Scott Sumner  

The macroeconomic elite is definitely wrong about something

Milgram's "Obedience to Author... The Bias of Modern Art...

Ben Southwood directed me to a paper by Lawrence Christiano, with the following executive summary:

The Great Recession was particularly severe and has endured far longer than most recessions. Economists now believe it was caused by a perfect storm of declining home prices, a financial system heavily invested in house-related assets and a shadow banking system highly vulnerable to bank runs or rollover risk. It has lasted longer than most recessions because economically damaged households were unwilling or unable to increase spending, thus perpetuating the recession by a mechanism known as the paradox of thrift. Economists believe the Great Recession wasn't foreseen because the size and fragility of the shadow banking system had gone unnoticed.

The recession has had an inordinate impact on macroeconomics as a discipline, leading economists to reconsider two largely discarded theories: IS-LM and the paradox of thrift. It has also forced theorists to better understand and incorporate the financial sector into their models, the most promising of which focus on mismatch between the maturity periods of assets and liabilities held by banks.

I find this incredibly depressing, as I think it's almost entirely wrong. (And yet I don't doubt that Christiano is expressing something close to the consensus view.) In my view, the Great Recession was caused by a sharp decline in NGDP, which was triggered by a flawed monetary policy regime (mostly a lack of level targeting, but other problems as well.)

In this post, however, I'd like to focus on another issue. It seems to me that even if Christiano is completely correct about the lessons of the Great Recession, his claim still represents a major indictment of the macroeconomic profession, particularly at its most elite levels. More specifically, these two views cannot both be correct:

1. The Great Recession requires a major rethink of macro theory, in the way outlined above by Christiano.

2. Elite grad programs in macro should require students to study lots of math and statistics, but should not require a course on macroeconomic history, or the history of macroeconomic thought.

(I'd say both are incorrect.)

The basic problem here is that we've been through this once before:

1. We had a very long depression.

2. The very long depression was associated with severe financial turmoil.

3. The financial turmoil was seen as the principle cause of the very long depression.

4. Interest rates fell to zero.

5. Monetary policy was viewed as largely ineffective.

6. There was renewed interest in fiscal stimulus.

7. There was renewed interest in financial regulation.

8. Theories of a paradox of thrift were developed.

9. Theories of secular stagnation were developed.

10. Classical (opportunity cost) approaches to economic were de-emphasized.

Does this sound familiar? It's exactly what's happened over the past 10 years.

It's hard to overstate just how embarrassing this state of affairs really is. We have the highest levels of the profession of macroeconomics doing a major rethink of their profession, based on "new information" that isn't new at all. This "new information" was readily available to anyone with a passing knowledge of macroeconomic history. We've been here before. It's OK for an art form to by cyclical, but not a science.

But it's even worse---far worse. Consider the standard view of the Great Depression, soon after it had ended. Many of the world's top economists would have had views of the Great Depression that are quite similar to these revisionist views associated with the Great Recession. Most would not have blamed the Fed for causing the Great Depression with a tight money policy. Indeed most would not have seen monetary policy as being tight at all.

Now fast forward to 1963. Friedman and Schwartz publish a landmark study showing that the Fed was largely to blame for the 50% fall in NGDP between 1929-33. Now fast forward to 2003. Fed governor Ben Bernanke admits that the Fed was to blame for the Great Contraction:

I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

Bernanke's right. But consider that this implies that between 1929 and 1963 the macroeconomic profession had a completely false theory of what caused the Great Depression. A false theory almost identical to the current consensus view of the causes of the Great Recession.

We re-evaluated the Great Depression once we realized that near-zero interest rates and lots of QE don't mean easy money. We re-evaluated the Depression once we understood that the Fed missed lots of opportunities to stimulate the economy. We re-evaluated the Depression once we saw (after WWII) that the economy was not suffering from secular stagnation. We re-evaluated the Depression once we saw (in 1968-70 and again in 1981-83) that monetary policy was far more powerful than fiscal policy. We re-evaluated the Depression once we realized (in the 1970s) that high interest rates don't mean tight money.

So today we've removed economic history courses from elite economics PhD programs. Then we have the consensus view of elite macroeconomists shift in a "Keynesian" direction, in almost exactly the same way it shifted in the period from 1930 to 1960. I used to have a low opinion of that era in macroeconomics. But what's going on today is far worse, for three reasons:

1. The Great Depression really did represent new information. The zero bound issue was new and unfamiliar. In contrast, the Great Recession has not provided any sort of new information that would lead an educated macroeconomist to rethink his or her views of the core theory. It was just a smaller version of the Great Depression, caused by smaller versions of the same policy errors that caused the Great Depression.

2. After the 1960s, we gradually learned that the original consensus view of the Great Depression was wrong. Now we've made those same mistakes twice. That's even less excusable.

3. In earlier decades, economists still valued economic history, and the history of thought. Economists used to be taught what went wrong when the Fed adopted a policy that boosted demand for bank reserves in 1937. With the exception of David Beckworth, I saw almost no one making that connection in October 2008, when the Fed again adopted a policy that boosted the demand for bank reserves.

