A naif's view of macroeconomics, macroeconomists and the marcoeconomic situation
I'm an economist but not a macroeconomist. But like many non-macro economists I'm deeply fascinated and concerned by what's going on. If only to document my current thinking, mostly derived from others' thinking, so that I might return to it one day and see how foolish I was, here are eight thoughts.
1) It’s really hard to be sympathetic to Real-Business Cycle (RBC) theories in the current environment. But current events only make especially salient what has been clear for a long time: the evidence aligns very well with Keynesian and New-Keynesian (NK) theories and not so well with RBC. This needs to be acknowledged more widely by those doing work in the area. And the burden is on this area of RBC macroeconomics to prove its ongoing relevance.
I should mention that I am sympathetic to these theories in the following way: RBC theories have pushed economists look more deeply into the underlying rigidities that make the world look more like Keynes and less like RBC theories, or neoclassical theory in general. It’s has been important and useful to have perfect-markets rational-expectations baselines against which to compare the real world.
At this point, however, beating this dead horse of RBC appears increasingly fruitless. Yes folks, economics is about theory and evidence.
More promising areas would seem to be toward refining and pairing down New Keynesian theories, and especially (in my naïf view) the role of risk aversion (more broadly defined than EU) in business cycles. This connects with the informal notion of “confidence” or lack thereof. In Keynes lack-of-confidence is just an outward shift in the demand for money. We need a more refined view and a more direct link to the risk premium. And psychology may be big part of it.
2) Conservative economists seem more aligned with RBC and Liberal economists with NK. This pattern is not universal. Milton Friedman was a Keynesian at heart and more conservatives need to embrace this fact. Greg Mankiw, Martin Feldstein, and Ken Rogoff are all conservatives and are all Keynesians at heart. I'm sure there are examples that go the other way as well. This is not and should not be a political issue.
3) I believe the old Keynes-Friedman monetarist vs. fiscal policy debate needs to be revived, if shifted a bit to suit the times. I believe it is an open question whether monetary policy of a non-traditional variety might be more effective at reviving the U.S. economy than fiscal stimulus. Will there be another Friedman of tomorrow saying that the reason we had this recession, and perhaps a long and deep one, is because the Fed, though aggressive, was nowhere near aggressive enough? If we’re willing to spend trillions in debt for bailouts and stimulus, why not print a trillion or two of cash instead? Would that have been more effective? Why didn’t they do it? Or maybe we’ll be saying why did it take them so long to do it?
My feeling is that this particular debate has been too subdued. Perhaps for political reasons. My feeling is that left-leaning economists don’t want to talk about it because they want fiscal stimulus, and they want that stimulus because they believe the government should be bigger anyway, and this is a way to achieve that alternative goal. To some extent, they have been clear in stating this intention. In principle if not in practice, I think policy goals should be kept separate. That is, if you want stimulus because you want a bigger government, then say that. Don't use bogus arguments that tax cuts can't work or that other kinds of monetary policy can't work. And don't ignore these alternatives either.
My feeling is that the right doesn’t want to talk about it because their inner-Austrian hearts still have sympathy for the gold-standard and they don’t like the idea of the Fed printing tons of money. Some don’t realize that this is what Friedman probably would have prescribed. Some don’t want others to realize that this is what Friedman would have prescribed, because it is so interventionist and they are non-interventionists at heart.
I suspect righties also don’t want to talk about it because they like talking about tax cuts for stimulus because they think this will help shrink the size of government (“starve the beast”). This is the right’s unstated agenda, like "growing the beast" is the sometimes unstated objective of the left. But the right is not clear about this objective at all. It is really strange to watch the intellectual gymnastics here because these are often the same guys arguing that fiscal stimulus is ineffective, Ricardian equivalence holds, and Ricardian equivalence says tax cuts don’t stimulate the economy.
Both right and left don’t want to talk about printing lots of money to buy risky and long-term assets because it makes them nervous. I can understand this. But I think that’s why they should be talking about it.
Serious economic scholars should put aside their personal agendas and start thinking hard about the tradeoffs between aggressive, novel monetary policy verses fiscal policy in terms of pure stimulative capacity and effect.
4) As far as fiscal policy goes, tax cuts do have the benefit of being quick to implement. But handing out cash will not provide much stimulus (it will just be saved). Handing out cash tied to new spending makes a lot more sense. This could work, but it needs to be well designed.
5) On the other hand, spending could have a bigger multiplier but it could take longer—too late, some say, to be effective. The way things are going, this may not be such a bad thing as we are likely to be well below full employment for at least several years. Still, quicker is better, all else the same.
