Thursday, January 15, 2009
What do macroeconomists know?
Well, they know a lot. But whether this helps them fully understand what is really happening is another question.
Menzie Chinn has a particularly good analysis of possible causes of our economic debacle: succinct, clear, and nicely argued.
Most of the blame goes to monetary policy, fiscal policy, flaws in the tax code, and regulatory malfeasance and corruption. OTOH, hypotheses such as a global savings glut, CRA, and existence of derivatives don't stand up to analysis. I highly recommend you read Chinn's analysis. (Hence two links!)
While he doesn't mention it, "animal spirits" also should be rejected. Once one understands the perverse incentives created by the institutional and policy environment, the current mess makes sense - no need to appeal to "irrational exuberance."
This begs another question, though: why did so many economists and policy makers seem not to understand what was happening? Why is our understanding so often after-the-fact?
Here's my conjecture, and it also helps explain another conundrum I've raised elsewhere: why so many economists who in late 2007 and early 2008 alluded to the Hayekian business cycle as an explanation for developing events now call for Keynesian stimulus as a response.
I just watched Ben Bernanke tackling Q&A after his recent LSE lecture. The second question asked him whether this mess didn't cast doubt on the entire Keynesian paradigm that macroeconomists almost universally accept, and whether the Mises-Hayek "Austrian" view might not have something valuable to offer.
Chairman Bernanke was either unable or unwilling to answer this question, and simply rambled about the benefits of markets and the importance of the Austrian insight that markets aggregate information.
My guess is that most macroeconomists, including Ben Bernanke, actually have next to no idea what the Austrian alternative, or other micro-based approaches to macro, might be, and are left trying to explain things on the basis of the broadest aggregates that don't really capture the many human actions that underlie them.
In my graduate school days at NYU, one of the cutting edge topics in monetary theory was whether the Fed responds to or drives interest rates and economic fluctuations. I just took a short course in monetary theory from two respected U. Minnesota economists and advisors to the Fed (excellent course, BTW). One of the things I came away with is how little monetary theory has advanced beyond this. In my view, macroeconomists remain wedded to a theoretical paradigm so exclusively devoted to aggregates that it cannot make the jump to our world of heterogeneous capital. It's perhaps worth mentioning that a respected MIT economist seems to have begun arguing essentially the same thing, in another context.
It's not that macroeconomists don't understand that differences across individuals, firms, industries, markets, and sectors are important; it's that the current paradigm is poorly equipped to model these differences. Hence despite the general recognition that expansionary monetary and fiscal policy led to malinvestment, the only solution most can see is for government to stimulate aggregate demand. And also, hence the failure to suggest the reforms to monetary and fiscal policy that are really called for.
All of this has me thinking that economists are barking up the wrong tree in proposing economic reforms: I suggest that the first thing we need to do is reform macro.
I haven't followed the post-Keynesians very closely, but did take a look at some of the Levy materials. I haven't sufficient grasp on the gist of the arguments to comment, but do observe that a system with central banking isn't a free market system, since some of the most fundamental prices -- interest rates -- are regarded as policy tools.
At some point I'll give a short Austrian account. I might even get to the point where I can comment on the Minsky theories.