New month I will attend a conference in DC, feature lots of members of the macroeconomic elite (Bernanke, Summers, etc.) It will be very interesting to observe how their view of the current situation compares to the original (and later discredited) standard view of the Great Depression. I'll keep you posted.

PS. FWIW, I believe the Fed triggered the Great Recession when it stopped printing money after July 2007, for a period of 10 months. (I.e., froze the base). The (initially mild) recession then further depressed an already weak real estate market, lowering the Wicksellian equilibrium interest rate. Then the Fed worsened the recession during April 2008-October 2008 by refusing to cut their interest rate target as the Wicksellian rate declined. They worsened it further by refusing to engage in "level targeting" (of prices or NGDP). In early October 2008, they worsened it further by adopting IOR.

The Fed inexplicably failed to cut IOR to zero, or better yet negative levels, despite a slow recovery. They repeatedly ended QE programs prematurely, despite an inadequate recovery. They refused to adopt monetary stimulus even when the economy was no longer at the zero bound after 2015, despite the price level being far below the trend line. Even worse, they refused to adopt monetary stimulus when no longer at the zero bound, even though even the rate of inflation remained below target, The Fed's massive policy failure of 2008 cannot be blamed on the zero bound issue, because we weren't at the zero bound in 2008. Ditto for the sub-2% inflation during the period since 2015.

The Great Recession had the same cause as the Great Depression, many years of tight money. The rest are symptoms.

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COMMENTS (17 to date)
JFA writes:


Just a quick question. You say the recession was caused by a sharp decline in NGDP, but isn't that (basically) just the definition of a recession? You can say that the recession was caused by bad monetary policy, but I'm not sure you can say that a recession (a decline in NGDP) was caused by a decline in NGDP (a recession).

Brian Donohue writes:
John Hall writes:

Great post. You should just add that PS to the bottom of all your posts, like an email signature.

Of course, it goes without saying that the people who get into these elite PhD programs are all very smart. However, especially with respect to macro/banking, historical knowledge is more valuable to a practitioner than the theoretical knowledge.

Becky Hargrove writes:

This is one of your best posts.

Owen Wall writes:

Could you perhaps write a response to broadly ignored post-Keynesian or MMT perspective on this? They largely agree with you that the great recession and depression were caused by not enough new money being created, but you don't seem to confront the question here: "How do you get the new money circulating in the real economy?"

You do mention negative rates, but can you express how you are sure that this will result in increased lending, when aggregate private debt levels, to the post-Keynesians, can be "maxed out"? No matter interest rates, new debt must be serviced.

Secondarily, once you've demonstrated how this will result in increased lending, could you discuss how this is preferable to higher rates, to limit and bring down inequality-fueling and entrepreneurship-killing aggregate private debt, with concurrent QE combined with government borrowing which creates the needed money to target NGDP while keeping the financial position of the government within stable bounds?

Thanks - Owen

Mark Bahner writes:


Scott can correct me if I'm mistaken, but I think his argument was that the NGDP decline was caused by bad monetary policy. He wrote:

In my view, the Great Recession was caused by a sharp decline in NGDP, which was triggered by a flawed monetary policy regime (mostly a lack of level targeting, but other problems as well.)

I'd also like to echo other commenters: This is a great post on a really, really important issue.


BC writes:

JFA, I believe a recession is a decline in *real* GDP. Nominal GDP, actually any nominal variable, is whatever the Fed wants it to be because the Fed controls the money supply.

It seems to me that lots of people, including elite economists, think of the Great Recession as a mini Great Depression. That makes it all the more puzzling why the default null hypothesis is not that the underlying cause was the same. I see very few elite economists even try to explain why the causes of the Great Recession were different from that of the Great Depression.

Is there a public choice explanation why economists involved in government policy would naturally gravitate towards "Keynesian" explanations rather than Friedman-Schwartz explanations? If it happens twice, maybe it's not a coincidence.

Benoit Essiambre writes:

This is such a dire, self inflicted condition for humanity.

The math and statistics should be as convincing as the history. Rowe style thought experiments are what convinced me and they are more like vague forms of math and probabilistic models than history.

BJH writes:

Great post!

Scott Sumner writes:

Thanks everyone!

JFA, You said:

"but isn't that (basically) just the definition of a recession?"

No, in 2008 Zimbabwe had a recession despite rapid growth in NGDP.

The US had a recession in 1974 despite more than 5% NGDP growth.

Owen, I'm strongly opposed to the MMT view, and have many earlier posts explaining why. Many of them are over at

Matthew Waters writes:

Two things:

1. In terms of the natural rate going below zero, I would not dismiss the narrative. Why did the natural rate go below zero in 9/2008 and not in the 50 years before? The "shadow banking system" plays a big part in a sudden demand for liquidity which did not exist before.

