What Did You Know, and When Did You Know It?

In the comments to my discussion of his NY Times article "How Supply-Side Economics Trickled Down," Bruce Bartlett says:

Interesting discussion. However, I think Mark misses the historical context of my analysis. In the 1970s, we were unaware of real business cycle theory or New Keynesian theory. We were confronting Old Keynesian theory. What Mark has basically done is take a current theoretical debate and superimposed it on the 1970s. That's fine if one's goal is to understand how the economy really worked in the 1970s or what the actual effects of policies taken at that time were. But as a matter of history, it is misleading. We didn't know any of this stuff because it didn't exist then. We were dealing with a far different situation in terms of what people knew about the economy (or thought they knew) and that's one reason why I believe that terms like "supply-side economics" have outlived their usefulness. The context in which the term had meaning no longer exists and therefore it has become a barrier to communication rather than a facilitator.

And, in another comment, he adds:

People need to keep in mind that this was not some purely theoretical debate taking place at some academic conference or in the pages of obscure journals. The people I was working with were members of Congress and their staffs and we were battling specific policies by putting forward specific policies of our own. Many people on both sides were unaware of the theoretical underpinnings because they were unstated, implicit. Part of the supply-side strategy was to make those assumptions explicit. I mention some of them in my article.

Paul Krugman then says:

Bruce Bartlett says this:

Among the beliefs held by the Keynesians of that era were these: budget deficits stimulate economic growth; the means by which the government raises revenue is essentially irrelevant economically; government spending and tax cuts affect the economy in exactly the same way through their impact on aggregate spending; personal savings is bad for economic growth; monetary policy is impotent; and inflation is caused by low unemployment, among other things.

Wow. You see, I was a grad student at MIT - the great Keynesian stronghold - in the 1970s, and this bears no resemblance to what was being taught.

In fact, I still have my copy of Dornbusch-Fischer, Macroeconomics, the 1978 edition - and it doesn't make any of those assertions. I'm particularly amazed by the "monetary policy is impotent" bit: no mainstream Keynesian in America believed that any time after, say, 1955. Dornbusch-Fischer is mainly *about* monetary policy, and how important it is.

Let me suggest that good economic doctrines don't have to be sold by misrepresenting what other doctrines say.

Which then set off a discussion on what we knew and believed in the 1960s and 1970s. Bruce Bartlett responds to Paul Krugman with:

If Paul Krugman is right, then where did all the policy mistakes of the 1970s come from? Why did the Fed act as if the money supply had no linkage to inflation until Volcker changed gears in 1979? Why did the Congressional Budget Office routinely report that a tax rebate, a permanent tax rate reduction, and an increase in government purchases would have exactly the same macroeconomic effect because their only impact was on aggregate spending? I have some of those old reports in my library and can dig them out if necessary.

Of course, there were those in academia who knew better. Maybe Paul was one of them. But they weren't in charge of the Fed or the CBO. Also, I think a lot of economists who lived through the the 1970s and know better today have simply forgotten how screwy some of the economic policies of that time were and how many reputable economists supported them. Go back and read Leonard Silk's columns in the New York Times to see what mainstream economics was all about in those days. Don't go back now and cherry pick the isolated case where someone had it right. We had to do what we were doing in real time without the luxury of long and careful study of all the alternatives. It was a crisis atmosphere and we did the best we could with what we had to work with.

Paul Krugman responds:

A late entry - I'm on the road.

Anyway, Bruce Bartlett's contention that the inflation of the 70s happened because people didn't think money mattered is just bizarre. There was a way too expansionary monetary policy in 1972, not because people didn't think it mattered, but because they did: it's widely believed that Arthur Burns pumped up the economy in an attempt to help Nixon win the election. Nixon's people worried about the effects of monetary policy all the time!

We might also want to mention two horrific oil shocks.

Again, what Bruce is describing is a caricature of a vulgar ultra-Keynesian, circa 1947. People like that never dominated Keynesian thought in the United States, and were pretty much nonexistent by the time supply-side economics came into existence. And no, it's not a matter of policy entrepreneurs versus academics: look at the people who were actually advising Gerald Ford or Jimmy Carter on economic policy, and they were nothing like the caricature Bruce describes.

It's sad, really: to make supply-side economics look respectable, it's apparently necessary to pretend that everyone else was an idiot.

Bruce Bartlett then says:

I think Paul's memory is just wrong. Has he forgotten how intense the arguments were about monetarism? A lot of people thought Milton Friedman's monetary ideas were crazy. And while it's true that Arthur Burns did a horrible job as Fed chairman, he inherited a situation in which inflation was already a serious problem. Jimmy Carter clearly had no clue about it and appointed G. William Miller as Fed chairman who gave us double digit inflation. I remember him testifying before the JEC that inflation was caused by failure of the anchovy harvest. I'm not making this up. They are used in fertilizer, which raised the cost of farming, which raised the cost of food and so on. Maybe up at MIT, people had it all figured out. But down in Washington, where I was, a lot of important people were seriously clueless.

