded.
                One simple answer to this paradox is that schools of thought are associated with macroeconomic crises, and macro synthesis follows periods of calm. Keynesian theory itself was born out of the Great Depression. The first Neoclassical Synthesis arose from the period of strong growth and low inflation in the post-war period. Monetarism gained strength from the rapid inflation of the 1970s. The more recent synthesis may be a child of the Great Moderation, and now we have the Great Recession, schools of thought have returned. Because these crises are macroeconomic, and there are no equivalent crises involving microeconomic behaviour or policy, then fragmentation of the mainstream into schools will be a macro, not micro, phenomenon.
                Attractive though this account seems, I think it misses some important points. As one of the comments on my original post pointed out, the New Neo-classical Synthesis was in many ways a celebration of New Keynesian theory which was not shared by many freshwater departments in the US. Now I think there are good reasons why New Keynesian economists might have imagined that their analysis was an uncontested part of the mainstream. As I noted here, it is used in nearly all central banks as their main tool in carrying out monetary policy. With monetary policy somewhat depoliticised through central bank independence, the Great Moderation allowed this division among academic departments to remain dormant.
                On the other side, there was a belief that New Classical economics had been revolutionary: a successful counter-revolution against Keynesian ideas.  Once again there were good reasons to support this belief. Nick Rowe in his comment on my Anti-Keynesian School post noted how many Monetarist ideas, opposed at the time by many Keynesians, were now part of the mainstream. We could do the same for the battles between New Classical and Keynesian economists: on consumption, rational expectations, the Lucas critique and more, traditional Keynesians had unsuccessfully opposed New Classical ideas. Furthermore, many of the leaders of New Classical thought did not want to update Keynesian thinking, they wanted to destroy it.
                There is a lot more that could be said here, but it would lead me to the conclusion that this counter-revolution failed. It led to fundamental and largely progressive changes in Keynesian analysis, and macroeconomics more generally, and Keynesian analysis survived and prospered. Yet, for many reasons including ideological ones, the would-be counterrevolutionaries did not want to give up their counterrevolution.
                So, perhaps unlike the first (post-war) neoclassical synthesis, the New Neoclassical Synthesis was partial in terms of its coverage among academics. This incompleteness was not apparent during the Great Moderation, because the synthesis was applied in nearly every central bank. The fault lines only became apparent when monetary policy became relatively impotent at the zero bound after the Great Recession, and fiscal stimulus was used both in the US and UK. Once that happened, what I called the Anti-Keynesian school re-emerged.
                This back story is important, because it raises the possibility of an optimistic (from a Keynesian point of view) way forward. This is that the New Neo-Classical synthesis becomes complete. (For possible signs that this has already begun, see here.) The microfoundation of macroeconomics does logically imply that mainstream macro should be as free from alternative schools as microeconomics. This would require freshwater macroeconomists to recognise that New Keynesian models are essentially RBC models plus sticky prices, and that the addition of price rigidity was not that offensive. All would recognise that the conditions in which fiscal policy was a major stabilisation tool were either rather unusual (the zero bound), or geographically remote (monetary union), and so not something to get so worked up about. Freshwater economists would come to realise that demand denial  just did not make academic sense.
                I fear a more realistic conclusion is that the Keynesian/Anti-Keynesian division is always going to be with us, because it reflects an ideological divide about state intervention. (For some supporting evidence, see here.) That divide occurs all the time in microeconomics, but because it involves arguing about many different externalities or imperfections it does not lend itself to fragmentation into schools. In macro, however, there is one critical externality to do with price rigidity, and so disagreements about policy can easily be mapped into differences about theory. Demand denial is attractive because it gives a non-ideological justification for what is essentially an ideological position about economic policy.

11 comments:

  1. Simon: "This would require freshwater macroeconomists to recognise that New Keynesian models are essentially RBC models plus sticky prices,...."

    I can imagine a model of a barter economy with sticky prices. And I can imagine a model of a monetary exchange economy with sticky prices. And those two models are very very different.

    In my opinion, New Keynesian macroeconomic models only make sense as models of monetary exchange economies. And the whole concept of aggregate demand and the problem of deficient demand only make sense in a monetary exchange economy.

    And I'm really not sure if all New Keynesians understand the importance of this distinction, and that NK models only make sense (if at all) in a monetary exchange economy. (I.e. NK models are nonsense in a barter economy).

    And I'm even less sure if "freshwater economists" are clear on this distinction.

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    1. "And I'm really not sure if all New Keynesians understand the importance of this distinction, and that NK models only make sense (if at all) in a monetary exchange economy. (I.e. NK models are nonsense in a barter economy)."

      I'm pretty sure Woodford would explicitly reject this assertion, he seems to believe money is not important for NK results, except as a unit of account. All that matters are sticky prices and the ability to control the interest rate.

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  2. On the micro vs macro difference: It seems to me that due to the prevalence of aggregate feedback loops in macro (output becomes income, savings becomes investment + consumption etc.) even minor behavioral "irrationalities" tend to amplify into major effects under some extreme conditions. E.g. herding leads to flights to safety leading to liquidity trap, inflation illusion leads to price stickiness leading to labor market clearance failure etc. This matters much less in micro since *aggregation* and feedback amplification are not that much of a problem.

