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February 4, 2013

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Posted: 19 Dec 2012 12:33 AM PST
Jeff Frankel urges central banks to adopt a nominal GDP target:
Central banks can phase in nominal GDP targets without damaging the inflation anchor, by Jeffrey Frankel, Vox EU: The time is right for the world's central banks to reconsider the framework they use in conducting monetary policy. The US Federal Reserve and the ECB are still grappling with sustained economic weakness, despite years of low interest rates. In Japan, Shinz┼Ź Abe, the new prime minister from the Liberal Democratic Party (LDP), was elected on the promise of a new, more expansionary monetary policy (Financial Times 2012). In the UK, Mark Carney, the incoming Governor of the Bank of England, is open to new thinking.
Monetary policymakers would do well to consider a shift toward targeting nominal GDP; Carney is evidently considering precisely this. They could phase in such a switch in two steps, in such a way as to preserve credibility with respect to inflation.
A number of monetary economists pointed out the robustness of nominal GDP targeting after monetarist rules broke down in the 1980s.1 "Robustness" refers to the target's ability to hold up in the long term under various shocks. The context at that time was the need in advanced countries for an explicit anchor to help bring expected inflation rates down. The status quo regime to achieve this, during the heyday of monetarism, was a money growth rule. Relative to the money growth rule, the advantage of nominal GDP targeting was robustness with respect to velocity shocks in particular.
These days, both the presumptive nominal anchor and cyclical context are very different than they were in the 1980s. The popular regime is inflation targeting. The advantage of a nominal GDP target relative to a CPI target is robustness, in particular, with respect to supply shocks and terms of trade shocks. For example, a nominal GDP target for the ECB could have avoided July 2008's mistake: the ECB responded to a spike in world oil prices by raising interest rates to fight consumer price inflation, just as the economy was going into recession. A nominal GDP target for the US Federal Reserve might have avoided the mistake of excessively easy monetary policy during 2004-6, a period when nominal GDP growth exceeded 6%.
The return of nominal GDP targeting
Why have proposals for nominal GDP targeting been revived at this particular juncture, after two decades of obscurity? The motive, in large part, is to deliver monetary stimulus and higher growth – needed in the US, Japan, UK and the Eurozone – while still maintaining a credible nominal anchor.2 For a country teetering on the fence between recovery and recession, such as the Eurozone, a target for nominal GDP that constituted a 4 or 5% increase over the coming year would in effect supply as much monetary ease as a 4% inflation target.
Some economists, such as IMF Chief Economist Olivier Blanchard (2010), have proposed responding to recent high unemployment by setting a target for expected inflation above the traditional 2% – say, 4% – as a way of reducing real interest rates in the presence of the "zero lower bound" on nominal interest rates. They like to remind Fed Chairman Ben Bernanke of similar recommendations that he made to Japan in the past.
Little support for high inflation target
Many central bankers are strongly averse to countenancing inflation rate targets of 4%, or even 3%. They do not want to abandon the hard-won 2% number that has succeeded in keeping inflation expectations well-anchored for so many years. Economists can say that the upward change in the inflation target would be made explicitly temporary, but central bankers worry that to target a higher number even temporarily would do permanent damage to the credibility of the long-term anchor.
This is also a reason why these same central bankers are wary of the current proposals for nominal GDP targeting.3 Fed governors, for example, worry that to set a target for nominal GDP growth of 5% or more in the coming year would naturally be interpreted as setting an inflation target in excess of 2%, and thus again would damage the credibility of the anchor, permanently. Their reluctance to give up on 2% is unlikely to change. But it doesn't have to.
A nominal GDP target
The practical solution for overcoming these worries entails phasing in a nominal GDP target in two steps.
One of the main communications devices currently used by the US Federal Reserve is the Summary of Economic Projections. The governors and regional presidents give their forecasts of real growth rate and inflation rates for each of the next three years and for the long run – as well as for interest rates. The press interprets these as policy statements, even if they are only labeled projections.
My proposal is to start, in Phase I, by:
  • Omitting near term projections for real growth and inflation.
Do keep the longer-run projection, and keep it at the setting where it is, 2% – formerly 1.5-2% – for the US. But add a longer run projection for nominal GDP growth as well, which should be around 4-4.5% to avoid any discontinuous jumps. That number would imply a long-run real growth rate of 2-2.5%, the same as now. Nobody could call such a move inflationary. For Japan, the targets for nominal and real GDP growth would have to be set at lower levels, due in part to the absence of population growth.
A few months later, in Phase II:
  • Add projections for nominal GDP growth for the next three years.
These numbers should be greater than 4% – perhaps 5% in the first year, rising to 5.5% after that – but with the long run projection unchanged at 4 or 4.5%. Much public speculation would ensue, as to how the 5.5% breaks down between real growth and inflation. The truth is that the central bank has no control over that – monetary policy determines the total but not the breakdown – and thus doesn't know what the answer is any more than anyone else does. But the nominal GDP target would insure that either real growth will accelerate, as we hope, or if real growth falls short, there will be an automatic decline in the real interest rate which will push up demand. The targets for nominal GDP growth could be chosen so as to put the level of nominal GDP on an accelerated path back to its pre-recession trend. In the long run, when nominal GDP is back on its path of 4-4.5%, real growth will be back at its potential, say 2.5%, and inflation back at 1.5%-2%.
