Paul Krugman recently gave a speech, Mr Keynes and the Moderns on several aspects of the legacy of the General Theory, including both the ways it has been read, and how it has been ignored. The latter is a recurring theme after the financial crisis as it became apparent that a great deal of the criticism of “Keynesianism” and aggregate demand analysis (and thus fiscal and monetary policy) was instead aimed at caricatures and strawmen and based on simple and long dead fallacies.
The following passage, describing the post Monetarist era of the Independent Central Bank caught my eye.
And this worked for a while – roughly speaking from 1985 to 2007, the era of the Great Moderation. It worked in part because the political insulation of central banks also gave them more than a bit of intellectual insulation, too. If we’re living in a Dark Age of macroeconomics, central banks have been its monasteries, hoarding and studying the ancient texts lost to the rest of the world. Even as the real business cycle people took over the professional journals, to the point where it became very hard to publish models in which monetary policy, let alone fiscal policy, matters, the research departments of the Fed system continued to study counter-cyclical policy in a relatively realistic way
I feel he is talking of American Economics rather than Economics. My reaction a few years ago was close to Joshua Gans’ in this 2008 post. I was taken by how much of the econocratic establishment in Australia both had a sufficient understanding of AD macro, and also that such a large proportion swung behind fiscal policy. The old fallacies were still around of course, but they didn’t seem to be coming from people who should be expected to know better. If the Western Empire in America had descended into a dark age, we were at least in Byzantium.
But why is this so?[fn1] Why were we having a debate about how much was too much and how well what was spent whilst in American economics there was a dispute about whether recessions, involuntary unemployment and output gaps even existed?
The simplest explanations would be a simple appeal to belief systems and culture, in this case an greater cultural skepticism of any role for the state. This undoubtedly is important and plays a role, but by itself it is unsatisfactory. Firstly because cultural (or preference) explanations can easily end up merely defining an partially unobserved exogenous variable in such a way to produce the observed endogenous variable, though the differing cultural trait in this case is not too hard to establish or attribute to history. The second is that the ignorance observed is of a particular form and espoused by people with strong pedigree in the elaborate nonsense of Real Business Cycle theory. If it was just ideology I’d have expected only Austrian Business Cycle Theory or unreconstructed Monetarism, both of which, although flawed, at least initially tried to explain observable reality, especially unemployment. The latter’s commitment to the real world was responsible both for its death as an ongoing school, but also for it’s positive influence on broader macro. RBC on the other hand is content to play in Ptolemaic cosmos filled with ever increasing numbers of epicycles divorced from anything in the real world.
Both RBC and Monetarism (as well as the Neoclassical synthesis) can be attributed to American culture, but where the latter were attached to reality, proved useful to an extent and withered, the former was always fantasy, completely useless and took over the American journals. This is Lucas’ progeny, not Friedman’s. I suspect something else is at play.
I have a number of speculations, none of which I think is satisfactory.
One might be the incentives faced and paths taken by postgraduate students. The Fed as monastery metaphor might hold some insight. A central bank, or a treasury or other government department is bound to theories and models attached to reality to provide some kind of policy direction. A central bank that was happy to assume something as silly as superneutrality of money isn’t going to get far. I have the impression (maybe wrong) that a great many of the post grads undertaken in Australia are by current [fn2] and ex members of the public service, sometimes funded by their departments. This would mean entering the program accustomed to useful theory and if funding was involved, a direction towards it. I am also of the understanding that American deparments are far more politicised than technocratic. Perhaps this means top American schools are thus geared towards purely academic incentives of publishing (both with an eye to tenure and simple prestige) in journals whose gatekeepers are the product of similar incentives not tied to applicability. A vicious spiral of irrelevance. Research grants might also play a role if an ability to attract them is tied to one’s career success in Australia.
I can’t say how plausible this is though, especially in light of my meagre experience and after the recent debate over the ERA guidelines.
I’d also note that a minuscule sample (n=3) of Gans, Leigh and Wolfers, whom had an undergraduate experience in Australia and American PhDs (and a career in the last case) do not exhibit the same tendencies. This might support a purely cultural explanation, or maybe there’s an earlier exposure at play. My earliest memories of my first exposure to economics, back in highschool in 2002, involved three concepts. The price mechanism, the production possibility frontier, and a four sector model with the paradox of thrift [fn3]. Gans also reports learning the last concept in high school. This suggests another hypothesis. Australian education systems are both larger (and thus may have more inertia, especially where intellectual fads are involved) and less susceptible to politicized school boards. The neoclassical synthesis may have been provided to many more potential Australian economists that carried it with them as they continued studying. Whatever economics is in US highschools may have been stripped of sensical macro by politicised boards with more malleable curriculums. But I have no real evidence to know how probable this hypothesis is.
The divergence between the countries could also be attributable to the specific circumstances of the past few years.
It’s tempting to think that a budget surplus here and deficit there played a large role. It certainly made it politically palatable, but it doesn’t explain a propensity to believe that mass unemployment was a spontaneous holiday. It’s also of note that a large part of this divergence was due to the prior embrace of non reality based policy, so the budget balance was not exogenous to this equation.
It may also have been due to partisan cues. Had the leadership of the Liberals been of the willfully ignorant wing and the leadership of the Liberals not been so in 2008 (say if Abbott and George H W Bush were the respective leaders instead of Turnbull and George W Bush) could people have reacted differently. Possibly, but I doubt it. The divergence in reaction seems deeper than that.
This is largely speculation, and I don’t know what Europe is like. I am still perplexed.
[fn1] Assuming the validity of a premise based on a subjective observation etc.
[fn2] Such as Quiggin’s utility work whilst at ABARES
[fn3] Interestingly though I can’t find it in the 2002 edition of the textbook which I inexplicably still have.