On the Non-Keynesianism of the New Nobels

Here's a great article about the latest economics Nobel winners, Thomas Sargent and Christopher Sims.

Sargent and Sims are famous for their work connecting expectations, economic dynamics and statistical methods.  Some seem to have called this "anti-Keynesian" because the classic textbook model by Keynes/Hicks (IS/LM) is a static model devoid of expectations about the future.

Today nearly all macroeconomic modelling takes expectations and dynamics into account.  If one assumes expectations are perfectly rational and assumes prices are not "sticky" then Keynes/Hicks predictions of monetary and fiscal policy effectiveness fall apart. So, it's not surprising that conservative-leaning economists point to these early findings from the 70s, most famously associated with Lucas and Prescott.

Except that, empirically, fiscal and monetary policies do affect the economy.   And, theoretically, this can happen just by putting sticky prices back into the mix and keeping the new sophisticated dynamics.  So it's sticky prices and monetary issues sit at the core of Keynesian business cycle insights, not the absence of dynamics and expectations. It therefore seems wholly inappropriate to call this an "anti-Keynesian" Nobel.  Indeed, as Sims notes in the article, even Mr Keynes wrote a lot about the importance of expectations.

Now, many critique the idea that expectations are fully rational and question where sticky prices come from.  And there are legions of articles that weigh into these issues.  But taken as a whole, the essential insights of Keynes and IS/LM are alive and well.  This Nobel, given for the wonderful tools that Sargent and Sims developed, is beside the point.

Comments

  1. Seems like a false dichotomy has sprung up too. Sticky prices versus uncertainty about future taxes as an "explanation" for sluggish adjustment.
    Wouldn't uncertainty about the future lead to sticky prices ? If I dont know what's going to happen, inertia is a rational decision.

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  2. Well, one could go in a lot of directions with that. There are lots and lots of explanations of sticky prices and lots of implications of uncertainty. Ben Bernanke has a fairly famous paper looking at so-called real option values associated with investment timing and how they are likely important for business cycles:

    http://www.jstor.org/pss/1885568

    Expectations clearly matter. Indeed, managing expectations is the one way Fed policy could still have a big effect right now. If they commit to keeping interest rates low for a long time, that will spur investment. Also, if they commit to having higher future inflation that, too, would help things right now.

    Uncertainty associated with debt ceilings, government shutdowns and generally dysfunctional political system would seem to be a generally bad thing for the economy.

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