The macro debates

The “economic problem” in today’s crisis is that of unemployment or macroeconomics: What policy will work — fiscal or monetary? If neither, what then? And why was it taking so long to get out of the 2008 global recession?  As of September, 2009 it seems we still don’t really know.  The stock and bond markets have recovered, but there is a lingering worry that we are not yet out of the woods. Some would say it’s all Taleb’s fault (joke!).

Paul Krugman favors fiscal policy, siding with the “new Keynesians” who try to marry rationality with price rigidity. He argues against the Say’s Law type of equilibrium, especially Ricardian equivalence. But Scott Sumner has some things to say for monetary policy, at least some very particular elements of it.

At Freakonomics, Justin Wolfers weighs in. He hints at a bias against doing research on fiscal policy, in favor of monetary policy. Mark Thoma gives some history of the economic thought of this debate, as does Greg Mankiw in his 2006 paper.  Mankiw considers himself a supporter of the new Keynesian school.

At Econlog, Arnold Kling thinks “modern macro” (another term for new Keynesian research)  is junk science. He seems to offer as an alternative a combination of Austrian school and Minsky. For how views oppose, see the Austrian perspective and that of the New York Times.

The IMF staff put their collective hats together, and represent perhaps a cross-section mainstream view.  We need both Keynesian remedies and institutional reforms.  But sometimes I wonder why it seems that outsiders seem to be better at explaining the IMF “advice” better than the IMF staff themselves.

Willem Buiter acknowledges the gaps in modern macro, echoing the ignored views of Minsky et al, and says “a new paradigm is needed.” He is in fact quite critical of the modern macro crowers, and he concludes that “knowing that you know nothing is the beginning of wisdom.”  Strong words directed at those who suggest that the rest of the world isn’t smart enough “to understand the math” (i.e., the kind of math that modern macro uses).    I once challenged a disciple of this school to explain it better to me because, like most of the world, including this near-famous critic of economics, Nassim Taleb, I was not convinced of the usefulness of modern macro.  The disciple retorted that my problem was that I hadn’t been to the library.  (I need not say more about ad hominem attacks other than that they reflect on the “attacker.”)

Morris Goldstein discusses practical policy aspects of financial sector reform.  Goldstein emphasizes a “no free lunch” approach to reform: The fixes he suggests, such as a clearinghouse for the OTC derivatives and increasing the reserve requirements imposed on banks, will make financial market transactions costs larger though more transparent. (I thought he came close to suggesting the revival of Glass-Steagall to prohibit banks and other institutions with publicly-funded safety nets from going into investment banking.)

Tyler Cowen has put forward a model of the financial crisis based on the work of Fischer Black (the Black of the Black-Scholes option pricing formula). Cowen’s thesis is that the crisis cannot be fixed by fiscal policy, and implicitly, also not by monetary policy.  At best these conventional macro instruments can perform some kind of triage to limit the damage from “excessive risk-taking” that brought about the preconditions for the crisis.

Where is Richard Shiller on all this?  Here, as interpreted by Richard N. Cooper. In short, Shiller somewhat echoes  the views of Cowen and Goldstein.  Something has to be done to fix the financial markets properly. In particular, Cooper states that Shiller supports  “a series of financial innovations that would enable people to sell short an index of U.S. residential housing prices, in order to introduce some discipline into future housing booms with a view to making the subsequent corrections less severe.”  In a forum at Yale, Shiller lent support to the idea that a massive Keynesian stimulus is necessary to fix the crisis.

Something to consider is Pres. Obama’s economics, as interpreted by a Hayek scholar.

When journalists weigh in, they tend to oversimplify and miss the most important (but hard) point of the debate.  An example is Peter Coy of Business Week. Not to be outdone, Krugman does a reprise and not surprisingly leaves out gaps that irritate those who actually called the Great Recession better than he did.  A less biased view as of August 2009 comes from Mario Rizzo and Peter Boettke.

The civilians probably know better.

Frank & Ernest


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