(4) and (5) are to say that fiscal stimulus is not just a question of tax cuts or spending. Like most things, the devil is in the details, and that has not been acknowledged as widely as it should be, probably due to sublime objectives to ‘grow-the-beast’ or ‘starve-the-beast’. Other non-Keynesian reasons for growing or shrinking the government should be put aside; or if, they are part of the rationale, make sure it is spelled out. No sublime motives, please.
6) We should worry more about unintended consequences of greater prospective debt. Economists worried about this a lot a few years ago. Now the problem has become much, much bigger. The worry is that foreign investors will get worried about the size of that debt and pull their money out fast. If they do, all the options we currently have would go by the wayside and we would be in really bad shape—that means high interest rates, runaway inflation, and the Fed would have to tighten and the government would have to reign in spending at the worst possible time.
I think this is unlikely. But the downside is really ugly. More should be worrying about it and writing about it. I’m guessing this is a small deal given foreign debt is all dollar denominated. This essential fact, in addition to the US being so large, is what makes such a crisis seemingly implausible. If people flee the dollar and dollar-priced assets like treasuries, the problem will be strongly self-correcting—inflation will make our debt much smaller, making our debt situation look much better, which will attract investment back. It will also increase demand for exports. This thinking makes me lean more in the direction of more ambitious monetary policy. A good bit of inflation seems like just what the doctor should order. It’s a good way of spreading the pain while simultaneously bringing back full employment. I may be way off-base here. I’d really like to read more from the guys who are smarter and know more than I do.
7) Regarding bank bailouts: It seems these have been and will continue to be necessary. This does not need to be done in a way that incites future moral hazards. The media jargon “bailout” is thus deeply unfortunate, as have been some of the particulars about the way this has been done so far.
Bailouts should not be a happy time for those getting bailed out. All shareholders should be wiped out. In my view this should be standard operating procedure on all future bailouts and the Treasury should unequivocally state this SOP now.
There are reasonable, non-moral-hazard-inducing, and tax-payer friendly ways of recapitalizing the banks. Several have suggested that in addition to shareholders being wiped out, institutional (non-FDIC insured) debt should be partly or mostly wiped out in exchange for shares in the new, recapitalized banks. This approach may recapitalize all banks without any taxpayer cash infusion. Firing all current CEOs without golden handshakes should also be part of the deal. It may or may not involve a short period of nationalization. This makes a lot of sense to me.
Call it a government-managed bankruptcy.
8) Finally, I’m rather ashamed at the low level of debate. I’m ashamed of my discipline of economics when past and prospective Nobel-Prize winners say and write things that are so plainly false and so plainly politically motivated. I’m ashamed that our field is so populated with ideologues wedded so firmly to moral philosophies and beliefs that it dramatically infects their professional work and objectivity on matters of pure positive economics. This whole episode makes it clear to me that our discipline is not yet the science that I would like it to be and that (hopefully) I strive for it to be. We are in the Dark Ages of economics and I hope current events ultimately bring about its renaissance.
1) It’s really hard to be sympathetic to Real-Business Cycle (RBC) theories in the current environment. But current events only make especially salient what has been clear for a long time: the evidence aligns very well with Keynesian and New-Keynesian (NK) theories and not so well with RBC. This needs to be acknowledged more widely by those doing work in the area. And the burden is on this area of RBC macroeconomics to prove its ongoing relevance.
I should mention that I am sympathetic to these theories in the following way: RBC theories have pushed economists look more deeply into the underlying rigidities that make the world look more like Keynes and less like RBC theories, or neoclassical theory in general. It’s has been important and useful to have perfect-markets rational-expectations baselines against which to compare the real world.
At this point, however, beating this dead horse of RBC appears increasingly fruitless. Yes folks, economics is about theory and evidence.
More promising areas would seem to be toward refining and pairing down New Keynesian theories, and especially (in my naïf view) the role of risk aversion (more broadly defined than EU) in business cycles. This connects with the informal notion of “confidence” or lack thereof. In Keynes lack-of-confidence is just an outward shift in the demand for money. We need a more refined view and a more direct link to the risk premium. And psychology may be big part of it.
2) Conservative economists seem more aligned with RBC and Liberal economists with NK. This pattern is not universal. Milton Friedman was a Keynesian at heart and more conservatives need to embrace this fact. Greg Mankiw, Martin Feldstein, and Ken Rogoff are all conservatives and are all Keynesians at heart. I'm sure there are examples that go the other way as well. This is not and should not be a political issue.
3) I believe the old Keynes-Friedman monetarist vs. fiscal policy debate needs to be revived, if shifted a bit to suit the times. I believe it is an open question whether monetary policy of a non-traditional variety might be more effective at reviving the U.S. economy than fiscal stimulus. Will there be another Friedman of tomorrow saying that the reason we had this recession, and perhaps a long and deep one, is because the Fed, though aggressive, was nowhere near aggressive enough? If we’re willing to spend trillions in debt for bailouts and stimulus, why not print a trillion or two of cash instead? Would that have been more effective? Why didn’t they do it? Or maybe we’ll be saying why did it take them so long to do it?