2. But the next paragraph is very bad, worse than the narrative quoted IMO:

"The conventional view on why the recession lasted so long is that the events described in the previous paragraph reinforced the desire to save, relative to the desire to invest. If markets worked efficiently, then the interest rate would have fallen to balance the demand and supply of savings, without a significant fall in employment. According to the conventional view, this required that interest rates be substantially negative, something that could not be achieved because the nominal interest rate cannot be much below zero."

The ZLB is waved away as obvious and self-evident. But if the ZLB is considered the cause of 10-20% unemployment, why isn't the ZLB considered the great crisis of macroeconomics? Why wave it away in one sentence as self-evident? If the ZLB is purely politics of acceptable Central Bank policy, why not condemn the politics?

I don't see a good answer to the above questions.

Alec Fahrin writes:

I am going to disagree to an extent with Sumner about the main cause of the Great Recession. My argument is along the lines of what Owen Wall writes above. Forewarning: Forgive my basic knowledge of monetary policy and simplistic questions.
Just because the Fed controls nominal GDP growth, that doesn't exactly translate to real GDP growth. Sumner always argues, "don't reason from a price change". Well, why does he reason that because nominal GDP growth (price change) slowed so much from July 2007 - June 2008, that must mean that the real GDP growth slowdown was largely linked/caused by this price change? I personally agree that nominal GDP growth changes have some effect on real GDP growth changes, but my broader question is how exactly the Fed's control of NGDP growth leads to a causal connection/factor in RGDP growth.
This is where Owen comes in. What stops banks from putting all the extra cash in a (hypothesized) safe? If they didn't use it and the extra cash only slightly changed their lending behavior (as the experience of QE showed), how would it still affect the real economy?
Yes. The Fed controls NGDP growth. Yet, you need a real economy mechanism that gets the causal factor in NGDP growth changes to somehow affect RGDP growth in the short-term. I believe that's where fiscal measures come into play.

Matthew Waters writes:


The causal factor is downward nominal wage rigidity. Nominal wages are extremely slow to adjust downward. So if market-clearing nominal wages go down significantly, then the wage rigidity acts like a minimum wage. The above-market prevailing wages leads to unemployment. The idleness leads to decline in real GDP.

The "extra cash" question has been debated a lot. The Fed acted against their asset purchases by paying interest on excess reserves. There is no reason the Fed cannot charge interest on its balances, which is not cash in physical form but entries in a database.

Interests could become so negative that the bank customers all get cash. Large amounts of cash have significant inconvenience and costs. But physical cash printing can also be restricted. More assets can also be bought. The Fed did not come close to buying all Treasuries or Agency MBS yielding more than 0%.

Cloud writes:

Actually, I have a recent interview with Prof. Christiano. Here is a part that may help understand his view more:

" own thinking has evolved. What I am trying to figure out a way to make really precise, based on data.

You probably hear of the book, “The Big Short”. The alternative view about the crisis and Sufi and Mian played an important role in describing the view, was that the existing banking system was just rotten. Then in “The Big Short”, there was this one artistic guy who notices that actually these whole things were really bad and he shorted the whole system. That view is very different from the one I was describing. It is very different.

The view I was describing doesn’t focus on the problem in the loans and the leverage restrictions, and all that stuff. No doubt those were problems, but those are problems of all time. I believe that those problems were not enough to crash the system. You needed the collapse in the shadow banking system to crash the system. To really document that, that takes a lot of careful thinking and that is what I am trying to do. But it is very hard because once the system crashes, then all the debts are bad.

If the system crashes, people are going to stop paying their mortgages. They are going to look real bad. They are really bad bet afterward. You can’t just look and see that lots of people went bankrupt or fail to pay their mortgages and conclude that, therefore, all the mortgages should not have been made in the first place. It could be that the collapse of the banking system because of the shadow banking system was the fundamental cause.

There is a very famous movie in the US called “It’s a Wonderful Life”. In that movie you can kind of see how a bank run can crash a town and all the borrowers in the town, like the one who borrows to renovate the grocery store, that loan may go bad because there was a bank run that causes the economic activity in the town to stop. But then, you wouldn’t have look at that loan and see that they didn’t pay and conclude that that was a bad idea in the first place. The problem was really the vulnerability to bank runs. It was not the loan per se. Wisely, we solve that problem by focusing on the bank runs and providing Federal Deposit Insurance.

We have to be very careful in looking at the crisis, not to infer from the fact that people stop paying their loans, not to infer from that observation to the conclusion that, “Oh, the banking system made bad loans and we have to make sure they cut back their loans severely in the future.” That maybe the wrong thing to do..."

Scott Sumner writes:

Matthew, Good comment.

Alec, See Matthew's reply.

Thanks Cloud.

Mr. Econotarian writes:

Well, the Fed did a better job with the Great Recession than it did with the Great Depression (and didn't even need the President/Congress to pass legislation to devalue to currency like in 1933).

Not a great job recently, of course, but I feel that we're improving with 70 years experience...

Steve F writes:

Thanks for fighting the good fight, Scott.

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