I believe that during the last financial crisis, macroeconomists (and I include myself among them) failed the country, and indeed the world. In September 2008, central bankers were in desperate need of a playbook that offered a systematic plan of attack to deal with fast-evolving circumstances. Macroeconomics should have been able to provide that playbook. It could not.DeLong argues that a better understanding of how to respond to economic crises exists, even if it is outside of Kocherlakota's realm of "modern macroeconomics." He goes back to John Stuart Mill:
Let me briefly set out what the macro playbook is, and how it has been developed by economists and policymakers over the past 185 years. Start with Say's or Walras's Law: the circular flow principle that everybody's expenditure is someone else's income--ands everyone's income is somebody else's expenditure. It has to be that way: for every buyer there is a seller: and for every seller who is disappointed because they sell for less than their cost plus normal profit because of excess supply there must be another who is exuberant from selling at more than cost plus normal profit.
How, then, can you have a depression--a "general glut," a situation in which there is excess supply of not one or a few but all commodity goods and services? How can you have a situation in which workers laid off from shrinking industries where demand is less than was expected and thus less than supply are not rapidly hired into industries where demand is more than was expected and hence more than supply?
Moral philosopher, libertarian, colonial bureaucrat, feminist, public intellectual, and economist John Stuart Mill put his finger on the answer in a piece he published in 1844:[T]hose who have... affirmed that there was an excess of all commodities, never pretended that money was one of these commodities.... [P]ersons in general, at that particular time, from a general expectation of being called upon to meet sudden demands, liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money, or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable...
DeLong puts the problem in terms of a shortage of "safe" assets. The policy response of creating more of them - issuing more government bonds - is the flip side of the traditional Keynesian remedy of deficit spending (or deficit financed tax cuts), as well as of an aggressive "lender of last resort" central bank policy. See also DeLong's related project syndicate column, and this Vox piece by Ricardo Caballero.
So, is this further evidence that we are living in what Krugman called the "dark age of macroeconomics"? Yes and no. As DeLong notes, policymakers have largely been following his playbook (though there are ominous signs they are pulling back too soon). However, academic models employing the reigning methodology of "dynamic stochastic general equilibrium" (DSGE) have generally not been very helpful. That paradigm is still relatively young - it remains to be seen if it will develop in a direction that makes it more useful for policy, or whether it will be supplanted in a more fundamental shift.