Krugman’s blog, 8/10/15

There was one post yesterday, “Trash Talk and the Macroeconomic Divide:”

Paul Romer continues to maintain that Chicago’s inward turn, the rejection of all salt-water macroeconomics that left it so hapless in the face of the Great Recession, was a defensive reaction to the sarcasm of Robert Solow. Brad DeLong points out that Solow was, as it turns out, right. Beyond that, as Brad notes and Paul actually acknowledges, what was actually going on at MIT was nothing like the implacable opposition of Chicago fantasies.

I was at MIT from 1974 to 1977, and everyone — both at MIT and basically everywhere in the profession — knew that Rudi Dornbusch and Stan Fischer were the preeminent teachers of macroeconomics. Both wrote seminal papers during those years — Rudi’s “Expectations and Exchange Rate Dynamics” and Stan’s “Long-term contracts, rational expectations, and the optimal money supply rule” that combined rational expectations with realistic limitations on wage and price flexibility. This was an attempt to build bridges, not a war on Chicago ideas.

But Chicago responded with trash talk. Lucas and Sargent 1978talked a lot about the “wreckage” of Keynesian economics, and included assertions like this:

For policy, the central fact is that Keynesian policy recommendations have no sounder basis, in a scientific sense, than recommendations of non-Keynesian economists or, for that matter, noneconomists.

And two years later, as Mankiw points out, this had descended into pure neener-neener, with Lucas asserting that

At research seminars, people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another.

All of this is relatively important, however; what matters is how you respond to evidence. In Lucas and Sargent, much is made of stagflation; the coexistence of inflation and high unemployment is their main, indeed pretty much only, piece of evidence that all of Keynesian economics is useless. That was wrong, but never mind; how did they respond in the face of strong evidence that their own approach didn’t work?

Such evidence wasn’t long in coming. In the early 1980s the Federal Reserve sharply tightened monetary policy; it did so openly, with much public discussion, and anyone who opened a newspaper should have been aware of what was happening. The clear implication of Lucas-type models was that such an announced, well-understood monetary change should have had no real effect, being reflected only in the price level.

In fact, however, there was a very severe recession — and a dramatic recovery once the Fed, again quite openly, shifted toward monetary expansion.

These events definitely showed that Lucas-type models were wrong, and also that anticipated monetary shocks have real effects. But there was no reconsideration on the part of the freshwater economists; my guess is that they were in part trapped by their earlier trash-talking. Instead, they plunged into real business cycle theory (which had no explanation for the obvious real effects of Fed policy) and shut themselves off from outside ideas.

Sorry, but I don’t see this as something that can be explained by Solow’s snark.



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