View source for Fighting the Last Macro War? (Slightly Wonkish)

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{{DES | des = Real Business Cycle Theory did well with the stagflation crisis, but didn't help with disinflation, the financial crisis or the persistently depressed economy. | show=}}
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Oh, good — Noah Smith has given me some more economic methodology stuff to waste time on, instead of turning to my various deadlines. OK, I’ll make this shortish.

Noah argues that macroeconomic theorists have been like French generals, always preparing to fight the last war — in the 80s they were working on finding solutions for the problems of the 70s, in the 90s they were working on the problems of the 80s, and so on. It’s a nice image — but I think it gives economists both too much and too little credit.

First of all, a large part of academic macroeconomics is dominated by real business cycle theorists — and to the extent that their work is motivated by any real economic problems, it’s still about the stagflation of the 1970s, which is at least two wars back. Those guys aren’t like French generals getting ready to fight World War I in 1939; they’re still working out how to repel cavalry charges.

Second, I think you want to be careful about defining the macro wars we’re allegedly refighting. When you do that, I think it puts Keynesians (of all stripes) in a better light than Noah grants.

So, what were the macro wars of the last few decades? First there was stagflation — and that did indeed knock Keynesians back for a while, even as it gave freshwater macro some credibility. As I’ve already indicated, the freshwater guys then stopped there. And I mean really, really stopped there: in many ways they seem to be forever living in 1979.

In particular, they never reacted at all to the second macro war, the disinflation of the 1980s. The point there was that disinflation was very costly, with protracted high unemployment — which shouldn’t have happened if freshwater macro were at all right. This reality, as much as clever new models, drove the Keynesian revival; the RBC guys paid no attention, and learned nothing.

It is, I think, somewhat fair to say that Keynesians spent a lot of time thereafter focused on price stickiness and momentum, on one side, and on monetary policy as the be-all and end-all, on the other. Did this leave them unprepared for the next war? A bit, but actually not so much.

For what was the next war? Contra what many people say, it was not the financial crisis. That crisis was a surprise, but not because we had no room for such things in our philosophy. Bank runs have been pretty well understood for a long time; the only thing was that few economists were aware of the institutional changes that had created the shadow banking system. Once you realized what had happened, that jumping haircuts on repo were the functional equivalent of a run on deposits, things fell into place.

And policy responded pretty effectively, too: the financial crisis may have come as a shock, but it was more or less contained by the spring of 2009.

No, the real war involved dealing with a persistently depressed economy, with monetary policy constrained by the zero lower bound. And I just don’t see an intellectual failure there. A number of Keynesians — yours truly, Eggertsson, Woodford, Svensson, whatshisname — Bernanke, that’s it! — and more had studied the issue. The models rolled out to make sense of the ongoing slump elaborated on but didn’t fundamentally change the approaches many of us had been working on since the late 1990s. And the predictions those models made, about interest rates, inflation, the output effects of fiscal policy, were both counterintuitive to many people and reasonably on target.

I just don’t see this as a story of economists unprepared to deal with new events. Personally, I’ve found the past five years, since we hit the zero lower bound, remarkably comfortable in intellectual terms: I’ve had to learn a few new things, but by and large this was the calamity I’ve been preparing for since 1998.

Now, you might ask why, in that case, we haven’t solved the problem. But the answer there has nothing to do with lack of economic understanding; it has to do with ideologues who made up new doctrines on the fly (like expansionary austerity or doom by 90 percent debt) to justify policies that made no sense in the standard models. If politicians turn to climate deniers, that’s not a reflection on climate science; if they turn to crank macroeconomics, that’s not a reflection on Keynesianism.

Bottom line: I am not a French general!
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