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Thursday, August 29, 2013

'Macro Workers and Macro Wars'

This expands on one of the points I tried to make here:

Macro workers and macro wars, by Simon Wren-Lewis: ... Nearly fifteen years ago I began working with DSGE models looking at monetary and fiscal interactions. [1] Doing this work taught me a lot about how fiscal policy worked in New Keynesian models. I understood more clearly why monetary policy was the stabilisation tool of choice in those models, but also why fiscal policy - appropriately designed - was also quite effective in that role if monetary policy was absent (individual countries in the Eurozone) or impaired (the ZLB). Why New Keynesian models? Because if you were interested in business cycle stabilisation, that is the framework that most involved in that area (academics and policymakers) were using. So when we hit the ZLB, the reaction of policymakers in using fiscal stimulus seemed logical, entirely appropriate and fully in line with current theory.
I also found that in these models the basics of Barro’s tax smoothing hypothesis continues to apply, so if you needed to reduce debt, you should do so as gradually as possible. This also seemed like as robust a result as one can get in macro.
The acid test for macro came in 2010. Policymakers, for a variety of reasons, went into reverse with fiscal policy. Austerity replaced stimulus around the world. If academic macroeconomists had been true to their discipline, they would have been united in saying that our standard models tell us this will reduce output and raise unemployment. They would have said that if markets allow, the time to reduce debt is when the ZLB comes to an end, and then it should be done gradually. Many did say that, but many did not. This division at least encouraged policymakers to continue with austerity.
So macroeconomists as a collective failed this test, repeating errors made in the 1930s. But unlike the 1930s, it did not have ignorance as an excuse. 
This is a crucial point that many on both sides tend to ignore. In 2010, the standard business cycle model was the New Keynesian model, and the implications of that model for the efficacy of appropriately designed fiscal policy are clear. So to blame the failure of 2010 on the current dominant macro model is just wrong. You may not like that model, but it cannot be blamed for the widespread adoption of austerity, or the ambivalent attitude of many macroeconomists towards that policy change.
So in my view macroeconomists, not the dominant macroeconomic model, failed. ...

There's quite a bit more in the post.

    Posted by on Thursday, August 29, 2013 at 12:42 AM in Economics, Fiscal Policy | Permalink  Comments (17)

          


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