My feeling is that this particular debate has been too subdued. Perhaps for political reasons. My feeling is that left-leaning economists don’t want to talk about it because they want fiscal stimulus, and they want that stimulus because they believe the government should be bigger anyway, and this is a way to achieve that alternative goal. To some extent, they have been clear in stating this intention. In principle if not in practice, I think policy goals should be kept separate. That is, if you want stimulus because you want a bigger government, then say that. Don't use bogus arguments that tax cuts can't work or that other kinds of monetary policy can't work. And don't ignore these alternatives either.
My feeling is that the right doesn’t want to talk about it because their inner-Austrian hearts still have sympathy for the gold-standard and they don’t like the idea of the Fed printing tons of money. Some don’t realize that this is what Friedman probably would have prescribed. Some don’t want others to realize that this is what Friedman would have prescribed, because it is so interventionist and they are non-interventionists at heart.
I suspect righties also don’t want to talk about it because they like talking about tax cuts for stimulus because they think this will help shrink the size of government (“starve the beast”). This is the right’s unstated agenda, like "growing the beast" is the sometimes unstated objective of the left. But the right is not clear about this objective at all. It is really strange to watch the intellectual gymnastics here because these are often the same guys arguing that fiscal stimulus is ineffective, Ricardian equivalence holds, and Ricardian equivalence says tax cuts don’t stimulate the economy.
Both right and left don’t want to talk about printing lots of money to buy risky and long-term assets because it makes them nervous. I can understand this. But I think that’s why they should be talking about it.
Serious economic scholars should put aside their personal agendas and start thinking hard about the tradeoffs between aggressive, novel monetary policy verses fiscal policy in terms of pure stimulative capacity and effect.
4) As far as fiscal policy goes, tax cuts do have the benefit of being quick to implement. But handing out cash will not provide much stimulus (it will just be saved). Handing out cash tied to new spending makes a lot more sense. This could work, but it needs to be well designed.
5) On the other hand, spending could have a bigger multiplier but it could take longer—too late, some say, to be effective. The way things are going, this may not be such a bad thing as we are likely to be well below full employment for at least several years. Still, quicker is better, all else the same.
(4) and (5) are to say that fiscal stimulus is not just a question of tax cuts or spending. Like most things, the devil is in the details, and that has not been acknowledged as widely as it should be, probably due to sublime objectives to ‘grow-the-beast’ or ‘starve-the-beast’. Other non-Keynesian reasons for growing or shrinking the government should be put aside; or if, they are part of the rationale, make sure it is spelled out. No sublime motives, please.
6) We should worry more about unintended consequences of greater prospective debt. Economists worried about this a lot a few years ago. Now the problem has become much, much bigger. The worry is that foreign investors will get worried about the size of that debt and pull their money out fast. If they do, all the options we currently have would go by the wayside and we would be in really bad shape—that means high interest rates, runaway inflation, and the Fed would have to tighten and the government would have to reign in spending at the worst possible time.
I think this is unlikely. But the downside is really ugly. More should be worrying about it and writing about it. I’m guessing this is a small deal given foreign debt is all dollar denominated. This essential fact, in addition to the US being so large, is what makes such a crisis seemingly implausible. If people flee the dollar and dollar-priced assets like treasuries, the problem will be strongly self-correcting—inflation will make our debt much smaller, making our debt situation look much better, which will attract investment back. It will also increase demand for exports. This thinking makes me lean more in the direction of more ambitious monetary policy. A good bit of inflation seems like just what the doctor should order. It’s a good way of spreading the pain while simultaneously bringing back full employment. I may be way off-base here. I’d really like to read more from the guys who are smarter and know more than I do.
7) Regarding bank bailouts: It seems these have been and will continue to be necessary. This does not need to be done in a way that incites future moral hazards. The media jargon “bailout” is thus deeply unfortunate, as have been some of the particulars about the way this has been done so far.
Bailouts should not be a happy time for those getting bailed out. All shareholders should be wiped out. In my view this should be standard operating procedure on all future bailouts and the Treasury should unequivocally state this SOP now.
There are reasonable, non-moral-hazard-inducing, and tax-payer friendly ways of recapitalizing the banks. Several have suggested that in addition to shareholders being wiped out, institutional (non-FDIC insured) debt should be partly or mostly wiped out in exchange for shares in the new, recapitalized banks. This approach may recapitalize all banks without any taxpayer cash infusion. Firing all current CEOs without golden handshakes should also be part of the deal. It may or may not involve a short period of nationalization. This makes a lot of sense to me.
