Sunday, February 1, 2009


Brad DeLong and Paul Krugman have vigorously criticized some prominent economists - particularly Eugene Fama and John Cochrane - who have offered apparently pre-Keynesian interpretations of the current economic mess. In particular, both seem to suggest that "Say's Law" holds, and therefore, fiscal policy cannot only reallocate - but not increase - output, an argument we thought Keynes had demolished in 1936. Krugman writes:
So how is it possible that distinguished professors believe otherwise?

The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.

And that’s what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.
Or, as he said to Mark Thoma, economists who "have spent their entire careers on equilibrium business cycle theory are now discovering that, in effect, they invested their savings with Bernie Madoff." By "equilibrium business cycle theory," he means the modern incarnation of classical economics, where markets clear and economic fluctuations arise from the behavior of rational, optimizing agents. Greg Mankiw offers a more charitable interpretation:
It is funny. I have a similar pedigree as Paul. Both of us have PhDs from MIT, and we learned a lot of our macro there. Both of us see the world through the lens of the Keynesian framework (by which I mean the IS-LM model, etc.) But we have very different perspectives on the equilibrium business cycle theorists.

The difference may reflect our research paths. Most of Paul's research has been in international economics, and throughout his career, he could easily ignore equilibrium business cycle theory. By contrast, I have done a lot of work on "new Keynesian economics," which tries to fix the flaws in the Keynesian model that the equilibrium business cycle theorists pointed out. Perhaps that work has given me more appreciation for their contribution, as well as for the defects in the Keynesian worldview.
Here is DeLong on Fama, and on Cochrane.

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