Eichengreen: Economics 115 Syllabus Spring 2009: The World Economy in the Twentieth Century
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Menzie Chinn: Edward Prescott Is Meshugannah

Edward Prescott says that real economists are opposed to the fiscal stimulus package:

"I don't know why Obama said all economists agree on [the need for a stimulus bill]," Prescott said. "They don't. If you go down to the third-tier schools, yes, but they're not the people advancing the science."

Edward Prescott thinks that the current recession is due either to (a) the fact that workers have decided that they would rather work less than they wanted to two years ago, or to (b) the fact that we have forgotten some productive technologies that we knew how to use two years ago.

There is a technical term for Edward Prescott: Edward Prescott is meshugannah.

Let me turn the microphone over to Menzie Chinn:

Econbrowser: The Current Downturn: Labor-leisure tradeoff or technological regress: Some views from an economist who is not "advancing the science". Reader Joseph commenting on the stimulus bills brings my attention the Cato ad.... Ed Prescott... Nobel laureate who won for work on growth/macroeconomics, so attention must be paid! I looked a bit for his reasoning, and only found this quote from the East Valley Tribune.... So, I think it's worthwhile to infer why Prescott is against the bill. I will refer to his... "Theory ahead of business cycle measurement":

Economic theory implies that, given the nature of the shocks to technology [i.e., that we occasionally, suddenly, unpredictibly and collectively forget about technologies we knew about two years before] and people's willingness and ability to intertemporally and intratemporally substitute [i.e., that we occasionally, suddenly, unpredictibly and collectively decide that we want to spend fewer hours at work than we did two years before], the economy will display fluctuations like those the U.S. economy displays. Theory predicts fluctuations in output of 5 percent and more from trend, with most of the fluctuation accounted for by variations in employment and virtually all the rest by the stochastic technology parameter.... Theory predicts that deviations [from trend] will display high serial correlation. In other words, theory predicts what is observed.... The policy implication of this research is that costly efforts at stabilization are likely to be counterproductive. Economic fluctations are optimal responses to uncertainty in the rate of technological change ... .

The paper lays out in a fairly straightforward fashion the logic. I highly recommend reading it. However, I think it useful to lay out the logic in a simplified manner, such as I would teach it in an intro macro course. Let output be given by:

Yt= ztkt1-θntθ

Where z is a technology parameter, or "shock", k is capital, and n is labor. Households optimize intertemporally, and both demand and supply jointly determine output (in the crudest Keynesian models -- but not the neoclassical synthesis -- output is demand determined). Output then only moves in response to changes in z, k and n. k might change if the user cost of capital changes. n might change as workers decide to alter their labor-leisure tradeoff, perhaps in response to changes in the real interest rate (or perhaps, there is an exogenous change in preferences of leisure against labor). Alternatively, z has changed. Let me focus on this, since that has been a central parameter in real business cycle (RBC) models.

In this interpreation, we have since September 2008 experienced substantial technological regress. What the exact nature of this technological regress is remains open to question. One could say that the financial system is part of technology, and we've forgotten how to overcome asymmetric information problems previously handled by a banking system combined with regulation. Or perhaps the trend rate of growth in technology has changed. Remember in the original Prescott paper, in order to match the time series pattern of deviation of output from the Hodrick-Prescott filtered data, the autoregressive parameter was set to near unity; but the trend was subsumed into the HP trend.

In [Prescott's] world... government spending would of course be counterproductive, since it would waste resources... all the current and incipient rise in unemployment is an optimal response to changing relative prices and prospects for technology growth.... But it is important to understand exactly how he thinks the world works before taking his prescriptions to heart.

Back in 2000 my teacher Olivier Blanchard wrote an article: "What Do We Know About Macroeconomics that Fisher and Wicksell Did Not?" http://www.j-bradford-delong.net/articles_of_the_month/pdf/W7550.pdf. But he wrote the wrong article. The Cato Institute and the Republican Party demonstrate that we economists have forgotten--or at least can no longer reach consensus on--things that Fisher and Wicksell knew very well indeed.