Winner of the New Statesman SPERI Prize in Political Economy 2016

Saturday 29 December 2012

Is academic macroeconomics flourishing?

How do you judge the health of an academic discipline? Is macroeconomics rotten or flourishing? Stephen Williamson is right that in one sense it is flourishing: many interesting avenues are being explored, and lots of interesting papers are getting written. Furthermore there is a common language. Of course there are pronounced local dialects, but there is mobility to, so having a freshwater dialect does not stop you giving a seminar that will be appreciated in a saltwater department, or indeed working in a saltwater department. So as an intellectual pursuit, one could claim that times have never been better for academic macro.

Society does fund some academics to engage in purely intellectual pursuits, but macroeconomics is not one of these. Yet much of the flourishing of ideas and research that is currently taking place has been inspired by recent events, and is directly or indirectly policy relevant. However having lots of ideas that are relevant to policy is not sufficient to make an academic discipline useful. It also needs to respond to the evidence in sorting out what ideas are helpful and what are not, so that it can be a progressive endeavour. In this respect, academic macroeconomics appears all over the place, with strong disputes between alternative schools.

Is this because the evidence in macroeconomics is so unclear that it becomes very difficult to judge different theories? I think the inexact nature of economics is a necessary condition for the lack of an academic consensus in macro, but it is not sufficient. (Mark Thoma has a recent post on this.) Consider monetary policy. I would argue that we have made great progress in both the analysis and practice of monetary policy over the last forty years. One important reason for that progress is the existence of a group that is often neglected - macroeconomists working in central banks.

Unlike their academic counterparts, the primary goal of these economists is not to innovate, but to examine the evidence and see what ideas work. The framework that most of these economists find most helpful is the New NeoClassical Synthesis, or equivalently New Keynesian theory. As a result, it has become the dominant paradigm in analysing monetary policy.

That does not mean that every macroeconomist looking at monetary policy has to be a New Keynesian, or that central banks ignore other approaches. It is important that this policy consensus should be continually questioned, and part of a healthy academic discipline is that the received wisdom is challenged. However, it has to be acknowledged that policymakers who look at the evidence day in and day out believe that New Keynesian theory is the most useful framework currently around. I have no problem with academics saying ‘I know this is the consensus, but I think it is wrong’. However to say ‘the jury is still out' on whether prices are sticky is wrong. The relevant jury came to a verdict long ago.

It is obvious that when it comes to using fiscal policy in short term macroeconomic stabilisation there can be no equivalent claim to progress or consensus. The policy debates we have today do not seem to have advanced much since when Keynes was alive. From one perspective this contrast is deeply puzzling. The science of fiscal policy is not inherently more complicated. What I have called a pure countercyclical increase in government spending (higher government spending now, financed by debt which is paid off by lower government spending once we are no longer at the Zero Lower Bound) can hardly fail to be expansionary in a New Keynesian framework if that debt can be sold.

What has been missing with fiscal policy has been the equivalent of central bank economists whose job depends on taking an objective view of the evidence and doing the best they can with the ideas that academic macroeconomics provides. This group does not exist because the need to use fiscal policy for short term macroeconomic stabilisation is occasional either in terms of time (when the Zero Lower Bound applies) or space (countries within the Eurozone). As a result, when fiscal policy was required to perform a stabilisation role, policymakers had to rely on the academic community for advice, and here macroeconomics clearly failed. Pretty well any outside observer would describe its performance as rotten.

The contrast between monetary and fiscal policy tells us that this failure is not an inevitable result of the paucity of evidence in macroeconomics. I think it has a lot more to do with the influence of ideology, and the importance of what I have called the anti-Keynesian school that is a legacy of the New Classical revolution. The reasons why these influences are particularly strong when it comes to fiscal policy are fairly straightforward.

Two issues remain unclear for me. The first is how extensive this ideological bias is. Is the over dominance of the microfoundations approach related to the fact that different takes on the evidence have an unfortunate Keynesian bias? Second, is the degree of ideological bias in macro generic, or is it in part contingent on the particular historical circumstances of the New Classical revolution? These questions are important in thinking how this bias can be overcome.


  1. Here's my bias: I hate fiscal policy for the same reason dentists hate pulling teeth. It's an admission of failure. If we got monetary policy right, we wouldn't need fiscal policy. We *ought* get monetary policy right, so we *oughtn't* need fiscal policy. Fiscal policy is a cop-out. It's a bodge job by a mechanic who recharges the battery as a temporary fix because he's too busy or lazy or incompetent to replace the alternator (magneto).

    I don't think the New Classical economists are especially political people. Like Steve Williamson, I think most of them are just nerds who love pure theory, which is fine, but you give them an office and a computer and wait and see what they eventually come up with. You don't put them in charge of the shop.

