Paul Krugman: “The state of macro is, in fact, rotten, and will remain so until the cult that has taken over half the field is somehow dislodged”
The cult here is freshwater macro, which descends from the New Classical revolution. In response
Steve Williamson: “At the time, this revolution was widely-misperceived as a fundamentally conservative movement. It was actually a nerd revolution.” “What these people had on their side were mathematics, econometrics, and most of all the power of economic theory. There was nothing weird about what these nerds were doing - they were simply applying received theory to problems in macroeconomics. Why could that be thought of as offensive?”
The New Classical revolution was clearly anti-Keynesian, in the sense of Keynesian theory of the 1960s/70s, but was that simply because Keynesian theory was the dominant paradigm? As Williamson says, these guys were outsiders, and they wanted to revolutionise the discipline, which meant attacking the dominant theoretical framework of the time, which was Keynesian IS/LM.[1]
I have no particular expertise here: when this was all happening I viewed it from afar and with a lag, although perhaps that is also an advantage. But for what it is worth, I think there is some truth in what Stephen Williamson (SW) says. I certainly think that New Classical economists revolutionised macroeconomic theory, and that the theory is much better for it. Paul Krugman (PK) and I have disagreed on this point before. It was New Classical economists who recognised the importance of Muth’s rational expectations idea, and it is hard to imagine making sense of what the Fed has done this year without it.
But this is not where the real disagreement between PK and SW lies. The New Classical revolution became the New Neoclassical Synthesis, with New Keynesian theory essentially taking the ideas of the revolutionaries and adapting Keynesian theory to incorporate them. Once again, I believe this was a progressive change. While there is plenty wrong with New Keynesian theory, and the microfoundations project on which it is based, I would much rather start from there than with the theory I was taught in the 1970s. As SW says “Most of us now speak the same language, and communication is good.” What New Keynesian theory does is allow central banks to apply New Classical ideas in a way that is relevant to the task they have to perform, which is inflation control through demand management.
I think the difficulty that PK and I share is with those who in effect rejected or ignored the New Neoclassical Synthesis. I can think of no reason why the New Classical economist as ‘revolutionary nerd’ should do this, which suggests that SW’s characterisation is only half true. Everyone can have their opinion about particular ideas or developments, but it is not normal to largely ignore what one half of the profession is doing. Yet that seems to be what has happened in significant parts of academia.
SW likes to dismiss PK as being out of touch with current macro research. Lets look at the evidence. PK was very much at the forefront of analysing the Zero Lower Bound problem, before that problem hit most of the world. While many point to Mike Woodford’s Jackson Hole paper as being the intellectual inspiration behind recent changes at the Fed, the technical analysis can be found in Eggertsson and Woodford, 2003. That paper’s introduction first mentions Keynes, and then Krugman’s 1998 paper on Japan. Subsequently we have Eggertsson and Krugman (2010), which is part of a flourishing research programme that adds ‘financial frictions’ into the New Keynesian model. You would not think of suggesting that PK is out of touch unless you are in effect dismissing or marginalising this whole line of research.[2]
I would not describe the state of macro as rotten, because that appears to dismiss what most mainstream macroeconomists are doing. I would however describe it as suffering from two unhelpful biases. The first is methodological: too much of an obsession with microfoundation purity, and too little interest in evidence. The second is ideological: a legacy of the New Classical revolution that refuses to acknowledge the centrality of Keynesian insights to macroeconomics. These biases are a serious problem, partly because they can distort research effort, but also because they encourage policy makers to make major mistakes.[3]
[1] The clash between Monetarism and Keynesianism was mostly a clash about policy: Friedman used the Keynesian theoretical framework, and indeed contributed greatly to it.
[2] It may be legitimate to suggest someone is out of touch with macro theory if they make statements that are just inconsistent with mainstream theory, without acknowledging this to be the case. The example that most obviously comes to mind is statements like these, about the impact of fiscal policy.
[3] In the case of the UK, a charitable explanation for the Conservative opposition to countercyclical fiscal policy and their embrace of austerity was that they believed conventional monetary policy could always stabilise the economy. If they had taken on board PK’s analysis of Japan, or Eggertsson and Woodford, they would not have made that mistake.
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