Why Oh Why Can't We Have Better Nobel Laureates in Economics (Robert Lucas Suddenly BFF with Ben Bernanke Edition)
Robert Lucas provides an annoying defense of his brand of economics here in the Economist:
Economics focus: In defence of the dismal science | The Economist: THERE is widespread disappointment with economists now because we did not forecast or prevent the financial crisis of 2008...
Lucas's defense is annoying for two big reasons:
First, some economists did indeed forecast the financial crisis of 2008--or, rather, forecast that Alan Greenspan's low interest rate policies of 2002-2004 (policies I approved of and endorsed, by the way) ran an unacceptable risk of getting the economy wedged into a position like the one it now is. All praise and honor to Dean Baker, Richard Thaler, Robert Shiller, Michael Mussa, and their posse. Here's Michael Mussa, writing in 2004:
Michael Mussa (2004), "Global Economic Prospects: Bright for 2004 but with Questions Thereafter" (Washington: Institute for International Economics: April 1): Policy interest rates are exceptionally low in most industrial countries: zero in Japan and Switzerland, 1 percent in the United States, 2 percent in the euro area, and at or near historic lows in the United Kingdom and Canada.... The very low level of policy interest rates is an imbalance (relative to normal conditions) that reflects exceptionally easy monetary policies to combat economic weakness. This policy imbalance poses an important challenge for the future conduct of monetary policy. Situations of low policy interest rates and low inflation tend to be associated with unusual inertia in the processes of general price inflation, which makes traditional indicators of rising inflationary pressures less reliable as measures of the need to begin to tighten monetary conditions. Also, these situations tend to be associated with high valuations of equities, real estate, and long-term bonds, which can become fertile ground for large, unsustainable increases in asset prices. In this situation, if monetary policy is tightened too much too soon (perhaps because of worries about unsustainable increases in asset prices), the result can be an unnecessary asset market crunch and economic slowdown, and monetary policy may have relatively little room to ease in order to counteract this outcome.
On the other hand, if monetary policy remains too easy for too long (perhaps because subdued general price inflation gives no clear signal of the need for monetary tightening), then large asset price anomalies may develop before corrective action is taken. The monetary authority would then confront the grim choice of trying to keep an unsustainable asset price bubble alive or trying to combat the collapse of such a bubble without a great deal of room for monetary easing...
Bingo. Here we are right now. Wedged.
The disappointment with economists is not because there were none of us who forecast the possibility of the crisis we are in, but rather that economists like Robert Lucas and myself did not listen with sufficient care and attention to hte Michael Mussa posse. (Indeed, I have a half-finished paper that will now never, ever be finished on how Mussa was wrong.)
So when Lucas writes things like:
Economics focus: In defence of the dismal science: One thing we are not going to have, now or ever, is a set of models that forecasts sudden falls in the value of financial assets, like the declines that followed the failure of Lehman Brothers in September. This is nothing new. It has been known for more than 40 years and is one of the main implications of Eugene Fama’s “efficient-market hypothesis” (EMH), which states that the price of a financial asset reflects all relevant, generally available information...
he darkeneth counsel without wisdom. It is true that no model is going to successfully forecast the time and date of a "sudden fall in the value of financial assets." But that misses the point. What Mussa and his posse correctly did was forecast the growing size of the left-side tail of the distribution of possible future financial asset changes.
Second, Lucas defends economics by suddenly becoming BFF with Federal Reserve Chair Ben Bernanke:
Mr Bernanke... [is] in the mainstream of what one critic [Paul Krugman] cited in The Economist’s briefing calls a “Dark Age of macroeconomics”. They are exponents and creative builders of dynamic models and have taught these “spectacularly useless” tools, directly and through textbooks that have become industry standards, to generations of students. Over the past two years they (and many other accomplished macroeconomists) have been centrally involved in responding to the most difficult American economic crisis since the 1930s. They have forecasted what can be forecast and formulated contingency plans ready for use when unforeseeable shocks occurred. They and their colleagues have drawn on recently developed theoretical models when they judged them to have something to contribute.... I simply see no connection between the reality of the macroeconomics that these people represent and the caricature provided by the critics whose views dominated The Economist’s briefing...
But when Robert Lucas stood up to talk at the Council on Foreign Relations only four months ago, he had a very different view of the competence of Ben Bernanke.
Then he said that economists--like Ben Bernanke--who believed that expansionary fiscal policies like the Obama stimulus might well be effective were either incompetent ("schlock economics" was the phrase) or corrupt. And Lucas went on to say that he "didn't get" the rationale for the banking-sector support policies Bernanke had put into place--which meant that Lucas had never bothered to understand any of the many, many papers Bernanke had written about the "credit channel" and economic activity.
If you are going to be a shrill and unbalanced somebody in the spring and then claim that you are their BFF in the summer, you owe your readers an explanation for why you have changed your mind. Lucas does not provide one.
So I have one of what I expect to be a number of responses to Lucas coming in the Economist this afternoon. Here it is:
Robert Lucas’s Mysterious Change of Mind
J. Bradford DeLong
University of California at Berkeley and NBER
August 5, 2009
Today in the Economist Robert Lucas is an enthusiastic supporter of the economics of Ben Bernanke. He sets the stage as the world economy stood late last September:
After Lehman failed and the potential for crisis had became a reality, the situation was completely altered. The interest on Treasury bills was close to zero, and those who viewed interest-rate reductions as the only stimulus available to the Fed thought that monetary policy was now exhausted...
