Noah Smith: KrugTron the Invincible: What Is His Secret Weapon?
Marking My Beliefs About Which Economists Mark Their Beliefs to Market to Market

What Economists to Listen to? And Why?

I really wish that Jonathan Portes had written this before I had to give my talk on economists as public intellectuals yesterday…

Jonathan Portes:

Not the Treasury view...: Which (macro)-economists are worth listening to?: [W]hen economists argue about the correct stance of policy, who should we (policymakers, commentators, and the general public) listen to?… I [had] pointed out that not only was the government's decision in 2010 to cut the deficit too quickly doing considerable economic damage, but that this was both predictable and predicted by economists such as Paul Krugman and Martin Wolf. Their response was essentially "how were we to know which economists to listen to? Others were saying the opposite". 

This is a fair question.  My answer to it is that policymakers and the public should listen to economists who fulfill two critera: first, they have made empirically testable predictions (conditional or unconditional - see Krugman here) that have proved, by and large, to be broadly consistent with the data; and second, they base those predictions on an analytic framework (not necessarily a formal model) that is persuasive.  In other words, getting it right alone is not enough; it should be possible to show your workings - to explain why you got it right. Otherwise, your predictions may be interesting, but they tell you little about how to formulate policy. 

My shortlist (apologies in advance to those I've omitted) of economists commenting on macroeconomic policy who I think qualify is something like the following: Krugman, Delong and Wren-Lewis on fiscal policy… Adam Posen on monetary policy… Paul de Grauwe on sovereign and eurozone debt… Martin Wolf on private sector savings and public sector deficits… Richard Koo on the implications of a "balance sheet recession"…. [E]ach have clear analytic frameworks for thinking about the economy, and have used them to make empirically testable claims; and have largely been vindicated….

This in turn generates an obvious list of economists or those commenting on economic issues who got it completely wrong, usually because they were using analytic frameworks that were incoherent or lacked empirical evidence.  I won't name individuals here, so I leave that to readers, but a short list of influential bodies that should have known better includes:

  • those responsible for writing editorials at the Financial Times,
  • macroeconomic forecasters at the OECD,
  • the European Department at the IMF (up until recently - their recent stuff on both UK and eurozone has been pretty good),
  • the senior leadership at the Bank of England and the Treasury, >* and probably worst of all senior economic policymakers at the ECB and European Commission.
  • Oh, and the credit ratings agencies, but that goes without saying. 

It is worth mentioning two economists who I respect, admire and find interesting but do not in my view qualify for inclusion on my shortlist. They are Nouriel Roubini and Ken Rogoff…. I - and maybe this is partly my fault - don't understand what… analytic framework they are using…. Nouriel's predictions… seem to be based largely on instinct and a sense of which data matters…. That's fine… but I just don't know how to evaluate the plausibility…. With Ken, I am even more confused; one of the finest theoretical macroeconomists of the last two decades has staked much of his reputation on a hypothesis - that there is something magic about a 90% debt to GDP ratio - which as far as I can see has no analytical or theoretical basis….

Finally, let me just point out that this is not hindsight on my part.  Most of those mentioned above were on the list of economists I read and, whenever possible, consulted when I was still a civil servant…. I don't think there's any doubt that if policymakers, both in the UK and elsewhere (especially in the eurozone) had, during the intervening period, listened to these people rather than their own economic advisers, the state of the UK and world economies would be significantly better than it is now.


We try… But, unfortunately, unlike Victor Laszlo, we do not succeed in shaping the world.

What is the secret of our success?

And what is the secret of their failure?

The moment when I realized that Olivier Blanchard was completely wrong--that the true state of macro was the opposite of good, and that there were many, many macroeconomists who knew far less than Fisher and Wicksell had known--came, I believe, fittingly enough, on April Fools' Day 2009, when a correspondent emailed me a link to Robert Lucas's talk at a symposium the previous day. You know the talk--it is the one where Lucas says that a governmental decision to spend extra money in a short temporary period must have no effect on the economy-wide flow of spending because households will see the extra future tax liabilities generated by the government deficit and will cut back their spending by the same amount in the same short period. A short run marginal propensity to consume of one. Milton Friedman wrote in vain: all knowledge of consumption smoothing out the window. It is the one where Lucas goes on to say that of course Christina Romer does not believe that a temporary boost to government spending can affect nominal GDP--she is simply telling untruths in order to serve her political masters.

