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Chicago Macroeconomists: They Blinded Themselves with Ideology...

A while ago, Simon Wren-Louis wrote an explanation for why so many economists have done so very badly indeed at analyzing the past four years. It was smart:

mainly macro: Mistakes and Ideology in Macroeconomics: Imagine a Nobel Prize winner in physics, who in public debate makes elementary errors that would embarrass a good undergraduate. Now imagine other academic colleagues, from one of the best faculties in the world, making the same errors. It could not happen. However that is exactly what has happened in macro over the last few years.

Where is my evidence for such an outlandish claim? Well here is Nobel prize winner Robert Lucas:

But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash.  It has no first-starter effect.  There's no reason to expect any stimulation.  And, in some sense, there's nothing to apply a multiplier to.  (Laughs.)  You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. 

And here  is John Cochrane, also a professor at Chicago, and someone who has made important academic contributions to macroeconomic thinking.

Before we spend a trillion dollars or so, it’s important to understand how it’s supposed to work.  Spending supported by taxes pretty obviously won’t work:  If the government taxes A by $1 and gives the money to B, B can spend $1 more. But A spends $1 less and we are not collectively any better off….

[S]urely very clever people cannot make simple errors of this kind? Perhaps there is some way to re-interpret such statements so that they make sense…. I prefer to just note that if any undergraduate or graduate student in the UK wrote this in an exam, they would lose marks. The more interesting question for me is why the errors were made…. [W]e cannot imagine members of a physics department making such errors…

Or, rather, if members of a physics department do make such errors, they are (a) likely to be in the heat of a seminar rather than in any form of print, and (b) quickly followed by embarrassment, retraction, and apology.

Simon goes on:

What is different about macro?

I want to suggest two answers. The first is familiarity with models. I cannot imagine anyone who teaches New Keynesian economics, or who talked to people who teach New Keynesian economics, making this mistake….

Lack of familiarity does not necessarily imply believing something is wrong. In a separate piece, Cochrane writes:

“New-Keynesian” thought is devoted to defending the importance of monetary policy, and incorporating specific frictions in the equilibrium tradition, not to rescuing the ancient view that fiscal stimulus is important and abandoning that tradition.  

This is broadly true for New Keynesian theory when monetary policy is unconstrained… but not when interest rates are stuck at a lower bound. Cochrane is not saying New-Keynesian theory is wrong, but implies incorrectly that it suggests fiscal stimulus will not work….

Lack of familiarity with New Keynesian economics may be partly explained by the history of macroeconomic thought that I briefly noted in an earlier post…. [I]t is possible to teach macro without getting round to teaching New Keynesian theory. However… how [can] monetary policy… at least… as seen by pretty much every central bank… be… an optional add-on in macroeconomics[?]

The second difference… is ideology…. Cochrane writes

These ideas changed because Keynesian economics was a failure in practice, and not just in theory. Keynes left Britain 30 years of miserable growth…. Keynes disdained investment…. Keynes did not think at all about the incentives effects of taxes. He favored planning…. Fiscal stimulus advocates are hanging on to a last little timber from a sunken boat of ideas, ideas that everyone including they abandoned, and from hard experience.  If we forget all that, we could repeat the economics of postwar Britain, of spend-and-inflate Latin America, and of bureaucratic, planned India.

Let’s not worry about where the idea that Keynes disdained investment comes from, or any of the other questionable statements here. This is just polemic: Keynes=fiscal expansion=planning=macroeconomic failure.  It is guilt by association. What on earth does fiscal expansion have to do with planning? Well, they are both undertaken by the state.

I have argued elsewhere that the problem too many macroeconomists have with fiscal stimulus lies not in opposing schools of thought, or the validity of particular theories, or the size of particular parameters, but instead with the fact that it represents intervention by the state designed to improve the working of the market economy. They have an ideological problem with countercyclical fiscal policy. But the central bank is part of the state, and it intervenes to improve how the economy works, so this ideological view would also mean that you played down the role of monetary policy in macroeconomics. So ideology may also help explain a lack of familiarity with the models central banks use to think about monetary policy. In short, an ideological view that distorts economic thinking can lead to mistakes.