    (BTW: Your "pure" government spending is what I once called "preponed" government spending. It has a multiplier of 2 in a simple NK model.)

    1. Should read: It has a multiplier of 2 in a simple NK model at the ZLB.

    2. Funny, this bias against fiscal policy from Market Monetarists who have trouble telling fiscal and monetary policy apart, but they just KNOW fiscal is bad.

      Someone could be as biased and say: " If we got fiscal policy right, we wouldn't need monetary policy. "

      People who predicted the crisis based on balance sheets and debt-constraints arguments say that monetary policy cannot possibly substitute for fiscal policy, because its impact on balance sheets is orthogonal to what you get from monetary policy, better listen to them than to people who admit they don't understand banking and money.

    3. PeterP. It's even funnier that you just KNOW I don't have any reasons for that belief.

    4. Yes, I know because I saw you many times confused on what is fiscal and what is monetary policy or attempting to define fiscal policy as monetary. And yet you know monetary=good, fiscal=bad. Looks like religion to me.

    5. Monetary policy is incapable of adding net fiscal assets to the private sector; if your current problem is a too-tight fiscal stance, no amount of rate jiggling is going to get you out of it.

    6. Nick: You're wrong.

      The difference between monetary policy and fiscal policy is that monetary policy adds a bunch of interest payments, which inevitably go to rich people.

      Now monetary policy PLUS steep progressive taxation and redistibutionist welfare policies may be able to mimic fiscal policy.

      Without steep progressive taxation and redistributionist welfare policies, fiscal policy is the only way to deal with problems caused by accumulation of wealth at the top of the pyramid; monetary policy is incapable of handling that.

    7. Note that I am criticizing the idea that an economy could be managed strictly by monetary policy *even* with a perfectly enlightened dictator; to do that, you would *at least* need a perfect system of redistributionary taxation (rich->poor). (I believe that the "zero lower bound" means that even with a perfect system of redistributionary taxation, you *still* would need fiscal policy if you hit the zero lower bound.)

      Here in the real world, without a perfectly enlightened dictator, the case is even stronger. Our system of taxation is extremely regressive, so fiscal policy is all there is for the government to do.

      In any case, the problem with monetary policy is closely related to the transmission channel. At the point we are at right now, loose monetary policy shoves money into the pockets of rich bankers -- period. This is useless economically because the rich bankers don't spend it buying industrial/agricultural products and services. We need more people buying industrial/agricultural products and services. Which means we need more money in the hands of the poor. Which can't be done by "lending" them money, because the poor are already up to their ears in debt.

      It can therefore only be done by *giving* money to the poor. This can be done by taxing the money away from the rich and giving it to the poor. Or it can be done by printing money and giving it to the poor. Or it can be done by raising the minimum wage... maybe (unemployment might persist). It can definitely be done by requiring featherbedding in all industries (I don't recommend this). But it cannot under any circumstances be done by monetary policy.

      To believe otherwise is to believe in the supply-side fallacy -- the idea that the rich are "job creators" who will spend all their money hiring people. They aren't and they won't. The economy has never in the history of the world, as far as I can tell, suffered from a lack of investment due to a lack of rich people -- in any case it is not suffering from this now. It is suffering from a lack of consumer demand due to a lack of money in the hands of average (right now, average==poor) people.

      Monetary policy means never giving money to the poor without strings (loans/interest) attached. Monetary policy therefore simply cannot address problems caused by the hoarding of wealth in the hands of a few billionaires.

  2. "Unlike their academic counterparts, the primary goal of these economists is not to innovate, but to examine the evidence and see what ideas work."

    I'm not sure what central bankers you have been around, but in the last 40 years, it has become increasingly difficult to distinguish between economists who work in central banks and academics. Sometimes economists move from central banks to academia, to central banks, and back to academia, as I have done in my life. Currently I have a full-time academic job, but I also spend a day a week at the Federal Reserve Bank of St. Louis. I assure you, whenever I visit a central bank, I find plenty of economists whose primary job is to innovate. Those people are judged by their research output - publication in peer-reviewed journals - just as academics are. Maybe you have been at the Bank of England and it doesn't seem to be working like that. If so, too bad for them.

    "However to say ‘the jury is still out' on whether prices are sticky is wrong. The relevant jury came to a verdict long ago."

    We understand a lot more than we used to about the behavior of prices - frequency of price changes, how the time series of the prices of goods and services behave relative to asset prices, etc. However, what does the observed "stickiness" actually mean? Does it have some important implications for monetary policy? Not at all clear. Maybe your self-appointed jury got tired, gave up, and went home, but some of us are actually thinking about these problems.