I listened, and I thought to myself: This is not a macroeconomist. This is Bozo the Clown. And yet this clown was awarded a Nobel Prize. Something is really wrong:

Robert Lucas: 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.... [I]t's a very naked rationalization for policies that were already, you know, decided on for other reasons…. 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… 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 then taxing them later isn't going to help, we know that…

Olivier Blanchard (2000): What do we know about Macroeconomics that Fisher and Wicksell did not?:

The answer to the question in the title is: A lot. In this essay, I argue that the history of macroeconomics during the 20th century can be divided in three epochs:

  • Pre 1940: A period of exploration, where macroeconomics was not macroeconomics yet, but monetary theory on one side, business cycle theory on the other. A period during which all the right ingredients, and quite a few more, were developed. But also a period where confusion reigned, because of the lack of an integrated framework.

  • From 1940 to 1980: A period of consolidation. A period during which an integrated framework was developed starting with the IS-LM, all the way to dynamic general equilibrium models and used to clarify the role of shocks and propagation mechanisms in fluctuations. But a construction with an Achille's heel, namely too casual a treatment of imperfections, leading to a crisis in the late 1970s.

  • Since 1980: A new period of exploration, focused on the role of imperfections in macroeconomics, from the relevance of nominal price setting, to incompleteness of markets, to asymmetric information, to search and bargaining in decentralized markets. Exploration often feels like confusion. But behind it may be one of the most productive periods of research in macroeconomics.

Olivier Blanchard (2008): The State of Macro:

For a long while after the explosion of macroeconomics in the 1970s, the field looked like a battlefield. Over time however, largely because facts do not go away, a largely shared vision both of fluctuations and of methodology has emerged. Not everything is fine. Like all revolutions, this one has come with the destruction of some knowledge, and suffers from extremism and herding. None of this deadly however. The state of macro is good.

20130413 Reconstructing Macroeconomics

Mervyn King: I cannot resist taking Larry [Summers's] challenge that we need to "reconstruct macroeconomics", and getting the views of others around the table…. Olivier [Blanchard], is it just a question of getting the right details in the financial models, or is there something more profound?

Olivier Blanchard: Suppose you are writing two textbooks, one undergrad, one grad. In the undergraduate textbook, it seems to me that when teaching the IS-LM, we have the same interest rate on the IS and the same interest rate on the LM. Basically, the policy rate that the central bank chooses by the LM curve goes into the IS curve when corrected for expected inflation. I think what we have learned is that these [two interest rates] can be incredibly different. So I would have an r and an rb, and have a machine in the middle--the banking system which would, depending on its health, determine the spread. It seems to me that if I want to communicate one message, that message is what I would communicate to undergrads.

At the graduate level, we now have this explosion of DSGE models which put one friction and another into the model. Again, targeting pedagogy, it seems to me that there are two mechanisms which are central. The first is leverage, which starting with Ben [Bernanke's] work and earlier work we have, I think we know how to deal with it. The second is liquidity. And I think there we are much less far along the way. Again, I am hoping that someday we will put it together and have a simple way of thinking about leverage and a simple way of thinking about liquidity. These two things will come into our New Keynesian model, and we will be able to tell a simple story. We are at the stage at which the DSGE models have much too much in them to be fully understood. This is a very engineering-based answer to your question. But that is what I would try to do….

Larry Summers: You know I was tempted to blast off at Dynamic-Stochastic General-Equilibrium models. That is, actually, my inclination. But on the other hand it occurred to me to ask the question: "What wouldn't be a Dynamic-Stochastic General-Equilibrium model?" That would be a Static-Certain Partial-Equilibrium model. It is hard to see how that represent any kind of an improvement. So I can't be against DSGE on principle.

Having said that, I think that, and maybe I will be proven wrong over time, there is a central question: Should we think of macroeconomics as being about--as it was thought about before Keynes, and came to be thought of again in the 1990s--cyclical fluctuations about a trend determined somewhere else, where the goal if you were successful was to reduce [the fluctuations'] amplitude; or as centrally about tragic accidents where millions of more people were unemployed for millions more person-years at costs of trillions of dollars in ways that were avoidable with more satisfactory economic arrangements.

Unless and until we adopt the second view, I think we are missing what is our principal opportunity to engage in human betterment. And as long as the question is conceptualized as "what friction should we insert into the existing DSGE model and we will have it?", I don't think we will get to the kind of perspective that I am advocating.

Now it is easy to say this, it is easy to say this. It is much harder to provide a constructive vision of just how to do it. But there are a number of schools of work that to date I think have been sufficiently abstract that they have not made easy connection with practical policy problems--schools that involve multiple equilibria, fragile equilibria, and so forth--that have the prospect of capturing the kind of notion that there are these periods in which you have a very bad outcome that you somehow could have avoided without compromising the future in a very serious way. It really is true that a little bit of avoiding what has happened over the past six years is worth a lot of making the amplitude of fluctuations around trend smaller. It seems hard to observe the past six years, which did not in fact achieve that much disinflation, and not think that it should somehow have been possible to avoid that waste.