One of the ways that macro differs from micro is that macro is essentially a branch of history. Micro is not. And yet today’s macroeconomists often have not studied monetary history. Marcus Nunes and Ramesh Ponnuru directed me to a paper by White House economics advisor Jason Furman:
A decade ago, the prevalent view about fiscal policy among academic economists could be summarized in four admittedly stylized principles:
1. Discretionary fiscal policy is dominated by monetary policy as a stabilization tool because of lags in the application, impact, and removal of discretionary fiscal stimulus.
2. Even if policymakers get the timing right, discretionary fiscal stimulus would be somewhere between completely ineffective (the Ricardian view) or somewhat ineffective with bad side effects (higher interest rates and crowding-out of private investment).
3. Moreover, fiscal stabilization needs to be undertaken with trepidation, if at all, because the biggest fiscal policy priority should be the long-run fiscal balance.
4. Policymakers foolish enough to ignore (1) through (3) should at least make sure that any fiscal stimulus is very short-run, including pulling demand forward, to support the economy before monetary policy stimulus fully kicks in while minimizing harmful side effects and long-run fiscal harm.
Today, the tide of expert opinion is shifting the other way from this “Old View,” to almost the opposite view on all four points.
I think this is right, but where Furman and I differ is on the desirability of this shift.
Furman refers to the view “a decade ago” but he might just as well have said 90 years ago. The New Keynesian consensus is actually not all that far from the views of progressive economists back in the 1920s, which favored a price level target and were skeptical about fiscal policy. After the 1930s, opinions moved in the old Keynesian direction. It wasn’t until the 1960s that the tide started swinging away from the “vulgar Keynesian” view that fiscal policy was more important than monetary policy. Friedman and Schwartz started he counterrevolution, and by the 1990s it was pretty much complete. Stabilization policy should rely on monetary policy.
And now we have still another swing of the pendulum, back toward the old Keynesian views of the post-1936 period. Here’s Furman:
The New View of fiscal policy largely reverses the four principles of the Old View—and adds a bonus one. In stylized form, the five principles of this view are:
1. Fiscal policy is often beneficial for effective countercyclical policy as a complement to monetary policy.
2. Discretionary fiscal stimulus can be very effective and in some circumstances can even crowd in private investment. To the degree that it leads to higher interest rates, that may be a plus, not a minus.
3. Fiscal space is larger than generally appreciated because stimulus may pay for itself or may have a lower cost than headline estimates would suggest; countries have more space today than in the past; and stimulus can be combined with longer-term consolidation.
4. More sustained stimulus, especially if it is in the form of effectively targeted investments that expand aggregate supply, may be desirable in many contexts.
5. There may be larger benefits to undertaking coordinated fiscal action across countries.
Those old Keynesian views of the late 1930s were rejected for lots of good reasons.
I’m not quite sure what is more humiliating for the profession of macroeconomics:
1. That we keep making the same mistakes, over and over again.
2. That we change our views of macro on “new information”, which in fact is not new to anyone with an even passing interest in macro history. (I.e., who know that the temporary QE of 1932 had little impact, just as the more recent temporary QE had little effect.)
3. That we don’t pay attention to the empirical studies that refute old Keynesianism.
4. That many macroeconomists are not even aware of the cyclical nature of their field.
It’s not unusual to find this sort of cyclicality in the arts. For instance, in the arts there are swings back and forth between a more “classic” style and a more “romantic” style. But it’s kind of embarrassing to see this in a science.
(And don’t embarrass yourself by arguing macroeconomics is not a science. Of course it’s a science. It’s failed science, but then so are some of the other sciences, at least based on what I’ve read about the crisis in replication. The term ‘science’ is not a compliment, it’s not some sort of award given to a field, like a Nobel Prize. It’s simply a descriptive term for a field that builds models that try to explain how the world works. Saying that science must be successful to be viewed as science is as silly as saying that a work of art must be good to be considered art.)
We need a “timeless” macro. That is, theories should not be developed to meet the specific conditions in the economy, at that moment. And yet that’s exactly what old Keynesianism is, which is why it goes in and out of style. Instead, theories should be developed to explain the entire history of macroeconomics—the full data set. If your model is not good at explaining hyperinflation, stagflation, liquidity traps and the Great Moderation, then it’s not a good theory.
Old Keynesianism is not a good theory.
PS. I’d like to congratulate Ben Klutsey for winning the Great Communicators Tournament in Washington DC on Wednesday night. Some of you may know that David Beckworth and I both participate in the Mercatus Center’s Program on Monetary Policy. Unfortunately we both live some distance from the headquarters in Arlington, VA. Ben is the program’s manager, and does a lot of the behind the scenes work that readers might not be aware of. I feel lucky to work with someone who is both a very nice guy and a highly talented manager.
Also congratulations to runner-up Charles Blatz, another Mercatus employee.