Bryan Caplan  

Cochrane's Political Economy

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"All Theories Are False"... The View from Outside...
From his rebuttal to Krugman:

Krugman is trying to say that a cabal of obvious crackpots bedazzled all of macroeconomics with the beauty of their mathematics, to the point of inducing policy paralysis.  Alas, that won't stick. The sad fact is that few in Washington pay the slightest attention to modern macroeconomic research, in particular anything with a serious intertemporal dimension.  Paul's simple Keynesianism has dominated policy analysis for decades and continues to do so. From the CEA to the Fed to the OMB and CBO, everyone just adds up consumer, investment and government "demand" to forecast output and uses simple Phillips curves to think about inflation.  If a failure of ideas caused bad policy, it's a simpleminded Keynesianism that failed. [emphasis mine]

As far as I can tell, Cochrane's right.  The only thing weirder than the sharp disconnect between undergraduate and Ph.D. macro is the fact that for practical purposes, Ph.D.s rely on what they learned as undergrads.


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COMMENTS (6 to date)
Joe Cushing writes:

We could have used some paralysis. We would have been much better off if congress was in recess for the last 2 years.

SheetWise writes:

Perhaps subjecting all of these macro enthusiasts, both undergraduate and Ph.D., to an e-meter would enlighten us all.

Bill Woolsey writes:

Caplan:

More or less correct.

We have had fiscal stimulous packages of one sort or other with every recession in my lifetime.

However, note that Republican administrations have focused on tax cuts, often shaped to provide supply-side incentives. And so, we would hear about the tax cuts raising disposable income, consumption, and nominal expenditure, but the lower marginal tax rates should also increase productive capacity and output, even if we did have market clearing and full Ricardian equivalence. (Was't Borro all in favor of marginal tax rate cuts this time around?)

(On a side note, perhaps things have changed as Mason these days, but in the earlier incarnations of the Virginia school, budget deficits and national debt were considered very bad. I think ricardian equivalence helped convince Republican policitians that funding government by debt isn't really a problem.)

During the current crisis, Bernanke and the FOMC lowered the target interest rate and increased base money. This is what principles macro says should be done in recession--to dampen and reverse decreases in nominal expenditure.

However, they also worked to reverse the disturbance in credit markets (trying to restart securitization markets.) This fits in with Bernanke's theory that it is disruption in real intermediation that relates banking to real output, something that would exist even in a market clearing model.

The Fed has focused on trying to keep inflation expectations on target. I think principles macro would instead be focused on raising nominal expenditure to get real output back to capacity. However, because the simple phillips curve story suggets an output gap will slow inflation, then lower interest rates and monetary expansion is called for in both situations. Inflation is below target and output is below capacity. Notice, however, that if we did have market clearing so that output equals capacity aways, then maintaining stable inflation is all that the monetary athority could do. So, their activity seems consistent with market clearing theory.

If I had to point to any failure of macroeconomics it would be that too many threw up their hands at the zero nominal bound. The economy slows, so lower the target for the Fed funds rate and implement by purchsaing T-bills. But once the target rate and the yield on T-bills approach zero, what do we do now?

I think Krugman's points about finance and macro are relevant because they point to how hitting that zero nominal bound on interest rates is more plausible. There are economic fundamentals that suggest that if _THE_ real interest rate is permanently negative, this will be too low. So, why worry? But having some real interest rates temporarily negative is much more realistic.

Targetting safe, short term interest rates may not be adequate in the aftermath of the popping of an asset price bubble. A flight to safety may require substantially negative real interest rates on safe and short assets in order to maintain nominal expenditure.

Of course, Krugman appears to be really interested in claiming that there is no way to avoid permanent Depression other remaking the U.S. economy in the image of Sweden. And by that I mean more social services and transfers. I think that version of Keynesian economics (secular stagnation,) was pretty much relegated to the dustbin a half century ago, justifiably so.

Bill Woolsey writes:

Caplan:

More or less correct.

We have had fiscal stimulous packages of one sort or other with every recession in my lifetime.

However, note that Republican administrations have focused on tax cuts, often shaped to provide supply-side incentives. And so, we would hear about the tax cuts raising disposable income, consumption, and nominal expenditure, but the lower marginal tax rates should also increase productive capacity and output, even if we did have market clearing and full Ricardian equivalence. (Was't Borro all in favor of marginal tax rate cuts this time around?)

(On a side note, perhaps things have changed as Mason these days, but in the earlier incarnations of the Virginia school, budget deficits and national debt were considered very bad. I think ricardian equivalence helped convince Republican policitians that funding government by debt isn't really a problem.)

During the current crisis, Bernanke and the FOMC lowered the target interest rate and increased base money. This is what principles macro says should be done in recession--to dampen and reverse decreases in nominal expenditure.

However, they also worked to reverse the disturbance in credit markets (trying to restart securitization markets.) This fits in with Bernanke's theory that it is disruption in real intermediation that relates banking to real output, something that would exist even in a market clearing model.

The Fed has focused on trying to keep inflation expectations on target. I think principles macro would instead be focused on raising nominal expenditure to get real output back to capacity. However, because the simple phillips curve story suggets an output gap will slow inflation, then lower interest rates and monetary expansion is called for in both situations. Inflation is below target and output is below capacity. Notice, however, that if we did have market clearing so that output equals capacity aways, then maintaining stable inflation is all that the monetary athority could do. So, their activity seems consistent with market clearing theory.

If I had to point to any failure of macroeconomics it would be that too many threw up their hands at the zero nominal bound. The economy slows, so lower the target for the Fed funds rate and implement by purchsaing T-bills. But once the target rate and the yield on T-bills approach zero, what do we do now?

I think Krugman's points about finance and macro are relevant because they point to how hitting that zero nominal bound on interest rates is more plausible. There are economic fundamentals that suggest that if _THE_ real interest rate is permanently negative, this will be too low. So, why worry? But having some real interest rates temporarily negative is much more realistic.

Targetting safe, short term interest rates may not be adequate in the aftermath of the popping of an asset price bubble. A flight to safety may require substantially negative real interest rates on safe and short assets in order to maintain nominal expenditure.

Of course, Krugman appears to be really interested in claiming that there is no way to avoid permanent Depression other remaking the U.S. economy in the image of Sweden. And by that I mean more social services and transfers. I think that version of Keynesian economics (secular stagnation,) was pretty much relegated to the dustbin a half century ago, justifiably so.

Mike Rulle writes:

It is possible that Krugman wishes he were Bernanke, Romer, Summers, or some other important political "player". Is PK really as intellectually clueless as he appears to be (according to Cochrane), or does he simply have another agenda?

Yet even smart people easily forget what they have studied when they stop studying. Krugman has become so obsessed with left wing government-centric politics that his energy is consumed by it; probably to the detriment of economic research and even understanding.

Or perhaps he simply likes the attention. Either way, he no longer appears relevant. Cochrane's critic is so strong that to focus any more effort on PK appears to be a waste of time.

Drewfus writes:

As Greg Mankiw pointed out recently, the unemployment rate is now higher than the presidents economic team predicted would have been the case without any economic stimulus!

http://gregmankiw.blogspot.com/2009/05/accountability.html

There is just no evidence that government/fed policies have been of any benefit to the economy, whatsoever.

Talking about zero/negative interests rates is also pointless - when has that policy ever worked?

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