Stories from the Macro Wars

Ian Parker's recent New Yorker profile of Yanis Varoufakis included this nugget: "He has written of his hope, as a professor, to present economics as 'a contested terrain on which armies of ideas clash mercilessly.'"

That may be an apt description of macroeconomics in the 1970s and 1980s.  On his website, Paul Romer has offered an interesting take on the methodenstreit between the dynamic general equilibrium approach (so-called "freshwater" macro, championed by Robert Lucas) and Keynesian macro-econometric models (the "saltwater" camp).  Romer is particularly critical of Robert Solow, arguing that his dismissive attitude towards Lucas et al., contributed into a counterproductive hardening of differences. He writes:

Solow also seemed to be motivated to attack harshly because he was concerned that the type of model Lucas was developing might undermine political support for active countercyclical policy. To his credit, there was a legitimate basis for this concern. The new Chicago school of macro eventually did oppose an active response to the financial crisis and its aftermath. But the type of response that Solow exemplified may actually have contributed to the emergence of this new Chicago school. In retrospect, if the goal was to maintain support for active macro policy, the better course would have been to take seriously what the rebel group that was forming around Lucas was saying. This might have kept the rebels from cutting off contact with all outsiders, even those who were taking seriously the issues they were raising.

Brad DeLong and Paul Krugman responded in defense of Solow. DeLong writes:

And, at this point, Romer ought to say that Solow’s and Hahn’s criticisms were (a) no more biting in their rhetoric than the criticisms that Stigler, Friedman, and company had been inflicting on their victims at Chicago for a generation, and (b) correct and accurate.

Romer has more interesting detail in his response, including this summary of the main points:

In the summer of 1978, Lucas and Sargent were making three claims:

(a) Existing multi-equation macro simulation models were not identified. That is, these models summarized correlations in the data but did not yield reliable statements of the form “if the government does X, this will cause Y to happen.”

(b) It was time to use SAGE models to address such fundamental questions about economic fluctuations as why changes in the supply of money influence economic activity; and

(c) SAGE models will imply that an active monetary policy cannot stabilize economic fluctuations.

Solow thought that Lucas and Sargent were wrong about the policy ineffectiveness claim (c). DeLong, Krugman, and I all agree. In the 2013 introduction to his collected papers, Lucas uses some asides about the Great Depression and the Great Recession to admit that now even he agrees. Claim (c) is what DeLong and Krugman have in mind when they say that  Solow was right and Lucas was wrong.
Yet all macroeconomists now agree that Lucas and Sargent were correct about the fatal problems with the large simulation models. Much of Solow’s response amounted to an implausible denial that there was anything wrong with them. So on this point, the roles are reversed. Lucas and Sargent were right and Solow was wrong.

[Romer uses "SAGE" to refer to general equilibrium models].  See also: this from Krugman, and this from DeLong.  David Glasner has a thoughtful post putting things in a broader context.

In his post, Romer cites several papers, including Lucas and Sargent's "After Keynesian Macroeconomics," from the 1978 Boston Fed conference.  Perhaps it should be known as "the throwdown in Edgartown."

Fascinating stuff... but fortunately for contemporary macroeconomists - particularly those of us with conflict-averse midwestern temperaments - things aren't nearly so rancorous now.  There certainly are differences of inclination and opinion, and economists can be blunt in expressing their differences, but the "saltwater" vs. "freshwater" cleavage is largely a thing of the past, as this Steven Williamson post explains.  Since the wars of the 1970s and 80s, there has been some convergence: macroeconomists have developed a class of models - sometimes called "New Keynesian" - which respond to Lucas' methodological critique but also allow for a stabilizing role for macroeconomic policy.  That's not to suggest we've figured it all out, of course; this recent Mark Thoma column highlights some of the weak points of contemporary theory.