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  3. "The microfoundation of macroeconomics does logically imply that mainstream macro should be as free from alternative schools as microeconomics."

    This is only true insofar as microeconomics means the same thing in both macro and micro. I'm not sure that it does. Microeconomists typically don't take the microfoundations in macro seriously; they seem to regard them as less rigorous than "proper" microeconomic analysis. So, even though macroeconomists claim to use models with microfoundations, this doesn't imply the analysis should be as free from schools of thought as micro appears to be.

    As for the absence of schools of thought within micro, I wonder if there's an element of people who tend to favour government intervention studying models with externalities, whereas others regard externalities as unimportant and hence research something else. I've often thought there may be an element of this in the climate change "consensus", as one is unlikely to become a climate change scientist if he does not initially believe in climate change, just as he is unlikely to devote his life to the study of the Bible if he is an atheist.

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    1. Scientists choose to study climate. The "change" aspect of it is an observation, not a vocation.

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    2. Perhaps. It would be interesting to know how the number of climate scientists and the amount of climate research has evolved since the climate change hypothesis became popular in the 1970s and 1980s.

      As a layman, my impression is that prior to the climate change hypothesis climatology was a much smaller field, mainly focused on understanding how the weather has evolved over time as a result of natural factors. Today, the enterprise seems much bigger and more focused on the possibility of human-caused climate change (and hence rather less scientific because there is much less evidence to go on--i.e. the past 100 years or so--and much more focused on extrapolating trends into the future).

      If I'm right, then there has been a big change whereby a rather small, arcane field of study has been replaced by a large-scale enquiry into the possibility of averting global disaster. Thus, most of the scientists currently in the field are probably motivated by the "sexy" climate change hypothesis, rather than the dry study of historical weather patterns.

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  4. "monetary policy became relatively impotent at the zero bound after the Great Recession"

    UK real GDP, quarter on quarter, vs Bank Rate:

    2008 Q1: 0.0% (Bank Rate: 5% throughout)
    2008 Q2: -1.5% (Bank Rate: 5% throughout)
    2008 Q3: -2.0% (Bank Rate: 5% throughout)
    2008 Q4: -2.3% (Bank Rate dropped to 2%; average rate over quarter 3.3%)
    2009 Q1: -1.6% (Bank Rate lowered to 0.5% by March, average rate 1% over q)

    This is the period during which monetary policy was "potent"? The UK suffered its deepest contraction in modern history in the period above, and Bank Rate was ABOVE ZERO FOR ALMOST ALL OF THAT PERIOD.

    If your model tells you monetary policy is effective ABOVE the ZLB, then why are you not decrying the MASSIVE failure of monetary policy in 2008? Why are you not asking how the Bank of England failed so badly?

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  5. Macro is limited. It tells you if something changes, something else must, but it doesn't necessarily tell you what the something else is. If only two things change, depending on which two they are macro either tells you they both go up or down together, or it tells you that as one goes down, the other goes up.

    It does not tell you how to make something happen - except if you control everything else, in which case you know it has to happen. But if you could control everything else you would be God and we wouldn't be in a mess.

    Various macro schools of thought reflect different views on what could happen, what might happen, or what has been known to happen in response to some change or other. These differences give rise to disagreements.

    Micro is about linkages and mechanisms. There are an imaginably large number of these, all of which are probably valid somewhere, so none of them are wrong. Each economist can add his or her own pet linkage without disagreeing about the other linkages of other economists. No discourteous disagreements are necessary, so no tribal taking sides in a duel to the death!

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  6. it reflects an ideological divide about state intervention

    is that true, or are those of us who are cynics right: that 1/2 of the divide is a group of economists who are continually seek to maximize their future earnings potential

    http://www.nakedcapitalism.com/2011/04/blacklisted-economics-professor-found-dead-nc-publishes-his-last-letter.html

    of course, events only re-enforce this POV

    Look at this paragraph by Alan Greenspan, so well mocked by so many:

    Today’s competitive markets, whether we seek to recognise it or not, are driven by an international version of Adam Smith’s “invisible hand” that is unredeemably opaque. With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.

    http://crookedtimber.org/2011/03/30/with-notably-rare-exceptions/

    Taylor then invites someone this intellectually dishonest to speak and participate in his new book and nothing is done to defrock either Taylor or Greenspan.

    Those of us in the public watch this level of intellectual dishonesty and have rightly concluded that something is very very wrong about macro.

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  7. "The kind of thing I had in mind here include politicians thinking that austerity would not increase unemployment, because those that worried that it would were from the same misguided Keynesian school that opposed Margaret Thatcher’s monetarism in 1981. "

    Didn't her policies radically increase unemployment?

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  8. I lived through Thatcher's economic policies and the unemployment devastated vast swathes of British society. It would seem that the old-school Keynesians were on to something. Thatcher's monetarism did nothing good and eventually led to rampant high interest rates 16.5% for a 30 year mortgage!! Can somebody tell me what good her policies did?

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