The Return of Schools of Thought Macro

When I first studied macro, it was all about ‘schools of thought’. Keynesians, Monetarists, New Classicals, and probably many more I cannot remember. Macroeconomists tended to take sides. Antagonists often talked across each other, and anyone not already on one side just got totally confused. I recall reading one textbook on international macro where each chapter represented an alternative ‘view’, with no clear idea of how each view or school was related to another. One thing that was pretty clear, however, was that most schools of thought could be identified with a particular ideological position.

                But then things began to change. The discipline appeared to become much more unified. It would be going much too far to suggest that there was a general consensus, but to use a tired cliché, most macroeconomists started talking the same language, even if they were not saying the same thing. I think there were two main reasons for this. The first was microfoundations: deriving the components of macro models from standard optimisation applied to representative agents. This gave macroeconomics the potential to achieve the same degree of unity as microeconomics. The second was the development of New Keynesian theory, which allowed an analysis of aggregate demand within a microfounded framework, and which integrated ideas like rational expectations and consumption smoothing into Keynesian analysis. To use the jargon, all models were now DSGE models.

                Goodfriend and King coined the term ‘New Neoclassical Synthesis’ (call it ‘synthesis’ for short), and other authors wrote along similar lines. So, even as recently as five years ago, I told masters students starting a macro course to forget anything they might have been told about alternative schools of thought: they were going to learn a unified framework that most macroeconomists – the mainstream – would sign up to. It was like the first half of David Romer’s popular textbook: start with Solow, but quickly replace a fixed savings propensity by an optimising intertemporal consumer to get the basic Ramsey model. Add endogenous labour supply to get RBC. Probably talk a bit about overlapping generations. Hopefully add to what was in Romer by doing some open economy stuff. Then add New Keynesian theory built around sticky prices. If the student went on to work in a central bank, they would probably encounter this framework as a central part of that institution’s forecasting and policy analysis.

I think this synthesis and the reasons behind it may have had one or two unintended and unfortunate consequences. Sometimes the emphasis on microfoundations became a bit of a fetish. (I have written about the shaky methodological grounds on which ‘microfoundations purists’ sometimes stand here.) Some have suggested that the emphasis on microfoundations meant too much time was devoted to elements that were easy to model within that framework rather than the things that really mattered. But I personally thought this synthesis had many more positive than negative consequences. I would not wish for every single macroeconomist to sign up to the synthesis: there is an important role for heterodox economists. However I liked the fact that the majority of macroeconomists used the same analytical framework.

                Just five years later and it seems rather different. I’ve encountered a much larger range of economics blogs in the last week or two (you can guess why), and it does feel like going back in time. Schools of thought in macro are definitely back. Since the recession it has become clear that the synthesis had not been adopted everywhere. In particular, in sections of the profession there remained a suspicion (to put it mildly) of New Keynesian theory, and partly as a consequence of this the amount of this theory that was taught to graduates differed widely.

                It is true that for some, schools of thought can be quite fun. Some students find the idea that academic macroeconomics consists of opposing forces locked in combat adds a degree of interest and motivation that might otherwise be lacking. However I am not persuaded that this spice was sufficient to offset misunderstanding. Personally when I was a student I found all the motivation I needed from socially destructive inflation, and widespread unemployment should do the same today. I do think that the schools of thought approach leads to an inexactness which can be misleading and annoying.

                Take the label Keynesian. Look up Wikipedia, and in the third paragraph you will find ‘Keynesian economics advocates a mixed economy — predominantly private sector, but with a significant role of government and public sector...’. Now I have a much more limited idea of what Keynesian economics is. For me, Keynesian macro is business cycle analysis based on aggregate demand and sticky prices. By this definition, the only ‘significant role for the public sector’ required is a central bank. Even in the rather unusual (I hope) times of a zero lower bound, Keynesian advocacy of fiscal stimulus implies is that the government brings forward its bridge building, and not that it permanently build more bridges. Does my preferred definition make me narrow-minded?

 Keynesian analysis as I define it implies that you need monetary policy, and occasionally countercyclical fiscal policy, to stabilise the economy, but that is not what is generally meant by a mixed economy! The extent of the public sector’s involvement in the economy will depend on microeconomics, not macro. Now it is true that those who tend to be antagonistic to state intervention may be uncomfortable with monetary and fiscal stabilisation policy, as I have suggested, but I am against ideology clouding economics, and I certainly do not want this connection hard wired as a school of thought.

                School of thought thinking also tends to bracket ways of looking at the economy with policy prescriptions, even when they are not inextricably linked. Take countercyclical fiscal policy, for example. Is that an intrinsic part of Keynesian thinking? For some time there has been general agreement among most macroeconomists that monetary policy was the stabilisation tool of choice, because of issues like implementation lags. This view has been strengthened by analysis over the last ten years that explicitly looks at welfare derived from a representative agent’s utility: the analysis of a simple basic case is contained in the Woodford paper I referenced here, and some of my own collaborative work has shown this result is surprisingly robust. So linking the routine use of countercyclical fiscal policy to what I think of as Keynesian theory is just misleading.

                  This sort of bundling together of ideas under one label at the very least causes confusion. (Here Jonathan Portes gives one recent example.) Worse still, it leads people to take sides on issues not because of the merits of the case, but because that case is associated with a school of thought whose other elements they do or do not like. I also miss the synthesis. I very much liked the idea that disagreements could be clearly located within a common framework. With the synthesis, I felt macroeconomics began to look more like a unified discipline - more like micro, and dare I say it, more like a science than a belief system.