Lawrence H. White of the Division of Labour recalls his classes at Harvard:

I was a freshman taking Economics 10 at Harvard in 1973 (my section was taught by Chip Case). Our textbook was Lipsey and Steiner. Unlike Paul Krugman, I find Bruce Bartlett's characterization of the Keynesian beliefs of time quite accurate.

"Budget deficits stimulate economic growth"? We were at least taught that they raise the level of income, via the balanced-budget multiplier.

"The means by which the government raises revenue is essentially irrelevant economically"? Well, in the macro half of the course, yes.

"Government spending and tax cuts affect the economy in exactly the same way through their impact on aggregate spending"? Yes.

"Personal savings is bad for economic growth"? Well, bad for the level of income, due to the paradox of thrift.

"Monetary policy is impotent; and inflation is caused by low unemployment, among other things." Yep. We were never taught MV=PY. We actually did hear that the bad anchovy harvest was a cause of inflation. A teaching assistant named Roger Brinner wrote an article about the causes inflation for the Harvard Independent (undergrad newspaper) in which he made not one mention of the word "money", much less any reference to growth in the supply of money.

What do I remember about economics in the 1970s? I was an undergraduate in the late 1970s and we learned the traditional IS-LM model, but not the "vulgar Keynesian" version - monetary policy could be used to lower interest rates and stimulate investment and output. We spent quite a bit of time studying the "transmission mechanism" for both monetary and fiscal policy and the special cases within the Keynesian framework when either of the two might fail to be an effective policy instrument. Here's more on "vulgar Keynesians":

Vulgar Keynesians, by Paul Krugman: Economics, like all intellectual enterprises, is subject to the law of diminishing disciples. A great innovator is entitled to some poetic license. If his ideas are at first somewhat rough, if he exaggerates the discontinuity between his vision and what came before, no matter: Polish and perspective can come in due course. But inevitably there are those who follow the letter of the innovator's ideas but misunderstand their spirit, who are more dogmatic in their radicalism than the orthodox were in their orthodoxy. And as ideas spread, they become increasingly simplistic--until what eventually becomes part of the public consciousness, part of what "everyone knows," is no more than a crude caricature of the original.

Such has been the fate of Keynesian economics. John Maynard Keynes himself was a magnificently subtle and innovative thinker. Yet one of his unfortunate if unintentional legacies was a style of thought--call it vulgar Keynesianism--that confuses and befogs economic debate to this day. ...

Consider, for example, the "paradox of thrift." Suppose that for some reason the savings rate--the fraction of income not spent--goes up. According to the early Keynesian models, this will actually lead to a decline in total savings and investment. Why? Because higher desired savings will lead to an economic slump, which will reduce income and also reduce investment demand; since in the end savings and investment are always equal, the total volume of savings must actually fall! ...

Such paradoxes are still fun to contemplate; they still appear in some freshman textbooks. Nonetheless, few economists take them seriously these days. ... What has made it into the public consciousness--including, alas, that of many policy intellectuals who imagine themselves well informed--is a sort of caricature Keynesianism, the hallmark of which is an uncritical acceptance of the idea that reduced consumer spending is always a bad thing...

To justify the claim that savings are actually bad for growth (as opposed to the quite different, more reasonable position that they are not as crucial as some would claim), you must convincingly argue that the Fed is impotent--that it cannot, by lowering interest rates, ensure that an increase in desired savings gets translated into higher investment. ...

No, to make sense of the claim that savings are bad you must argue either that interest rates have no effect on spending (try telling that to the National Association of Homebuilders) or that potential savings are so high compared with investment opportunities that the Fed cannot bring the two in line even at a near-zero interest rate. The latter was a reasonable position during the 1930s... But the bank that holds a mortgage on my house sends me a little notice each month assuring me that the interest rate in America is still quite positive, thank you.

Anyway, this is a moot point, because the people who insist that savings are bad do not think that the Fed is impotent. On the contrary, they are generally the same people who insist that the disappointing performance of the U.S. economy over the past generation is all the Fed's fault... [Slate 1997]

Update: Brad DeLong has a more extensive summary of the comments.

Further discussion of the original post at: Angry Bear, Political Animal, Ezra Klein, Angry Bear again, Division of Labour, and Tim Worstall. Update: One more from Angry Bear. Update: Lawrance Lux comments. Update: Angry Bear with more. Update: Talk Left also.

Update (4/11): Follow-up here.