Several years ago, in his brief intellectual history, "The Macroeconomist as Scientist and Engineer" [JSTOR] Greg Mankiw suggested that, after the vicious internecine strife of the 1970s and 80s, the field had arrived at an uneasy peace:
Like the neoclassical-Keynesian synthesis of an earlier generation, the new synthesis attempts to merge the strengths of the competing approaches that preceded it. From the new classical models, it takes the tools of dynamic stochastic general equilibrium theory. Preferences, constraints, and optimization are the starting point, and the analysis builds up from these microeconomic foundations. From the new Keynesian models, it takes nominal rigidities and uses them to explain why monetary policy has real effects in the short run. The most common approach is to assume monopolistically competitive firms that change prices only intermittently, resulting in price dynamics sometimes called the new Keynesian Phillips curve. The heart of the synthesis is the view that the economy is a dynamic general equilibrium system that deviates from a Pareto optimum because of sticky prices (and perhaps a variety of other market imperfections).Much has happened in the short time since, and the implications for the field are not yet clear. Paul Krugman's essay in this week's NY Times Magazine, "How Did Economists Get it So Wrong?" continues the story. The truce is over, he says:
It is tempting to describe the emergence of this consensus as great progress. In some ways, it is. But there is also a less sanguine way to view the current state of play. Perhaps what has occurred is not so much a synthesis as a truce between intellectual combatants, followed by a face-saving retreat on both sides. Both new classicals and new Keynesians can look to this new synthesis and claim a degree of victory, while ignoring the more profound defeat that lies beneath the surface.
Between 1985 and 2007 a false peace settled over the field of macroeconomics. There hadn’t been any real convergence of views between the saltwater and freshwater factions. But these were the years of the Great Moderation — an extended period during which inflation was subdued and recessions were relatively mild. Saltwater [New Keynesian] economists believed that the Federal Reserve had everything under control. Freshwater [New Classical] economists didn’t think the Fed’s actions were actually beneficial, but they were willing to let matters lie.This became most apparent in the intellectual debate over the fiscal stimulus:
But the crisis ended the phony peace. Suddenly the narrow, technocratic policies both sides were willing to accept were no longer sufficient — and the need for a broader policy response brought the old conflicts out into the open, fiercer than ever.
Freshwater economists who inveighed against the stimulus didn’t sound like scholars who had weighed Keynesian arguments and found them wanting. Rather, they sounded like people who had no idea what Keynesian economics was about, who were resurrecting pre-1930 fallacies in the belief that they were saying something new and profound.Krugman may be right. However, I think it may be premature to declare that combat has resumed. Krugman and Brad DeLong have found a number of examples of alarmingly pre-Keynesian thinking from some very big names in the field, but it is not clear they have a broad following. The recession presents a real challenge - and opportunity - for macroeconomists. While it would be natural for Minnesota and Chicago types to use more "freshwater" style tools to try to explain it, I am optimistic that most of the profession will be interested in convincing hypotheses of any degree of salinity.
Justin Fox has similar sentiments, but Brad DeLong is less optimistic.
Update (9/6): EconomistMom responds, with a Washington "engineering" perspective; she says "as I've gotten older, my elasticities have shrunk." On his blog, Krugman offers additional notes.