    "However, it has to be acknowledged that policymakers who look at the evidence day in and day out believe that New Keynesian theory is the most useful framework currently around."

    For actual policymakers in central banks (in contrast to the innovative economists mentioned above) day-to-day policy is not driven entirely by evidence. Indeed, these people will persist with ideas which have no foundation in empirical evidence - for example the idea that output gaps help to forecast inflation. I don't think you want to argue that central bank policymaking is somehow the seat of practical application of sound theory supported by evidence. The theory and evidence supporting the application of quantitative easing is pretty weak.

    1. As an economist at the Board of Governors, I agree with Stephen's view that economists in the Reserve System are expected to do innovative research. (Sometimes we are even waiting for academics to catch up, so I thinks it's a bit unfair to say who is the primary source of innovation.) One difference from some other central banks is that FRS staff economists do both research and policy work (with roughly equal time allocations). This mixed mode expertise is a real benefit when faced with unusual macro challenges.

      I do have to break with Stephen on his claim that ideas persist at central banks with "no foundation in empirical evidence." He may disagree with the choices made and it's true they might not be based on the bell and whistle latest model, but they reflect a lot of critical analysis. I have often wondered what would happen if our forecast team was suddenly populated by a bunch of bloggers and academics. Of course, we each have our strengths and role to play.

      And I would agree with Simon that the policy decision maker impacts the economic consensus. There is considerable demand for fiscal policy studies...the Reserve System is consumer/producer of this work since monetary policy needs to anticipate fiscal policy effects. Yet, while economists participate in the formulation of fiscal policy, they do not make the decisions. Political concerns often trump economic ones, so that may diminish economists' desire or ability to test their theories or it may push some to more politically minded advice (not our comparative advantage).

    2. "However, what does the observed "stickiness" actually mean?"
      It's hard to lower wages. Prices can only be raised at rare intervals, not frequently. Prices are cut relatively infrequently, too.

      "Does it have some important implications for monetary policy?"
      Yes. What are they? Basically, it implies that low-interest-rate monetary policy works slowly. Undesirably slowly. If you want to get something done fast, you need fiscal policy. (High-interest-rate monetary policy does have a channel for working quickly -- bankrupting highly-leveraged firms when they need to refinance, causing them to fire everyone and liquidate.)

      Of course, since you're not making a serious attempt to figure out what's going on, you're not studying things like this.

  3. Economics has become nearly useless in the political arena imho. Politics picks simply the economic theory that is convenient. Which means the possibility of failure will be 50%ish (read huge and a very rough estimate on basis that there are 2 theories one correct one incorrect). And every failure is a nail to the coffin of the credibility of economics. Made even worse by the fact that the expectations of the man in the street about 'the economy' are probably 'overrosy'.
    Politicians can get away with this because the people that have to 'judge' them, donot have a clue about the subject matter and/or policies are seen as a political standpoint anyway.

    Economist as a profession do simply a horrible job in selling it to the public. They could as well have talked Chinese in many cases.

    Leaves the monetary policy which is largely on expert level. However for how long remains to be seen. With no policies properly working at the moment it could move either way. Draghi-ish more power for CBs, but more likely imho is Abeish. And it could be different from country to country. At the end of the day when things not work politicians will be electionbox liable. It is hard to see if ECB policies lead to a relatively high inflation in Germany say 4-5% (to compensate for deflation somewhere else) that the German government would not be sent home at the first election. They know that so will want to keep grip on the issue.

    Where do economists go wrong. Simply by missing most of the politics and other relevant factors that are playing and often donot fit in economic models so the first reaction is ignore it.
    Just some example where things went wrong:

  4. Some examples.
    -In the Euro austerity/stimulus discussion it was complete ignored by many that the EZ cannot be seen as one country. They are more 17 seperate countries than one. Inconvenient sure, but very relevant as well. Any solution that de facto leads to some transfer from one to another is therefor extremely difficult to sell.
    -Inflation as an option. By getting the Germans ans similar countries in you simply have limited your possibilities in this respect. As longer term 4-5% inflation in Germany simply doesnot look politically sustainable.
    -Target2 discussion. Repayment after heavy inflation was seen by many macro economists as perfectly acceptable. It simply is not for a lot of Germans for instance which makes it a political relevant fact.
    -AnotherTarget2. Looking macro has it limitations. What we have seen is some economist defending that it is the same thing (eg Germany isnot better or worse off) if business benefits and ultimately the taxpayer pays for that. You move wealth from A to B. This is usually what politics is about.
    Just some examples that economists simply didnot have a clue that the Euro issue is mainly a politicl problem.

    A similar thing on the legal aspects.

