Afghanistan is a disaster. Even Michael Steele can see that. More on that tomorrow. But Afghanistan is not the only conservative disaster that Obama has managed to make his own over the past year and a half. In fact, making conservative disasters his own is sort of an Obama specialty. He's not alone in this, of course. It's sort of a "Third Way" thing. In fact, it practically defines what it means to be "Third Way". You take a few "high-minded" liberal ideals, combine them with a shit-load of failed (and/or doomed to fail) conservative policy frameworks, and voila! there you have your "Third Way" in its entirety. Earlier this week, in "Learned Helplessness In Macro", Paul Krugman gave a quick run-down of what this looks like in the economic policy realm:
the basic story of "modern" macro runs like this:
1. Lucas and his disciples agree that the economy looks Keynesian - that is, it surely looks as if monetary and fiscal policy have real effects - but argue that an equilibrium approach with imperfect information can explain why, while rejecting Keynesian policy implications. And they ridicule Keynesian economics.
2. By 1980 - three decades ago! - it is already clear that the Lucas project has failed. Equilibrium models with imperfect information cannot, in fact, explain key facts about business cycles, especially the way recessions persist even though everyone knows that they're in a recession.
3. Rather than admitting that they went down the wrong track, however, the advocates of freshwater macro double down; they decide to forget about what they used to know about the apparent effects of demand shocks, and explain the business cycle in terms of real shocks.
4. This approach also falls short; in an attempt to rescue the models, ever more epicycles are added, and whatever clarity may once have existed gets lost.
5. Freshwater economists declare that the business cycle is deeply puzzling, and that we need much more research before we can make policy recommendations.
In short, what we're looking at is learned helplessness.
This is actually not what the term "learned helplessness" means, since it refers to a psychological, not an intellectual, process. But, then, calling this morass of misundersanding "intellectual" is a bit of its own stretch, don'tcha know! So I'm not going to push it.
To add a bit more detail to this story, the core mistake here is two-fold: (1) the belief that macro-phenomena must be reduced to micro-phenomena (as opposed, say, to seeing that both micro- and macro- phenomena can influence each other), and (2) the belief that micro-phenomena can be explained in terms of "rational expectations", a relatively simplistic, static model of human decisionmaking that directly contradicts much of what cognitive & social science has to tell us about human cognition and decisionmaking.
This approach doesn't work from the very beginning, but to try to make it work, they adopt a practice reminiscent of pre-Copernican astronomy, when any deviation from "perfect" circular orbits was dealt with by adding smaller epicycles of circular orbits around the paths of larger circular orbits. In this case, they took the relatively new discoveries of "imperfect information"--which looked at one way destroyed the foundations of classical micro-economics--and used them to try to show how their micro-based vision could work. This was all embodied in Krugman's first point above--and his second point spelled its doom.
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With this in mind, let's follow Krugman's own link back to an earlier post from last September where he provides more detail for those early steps:
As I remember it, it all began with the Phelps volume: Microeconomic Foundations of Employment and Inflation Theory....
Phelps and others tried to explain why the economy looks so Keynesian in terms of imperfect information: workers and firms respond to a change in the price level as if it were a change in relative prices, because they can't at first tell the difference. Over time, however, they will realize their mistake - so that, for example, a rise in the inflation rate will reduce unemployment at first, but won't do so on a sustained basis, because eventually inflation will get built into expectations. So the new theory predicted the emergence of stagflation, a prediction that was duly confirmed.
But where do expectations come from? Robert Lucas married Phelps-type models of employment with rational expectations, the view that people in the economy use all available information to make predictions. And this led to a startling conclusion: anticipated policies have no effect on employment. Only surprise changes in, say, the money supply matter - which means that you can't use monetary or fiscal policy to stabilize the economy.
So, not only do they get their wet dream of (1) reducing macro-phenomena to micro-phenomena (2) explained in terms of "rational expectations" (with an epicycle fudge-factor of "imperfect information"), they also show that policies can't help with employment if people see them coming--which easily morphs simply into " policies can't help with employment", even though there actually endless paradoxes involved in this sort of conceptual slight-of-hand. (For example: If it doesn't work because it's foreseeable, then you don't do it, but everyone knows you won't do it, so then when you do it, it's not forseeable, so it must work!)
Krugman continued:
The Lucas view took the economics profession by storm - not because there was any solid evidence for it, but because it was so clever, because it led to nice math, because it let macroeconomists give in to their inner neoclassicists.
But by the late 70s it was already clear that rational expectations macro didn't work. Why? Because people have too much information.
Think about the story of unemployment I've just described. It's a story in which a contraction in the money supply can produce a recession - but only as long as people don't know that there's a recession! You see, if people do know that there's a recession, they know that the low prices they're being offered reflect low overall demand, not specifically low demand for their products.
In Lucas-type models, people were supposed to look at the prices they received, and optimally extract the "signal" from the "noise". The models broke down, however, as soon as you let people have access to any other information - say, by looking at interest rates, or reading a newspaper. And the reality, of course, is that recessions persist long after everyone knows that there's a recession, so that the confusion required by Lucas-type models is long since gone.
This was both oddly similar yet dissimilar to the pre-Copernican obsession with epicycles and preserving circular orbits. The best pre-Copernican were much more data-driven than their economist descendents, and that was a notable dissimilarity. But they were equally obsessed with their notion of what counted as a pure and simple core explanation, staunchly refusing to let go just because the data stubbornly refused to behave.