Call it a government-managed bankruptcy.
8) Finally, I’m rather ashamed at the low level of debate. I’m ashamed of my discipline of economics when past and prospective Nobel-Prize winners say and write things that are so plainly false and so plainly politically motivated. I’m ashamed that our field is so populated with ideologues wedded so firmly to moral philosophies and beliefs that it dramatically infects their professional work and objectivity on matters of pure positive economics. This whole episode makes it clear to me that our discipline is not yet the science that I would like it to be and that (hopefully) I strive for it to be. We are in the Dark Ages of economics and I hope current events ultimately bring about its renaissance.
Very nice posts and observations - keep it up.
ReplyDelete"growing the beast" is the sometimes unstated objective of the left."
Not sure I agree with you -- Large government for its own sake? Never heard that before. Furthermore, a big part of "govt" is the military, and I would guess that many on the left would be happy to shrink it.
"We are in the Dark Ages of economics"
How about dark ages of MACRO-economics? Economics is arguably doing well with respect to study of: market failures, need for institutions, quasi-rationality, libertarian paternalism, etc.
What about post-Keynesianism as a viable strand of macroeconomics ? The work of Minsky and Godley is looking very good right now
ReplyDeleteGreat post. I think you may be mistaken on one point, though.
ReplyDeleteConservatives don't want to propose that the Fed print money because it goes against their principles. I agree with this thesis.
However, conservatives have shown time and again in the past ten years that if the Fed DOES decide to print, they will support it.
By the same token, liberals don't want to be blamed for debasing the currency a la Jimmy Carter. But if the Fed DOES decide to print, they will support it.
In short, assuming that monetary policy is the more important economic policy by far, our politicians have outsourced policy-making to the Fed. If the Fed is too tight, they will complain. If the Fed is too loose, find me a political constituency that will care. Oh yeah, Ron Paul's followers. How many votes did he get again?
I agree with Jeff: "Size of government" is a bogus frame: what Right and Left diverge on, is the distribution of income and risk. The Left wants gov't to provide a lot of cheap insurance, in various forms, to the poor and middle classes. The Right wants the Rich, and business corporations, to be left free to use their wealth, aka their claims on rent-earning resources, to sell insurance in various forms (e.g. payday loans, credit cards at 33%, at-will employment with no overtime and no severance, etc.) on terms very favorable to the Rich.
ReplyDeleteSo the Right destroyed the S&Ls, regulated mortgage finance, labor unions, private pensions, and wants to "reform" Social Security, while opposing national health insurance and public education.
Jeff and Bruce,
ReplyDeleteI didn't mean to say that the left wants larger government for its own sake--they surely have their reasons.
While one can never be sure, my worry is that some economists on the left are pushing for spending over tax cuts partly under false pretenses--that spending is the only available policy or the best bang-for-the-buck policy. I don't think that is clear at all, but they're pushing that angle because they think government should be bigger anyway.
Note that my post was directed a bit more toward left and right economists which can differ a bit from more mainstream left and right. Politicians always have sublime motives. Economists shouldn't. Or at least they should bend over backwards to avoid the temptation.
Michael: This is a very good post.
ReplyDeleteI would too like to see more of a debate on the subject of very aggressive unconventional monetary policy vs fiscal policy. It is not at all obvious which is best.
Part of the problem, though, is that we have a very poor understanding of unconventional monetary policy. It's on the boundary between macro and finance for one thing, and there's few economists who understand both well. And we have very little past experience to work with, so nothing like good econometric estimates of unconventional monetary policy multipliers.
Politicians on the right keep desiring tax cuts but do nothing to starve the beast. Indeed they relish feeding the military aspects of the beast--e.g., $2tn war in Iraq. Their tax cuts are deemed long term for incentive effect reasons, so the real effect is a federal budget that is strucuturally--not counter-cyclically--in deficit. The imbalance from inadequate taxation is resolved only by borrowing from abroad, which reduces the capital stock owned by Americans that could support their pensions, etc. rather than those of, say, the Chinese. (Ricardian Equivalence assumes taxes go up subsequently to pay for the interest.) Fiscal responsibility arguments are heard from the right only in the context of starving the non-military beast.
ReplyDeleteIt is not the Nobel Prize, it is the Sveriges Riksbank prize.
ReplyDeleteFor a "naif", you make much more sense than some much more prominent members of your profession. It's not that you purport to have the answers, but rather you raise questions that are being overlooked or downright hidden as the debate becomes more ideological and less analytical.
ReplyDeleteAs typified by the debating point scoring comment: "It is not the Nobel Prize, it is the Sveriges Riksbank prize."