    Another one being the way communication was done to the general public. Extremely relevant as these kind of issues decide elections.
    Economics should find a way to communicate with the general public if it wants to influence the discussion. Issues are now mainly determined by simply individual interests and how capable a politicians is in selling things to the general public.

    Regulators messed things up pretty badly (sometimes the CBs sometimes indepent regulators). Effectively the got away lightly in the public domain with it. Bankers got most of the Flak and the credibility of politics in general really took a hit. In this respect CBs were simply lucky. Probably the issue is too technical.

    I do see monetary policies and fiscal policies move closer to each other and more to the political side (whether that is positive is another issue). Economic questions are probably at the centre of the politics the coming decade at least. If economists want to keep playing an important role they will have to adjust to this situation. Mainly:
    - integrate political issues better in their models/solutions (solutions should be 'sellable' (alternatives are not determined so much by economic theory, but by sellability); and
    - being able to explain things in much simpler language).

  5. Another point. Imho part of the problem is that too many economists are simply far below reasonable standards.
    Especially macro is a very complicated subject matter. You need to be able to see (at least have a proper idea about it) if the assumptions made in theory work in practice. What I have seen is people hardly grasping the most of the time rather simple maths. And applying that. Simply is not enough and often completely useless for decisionmaking.

    With as additional problem that the general public cannot properly make a distinction between the good and the bad for lots of reasons. Presentation skills and simply individual interests determines more if an economist is seen as credible/knowledgeable than theoretical knowledge (he tells what is good for me so he is right).

    As a general education there are probably a lot more useful subjects imho than Macro. Businesseconomics for instance, skills are simply more practically usable in most jobs. Most of the technical stuff, although you need more maths for that, often a problem. Which basically says it, a lot of the students are simply 2nd or 3rd grade mathinaticians that try to bring a rather mathematicised subject to a good end.

  6. "Imho part of the problem is that too many economists are simply far below reasonable standards. "

    Bingo. I've seen competent economics, but I've seen so much incompetent economics from "prominent", "peer-reviewed" PhDs that I don't think the credentialling is worth anything.

  7. "It is obvious that when it comes to using fiscal policy in short term macroeconomic stabilisation there can be no equivalent claim to progress or consensus. The policy debates we have today do not seem to have advanced much since when Keynes was alive. From one perspective this contrast is deeply puzzling. The science of fiscal policy is not inherently more complicated."

    Yep, the reason is political. There is a lobby (call it the 0.1%) which thinks it is in their short term interests to prevent the redistributionary effects of fiscal policy. It's that simple.

  8. Seeking consensus over macroeconomics policies can be a risky quest. For the last forty years we have contemplated the consolidation of neo-classical theory with new-Keynesianism leading to a complacent “Great Moderation” and the 2007 financial crisis. As argued in our article at Warning Signals, Prescott’s Real Business Cycle model (RBC), with a narrow inflation targeting mandate for central banks, was proved wrong by the subprime crisis. The consensual monetary policy turned out to be insufficient or even ineffective during the Great Recession.

    Most central banks questioned their tool kit and effectiveness over the past four years—evidence is their extensive use of unconventional policies. And reacted rapidly, thanks to the work of macroeconomist in central banks, as rightly pointed out by Simon Wren-Lewis. When it comes to fiscal policy the quest is even harder. Not because of the lack of an institution capable of taking the required actions, but due to the lack of independency. The responsible authority for the fiscal policy, the finance ministry, is subject to the approval of the congress and to all the political process related to it. The fiscal policy debate dates back way before the birth of Keynes, it exist since the beginning of politics.

    1. Link to the article mentioned above:

  9. So the Keynesian views fiscal policy as necessary demand stabilization tool only during a liquidity trap respectively the Post Keynesian during a balance sheet recession. Sanity so far.
    Now the dismal parts of our science: the Monetarist loathes fiscal policy, well, just because ZLB doesn't exist in his world and the Classical denies that demand matters and that prices are sticky and then dares to use the word evidence.

  10. I would love to introduce you to my better way of envisaging the logical and almost exact way I have devised for theoretical macroeconomics analysis. I am afraid that there will be so much prejudice against my fresh approach that nobody would want to bother to look at I am saying, because it is my claim that just about all the past theory is hopelessly wrong. I would replace it with an engineering approach to our science and get some results which not only are covering the whole of the big picture seamlessly, but are sufficiently easy to follow that we can actually see what is going on and how the system works. In my new book this is shown not to be an exaggeration and we can finish up with a whole lot better knowledge of a scientific kind.

    But again I find that nobody REALLY wants to know. My book is called "Consequential Macroeconomics" and I am not on the make--I simply wish to let others know what I have discovered through a lot of spare-time research. Write to me for a reviewer's (free) copy


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