Nick Rowe has an interesting post on why macroeconomists disagree. He makes some good observations about how it’s difficult to measure the impact of fiscal and monetary policy when the policymakers are actively trying to stabilize the economy. The so-called “thermostat problem.” But I think this comment is too pessimistic:
You want us macroeconomists to figure stuff out better? Sure. No problem. Just lend us 100 countries for a couple of decades, and let us play dice with monetary and fiscal policy.
Let’s take three schools of thought; monetarists, Keynesians, and real business cycle enthusiasts. Monetarists and Keynesians often argue about the relative effectiveness of monetary and fiscal policy in boosting AD, especially at the zero bound. Both agree that changes in demand have a short run impact on output, but primarily affect prices in the long run. RBC-types think demand shocks merely affect prices, and supply-side factors drive changes in real output.
We already have an excellent way of determining the impact of monetary and fiscal policy on demand, just look at how the TIPS spread responds to policy surprises. For instance the fact that TIPS spreads increased modestly in response to the various QE programs suggests that those programs are effective, but not highly effective. But we don’t quite have the tools to distinguish between the two demand-side models on the one hand (monetarism and Keynesianism) and the RBC view. Could we test Richard Fisher’s view that more monetary stimulus would boost prices but not output? Yes, it would be quite easy, just set up and subsidize trading in both NGDP and RGDP futures markets. Then watch how those prices respond to policy surprises. Hundreds of billions of dollars, perhaps even trillions of dollars, ride on decisions made by Richard Fisher and his colleagues. Prediction markets could be set up and subsidized for a few hundred thousand dollars. Yet the economics profession doesn’t seem to have any interest in testing competing macro worldviews.
The term “worldview” might sound a bit grandiose, but I think it applies here. Nick claims that macroeconomists disagree because it’s hard to test theories. I believe it’s easy to test theories, we just don’t want to. I see the disagreement resulting from radically different worldviews. It’s as if some economists look at the world and see the visible light spectrum, others see only infra-red, and others see ultra-violet. Monetarists see money as the key asset. Goods, services, and assets are priced in terms of money. So when something happens to the market for money (supply or demand) all other prices must adjust. Because many wages and prices are sticky, and because debts are often nominal, this causes all sorts of real problems.
Keynesians take an “expenditure approach.” They see the economy as a series of sectors; consumption, investment, government and net exports. If monetary policy has any effect, it is because prices are sticky and thus monetary shocks initially impact interest rates. That impacts various expenditure categories such as investment. Everything about these worldviews is different. They use different languages, different identities, different assumptions about the nature of policy, and different assumptions about the transmission mechanisms of policy. They don’t even agree on what monetary policy actually is. And of course RBC-types have their own worldview, focusing on how labor market distortions such as unemployment insurance reduce the level of employment.
Recently a commenter asked if switching from a tax on investment income to a tax on consumption would slow the recovery. This question didn’t make much sense to me; more investment, less consumption, what’s the problem? But to someone with a Keynesian worldview it might make a lot of sense. If we all thought the IS-LM approach was the right way of thinking about the economy, and we simply differed on the relevant parameter values, we might be able to resolve our disputes. But many monetarists and RBC-types don’t see much value in the IS-LM approach.
I still haven’t answered the question of why economists don’t demand the government set up inexpensive prediction markets to test RBC theory against mainstream demand-side theories. Money can’t be the reason; taxpayers spend tens of billions of dollars on medical research. Presumably most economists think the answer is obvious, and no test is needed. The problem is that many of those economists who think the answer is obvious serve on the FOMC. And they don’t seem to agree on which of the “obvious” answers is correct.
You don’t see scientific labs were chemists and alchemists serve side-by-side. Or observatories where astronomers and astrologers serve side by side. Isn’t it time we figured out who are the equivalent of astrologers and alchemists, and expelled them from the economic policymaker process? What are we waiting for?