And then Bernanke swung into action:
Bernanke immediately switched gears, began pumping cash into the banking system, and convinced the Treasury to do the same. Commercial-bank reserves grew from $50 billion at the time of the Lehman failure to something like $800 billion by the end of the year. The injection of Troubled Asset Relief Programme (TARP) funds added more money to the financial system.... The recession is now under control and no responsible forecasters see anything remotely like the 1929-1933 contraction in America on the horizon. This outcome did not have to happen, but it did...
There follows Lucas’s praise of Bernanke (and his Federal Reserve colleague Ric Mishkin) and his excoriation of the critics of economics:
Mr Bernanke and Mr Mishkin are in the mainstream of what critics cited in The Economist’s briefing call a “Dark Age of Macroeconomics.” They are exponents and creative builders of dynamic models and have taught these “spectacularly useless” tools, directly and through textbooks that have become industry standards, to generations of students. Over the past two years they (and many other accomplished macroeconomists) have been centrally involved in responding to the most difficult American economic crisis since the 1930s.... They have drawn on the ideas and research of Keynes from the 1930s, of Friedman and Schwartz in the 1960s, and of many others. I simply see no connection between the reality of the macroeconomics that these people represent and the caricature provided by the critics whose views dominated The Economist’s briefing...
I approve of Robert Lucas’s praise of Ben Bernanke.
I agree with it.
I am and have long been an enthusiastic fan of and supporter of Bernanke (and Mishkin too). I think he is one of the very best we have, and I do not see any better candidates (I do see some as-good candidates however) for the seat he occupies.
If Lucas now says that Ben Bernanke and company know what they are doing—as I think that they do—and that their judgments are to be respected (which include judgments that banking-sector recapitalizations, loan guarantees, and other credit-channel policies on the one hand and expansionary short-run fiscal policy on the other have their proper place in dealing with the recession), then we can all agree and go home.
But I would like everybody to note that Robert Lucas thought very differently, or at least appeared to think very differently, only four months ago. Ben Bernanke’s principal theoretical contribution to economics has been his investigation of the “credit channel”–how, independent of the supply of money, the health of the banking system and the configuration of interest rates affect the level of spending. Ben Bernanke’s principal empirical contribution to economics has been documenting that the “credit channel” has in fact mattered. And Bernanke’s chief policy innovation has been to expand the Federal Reserve’s role from standard expansionary monetary policy open-market operations into a host of innovative financial policies aimed at this “credit channel.”
Last March at the Council on Foreign Relations Lucas commented on Bernanke’s “credit channel” policies—bank bailouts, etc. Lucas said he “didn’t really get it”:
I avoided this bank bailout issue in my 15 minutes and there's a reason for it. I don't really get it. Some of the problems you're talking about about deciding who gets paid and who doesn't, that's the whole function of bankruptcy law is to deal with that in an effective way. Now, it may be that the kind of neighborhood effects of the bankrupt banks are sufficiently different from the neighborhood effects of a bankrupt auto company—that they need some kind of special treatment. But then it seems like the right public policy is something that— maybe some kind of accelerated bankruptcy proceedings. Just to say make them well on all the money they've lost over this thing, I just—I do not get it...
And last March Lucas had nothing but contempt for judgments like Bernanke's that a fiscal stimulus program—temporary increases in government spending and a temporary tax cut—would boost spending. Bernanke endorses the Congressional Budget Office and its:
estimates of the effects of the stimulus package on real GDP and employment that appropriately reflect... uncertainties.... [B]y the end of 2010, the stimulus package could boost the level of real GDP between about 1 percent and a little more than 3 percent and the level of employment by between roughly 1 million and 3-1/2 million jobs...
But Lucas says--or rather said last March:
[W]ould a fiscal stimulus somehow get us out of this bind, or add another weapon that would help in this problem?... I just don't see this at all.... [T]he only part of the stimulus package that's stimulating is the monetary part.... But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder... then it's just a wash... there's nothing to apply a multiplier to. (Laughs.)... And then [running a budget deficit now and] taxing them later isn't going to help, we know that...
Lucas went on to explain why he thought Bernanke and ihs colleagues like Christina Romer were testifying before Congress that he believed the stimulus would be effective:
Christina Romer... here's what I think happened. It's her first day on the job and somebody says, you've got to come up with a solution to this— in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning. So she scrambled and came up with these multipliers and now they're kind of—I don't know.
So I don't think anyone really believes. These models have never been discussed or debated in a way.... These are kind of schlock economics. Maybe there is some multiplier out there that we could measure well but that's not what that paper does. I think it's a very naked rationalization for policies that were already, you know, decided on for other reasons...
When Paul Krugman calls today a “Dark Age of Macroeconomics” he is not referring to Ben Bernanke and Ric Mishkin, with their keen awareness of the potential and the limits of both fiscal policies and credit-channel policies to affect the level of spending alongside monetary policy. He is referring to people like Robert Lucas as he was last March—when the only reason Lucas could think of for why Romer and Bernanke were saying that the stimulus was likely to be effective was that they were corrupt, and when Lucas just “really didn’t get” any piece of Bernanke’s major contribution to economics. Krugman does call this a “Dark Age,” and I think Krugman is right: until this year I taught that the empirical and theoretical issues about whether credit channel and fiscal policies could affect the economy were settled for economists in the 1930s with, in each case, a “yes.”
Don’t get me wrong: it is, I think, a very good thing that Robert Lucas has much more respect for Ben Bernanke and for Bernanke’s judgments on the importance and efficacy of credit and fiscal policies now than Lucas did last March.
But I am curious: Why? Why does Lucas think Bernanke's work on the credit channel shows that he is an "exponent and creative builder of dynamic models" now when Lucas "didn't really get it" last March? Why are the models in which fiscal policy matters that Bernanke presents in his textbooks "[economic] industry standards" right now when they were "schlock economics" last March?