Received wisdom in macroeconomics

For both non-economists and economists

There has been some talk recently about what is wrong with macroeconomics. (Jérémie Cohen-Setton has a good summary, although non-economists are allowed to do a bit of skipping. And yes, I am a little late on this - cannot think why.) Of course there is always talk of this kind - it just ebbs and flows. But I think this recent upsurge has missed an important point (which, as is often the case, is an elaboration of a point already made by Paul Krugman). .

Many of the complaints about macro are along the lines that it needs more models involving X. Now X can be many things: a financial sector, nonlinearities, multiple equilibria etc. Yet as anyone who is involved in modern macro knows, pretty well whatever X is, there are models that have those things. If you want chapter and verse on this, see Tony Yates (as in here). Indeed, one of the characteristics of modern macro, as opposed to the stuff I dimly remember from my youth, is the huge variety of approaches on offer. In that sense, academic macro is flourishing.

Does that mean the critics are wrong? Not necessarily. I think what is missing in this discussion is the concept of a received wisdom which non-academics (including politicians and civil servants) can readily access. There may be plenty of models which allow for recessions to persist indefinitely, for example, but the received wisdom might still be that recessions are temporary affairs caused by price stickiness and therefore the economy always ‘self-corrects’. So the criticism should not be that there is no analysis of X, but that X is not part of the received wisdom.

A related point can be made about the financial crisis. It is not the case that we need a whole new set of economic tools to understand financial crises: it turns out we had most of the tools already. (Most, not all - see for example the reference here to the Bank of England’s work on networks). The problem was more the received wisdom, which was that the problems that the financial system had shown in the past had been solved, and so we could just ignore them. Once that received wisdom was shattered, there were plenty of tools in the toolbox to analyse what had gone wrong.

So where exactly is this received wisdom of which I speak? An obvious place to look is the textbooks we use. However the pace at which the subject moves (often propelled by events) means they are far from a perfect source, and they are not that accessible for non-economists. In the sciences the received wisdom is normally common knowledge among academics; in macroeconomics less so. One place you will clearly find it is in institutions that have to use that knowledge to do their job. So there is clearly a received wisdom about monetary policy, and you will find it among the economists in central banks.

That is why I’m happy to talk about the New Keynesian model being the consensus model as far as business cycles are concerned, because that is the case in central banks. Others have disagreed with this consensus label, but often because they are thinking about the lack of consensus among the wider academic community. Sometimes you can go further still, and argue that the received wisdom in an institution can be found quite precisely in the model that they use to forecast and do policy analysis.

I think this way of thinking can help us understand one reason why governments across the globe have so easily failed by implementing premature austerity. In the past, and perhaps if they did not have an independent central bank, they would probably have had in house capacity (and perhaps a model) to know what damage austerity would cause. But with the widespread adoption of independent central banks, that capacity has faded. Finance ministries have lost that expertise, and become much more about expenditure control. Independent central banks had the knowledge to know that fiscal austerity would be damaging, but for a variety of reasons typically chose not to express it.

Without a clear sense of received wisdom, policymakers are at the mercy of policy entrepreneurs or ideology-based think tanks, and may be unaware that the line they are being sold might be viewed as rubbish by many academics. That of course is putting it very charitably: the problem may be that the policymaker is fully aware of what they are doing, but know they can get away with it because the media is unaware of any received wisdom, or may find it difficult to express. Whichever it is, it suggests one particular route by which independent central banks are part of the reason for the persistence of the Great Recession. By locating the received wisdom about fiscal policy in an institution that was unwilling to express this wisdom, that wisdom was effectively lost.