Actually, the better analogy might not be the pre-Copernicans, but rather the last true believer in epicycles, the post-Copernican king of astronomers Tycho Brahe, for whom Kepler worked as an assistant for almost a decade. Brahe proposed a hybrid model, in which all the planets except Earth revolved around the Sun, while the Sun and the Moon both revolved around the Earth. It was a great simplification, on the one hand, vastly reducing the number of epicycles needed, but a relatively sophisticated model, on the other hand. Of course it didn't work. But it certain was impressive. And the clever way it eliminated some epicycles while elevating others suggests a similarity to how Lucas-type models required a similarly arbitrary view of perfect vs. imperfect information.
Krugman (in his September 2009 diary) continued:
I recall a seminar, I think in 1980, in which Robert Barro was presenting a rational-expectations business cycle model. Someone asked him how he could reconcile his model with the severe recession taking place as he spoke. "I'm not interested in the latest residual," Barro snapped.
But by 1980 or 1981 it was basically clear to everyone that the Lucas project - the attempt to explain the evidently Keynesian behavior of the economy in terms of nothing but imperfect information - had failed. So what were macroeconomic theorists supposed to do?
The answer was that they split. One faction said, in effect, "OK: we can't explain what we think we see in terms of full maximization. So we have to assume that there are some limits to maximization - costs of changing prices, bounded rationality, whatever." That faction became New Keynesian, saltwater economics.
The other faction said, in effect, "OK: we can't explain what we think we see in terms of full maximization. So we must be interpreting the data wrong - things like changes in the money supply must not be driving recessions, because theory says they can't." That faction became real business cycle, freshwater economics.
Before going on with Krugman's story, I want to make a deeper point: Neither of these groups rejected the second part of the two-fold core mistake I mentioned above:
(1) the belief that macro-phenomena must be reduced to micro-phenomena (as opposed, say, to seeing that both micro- and macro- phenomena can influence each other), and (2) the belief that micro-phenomena can be explained in terms of "rational expectations", a relatively simplistic, static model of human decisionmaking that directly contradicts much of what cognitive & social science has to tell us about human cognition and decisionmaking.
The freshwater economists remained firmly wedded to both these beliefs, while the saltwater economists seemingly preferred civil unions. Krugman continued:
But here's the thing: at this point, the freshwater school no longer remembers any of that - largely because they purged Keynesian and even monetarist thought from their classes. All they know is that Keynesianism was "disproved", and that none of it - not even New Keynesian models with rational expectations (an approach which, as Greg Mankiw says, "provides a rationale for government intervention in the economy, such as countercyclical monetary or FISCAL POLICY.") - is worth listening to.
So that's how we got to where we are today.
That diary by Krugman was roughly contemporaneous with his NYT magazine piece, "How Did Economists Get It So Wrong?", which I wrote about in my diary, "What Went Wrong-Krugman And Beyond"
One part of that diary is worth quoting here:
(4) Because Keynes rejected the full set of neo-classical assumptions, his theory of the economy as a whole (macro-economics) could not be compatible with the neo-classical theory of economic transactions at the level of individuals, firms and limited markets (micro-economics). But Keynes never supplied an alternative micro-economics to go with his theory. So-called Keynesians since him have generally tried to combine neo-classical micro-economics with Keynesian macro-economics, sometimes introducing variations, such as making the micro-economics more realistic via behavioral economics. Post-Keynesians have generally rejected this approach as intellectually incoherent. Their tendency has been toward empirical studies of actual micro-economic behavior, rather than depending on axiom-dependent models of any kind.
On the micro-economic side, the just-published Issue 53 of the Real World Economics Review contains an article, "Debunking the theory of the firm-a chronology" by Steve Keen and Russell Standish. The article is "heavy going" as Keen himself says in a personal introduction, and I haven't even tried to do more than glance at it. But the point is, there is a rigorous criticism of the original neoclassical micro-economics out there, in addition to more recent criticisms in terms of its basic assumptions running counter to other social and cognitive science findings. In short, the entireedifice of existing economic theory--micro as well as macro--is really only as good as its predictions turn out to be. If it works--fine. But if it doesn't, there's no clear core of well-grounded theory to fall back on. It's all a project of "almosting it", as James Joyce so quaintly put it.
Krugman concludes his diary from this week thus:
Economists who didn't go down this path, who didn't flush everything the profession had learned between 1936 and 1973 down the memory hole, aren't especially baffled by the situation we're in now; on the contrary, it looks like an extreme version of a fairly familiar event, and policy recommendations aren't hard to make.
It's only if you're committed to a failed research project - a project that failed a generation ago, but refused to admit it - that you're baffled.
And he's quite right... so far as he goes. It's not that New Keynesians have an intellectually sound model of economics. They have a good enough grasp of what needs to be done to avoid utter catastrophe along the lines of past disasters. And good enough should be good enough to get on with it, and avoid another 1937, another lost decade, another long depression. Much,much more needs to be done than that. But unless we do that, then things will get very ugly indeed.
The failures of conservatism must be recognized for what they are: Utter failures that need to be utterly rejected. They are failures of the past that simply need not be repeated again. Only once we have put them behind us can the real work begin. Only then can we hope to sort through the relative relative short-comings of various left-liberal approaches, and which ones represent the most promising ways forward in dealing with the future challenges that face us. |