This way of phasing in nominal GDP targeting delivers the advantage of some stimulus now, when it is needed, while satisfying central bankers' reluctance to abandon their cherished low inflation target.
References
Bean, C (1983), "Targeting Nominal Income: An Appraisal", The Economic Journal, 93, 806-819.
Bernanke, B, (2000), "Japanese Monetary Policy: A Case of Self-Induced Paralysis?" Chapter 7 in Ryoichi Mikitani and Adam S. Posen (eds.) Japan's Financial Crisis and Its Parallels to U.S. Experience, pp. 149-166, Institute for International Economics.
Blanchard, O, G Dell'Ariccia and P Mauro (2010), "Rethinking Macroeconomic Policy", IMF Staff Position Note, 12 February.
Financial Times (2012), "Monetary policy moves to forefront in Japan", December 17.
Frankel, J (1995), "The Stabilizing Properties of a Nominal GNP Rule," Journal of Money, Credit and Banking 27, 2, May, 318-334.
Frankel, J (2012), "Inflation Targeting is Dead. Long Live Nominal GDP Targeting," VoxEU.org, 19 June.
Feldstein, M and J Stock (1994), "The Use of a Monetary Aggregate to Target Nominal GDP" in N Gregory Mankiw (ed.) Monetary Policy, NBER, University of Chicago Press).
Hall, R E and N G Mankiw (1994), "Nominal Income Targeting", in N Gregory Mankiw, ed., Monetary Policy, (University of Chicago Press), 71-93.
Hatzius, J (2011), "The Case for a Nominal GDP Level Target," US Economics Analyst, issue 11/41, Goldman Sachs, October.
Krugman, P (2011), "A Volcker Moment Indeed (Slightly Wonkish)," blog, 30 October.
Krugman, P (2012a), "Two per cent is not enough", The New York Times, 26 January.
Krugman, P (2012b), "Earth to Bernanke", The New York Times, 24 April.
McCallum, B T and E Nelson (1998), "Nominal Income Targeting in an Open-Economy Optimizing Model," Journal of Monetary Economics, 43(3), 553-578.
Meade, J (1978), "The Meaning of Internal Balance", The Economic Journal, 88, 423-435.
Romer, C (2011), "Dear Ben: It's Time for Your Volcker Moment," The New York Times, 29 October.
Woodford, M (2012) "Methods of Policy Accommodation at the Interest-Rate Lower Bound," presented at the Jackson Hole symposium, August, Federal Reserve Bank of Kansas City.

1 James Meade (1978), followed by Bean, Hall, McCallum, West, Feldstein, Stock, Frankel, McKibbin.
2 The new proponents show up on the left, the right, and the center of the political spectrum: Romer (2011), Krugman (2011); on the Left; Scott Sumner (at Money Illusion), Lars Christensen (at Market Monetarist), David Beckworth (at Macromarket Musings) on the Right; Goldman Sachs (2011) and Woodford (2012) in the center.
3 Central bankers have long had some other concerns as well about nominal GDP targeting. (1) One is that the public doesn't know the difference between nominal GDP, real GDP and inflation. But communications clarity is not a reason to go with a complicated function of inflation and real growth (as in the ubiquitous Taylor rule) as opposed to the simpler nominal income target. Furthermore, the financial markets do understand the difference. (2) Central bankers also worry they may not be able to achieve the target. Needless to say, the margin around the target could and should be wide, though there is no reason why it has to be wider than the bands around the old M1 targets or the more recent inflation targets, and there are reasons to think the width of a nominal GDP band could be a bit less. Moreover, under current conditions, the shift in policy need be nothing more than a commitment to keep monetary policy easy so long as nominal GDP falls short of the target. It would thus serve a purpose similar to the Fed's December 12, 2012, announcement that it would keep interest rates low so long as the unemployment rate remains above 6.5% - but it would not suffer the imperfections of the unemployment number (particularly its inverse relationship with the labor force participation rate and its tendency to lag other measures of expansion).
Posted: 19 Dec 2012 12:06 AM PST
Posted: 18 Dec 2012 10:59 AM PST
Via Roger Strassburg, a talk by Jamie Galbraith (there is also an accompanying interview, I'll post it tomorrow):
Change of Direction, IG Metall Conference – Berlin, Germany Professor James K. Galbraith December 6, 2012 [audio]: My friends, it is a pleasure and honor to be asked to speak to you this morning. And I want to begin by congratulating you for taking up a theme that I think is a common theme around the world – the idea of the good life.
I suppose I first encountered this theme a year or so ago at a meeting to discuss the future of development in Ecuador. And it reflects a little bit of the concerns my father had late in his life when he wrote a book entitled, "The Good Society."
I think it is a right and resonant theme for the future as we grapple with the problems that we face today. But first we must indeed deal with these problems —with the dark matters and imminent dangers that are before us now. And so I will focus my remarks on the first two words in the title of this conference, the question of changing course.
Five years ago when the great financial crisis broke into public view, those who claimed falsely that no one could have predicted it also claimed that our economies would recover. Standard forecasts foretold rapid growth and high employment within five years. Banks in America would start lending again. Confidence would return in Europe. Those of us who said no, that there would be no return to normal, were for the most part ignored. Yesterday we heard Professor Nouriel Roubini give a magisterial and very high speed tour of the world situation making it clear of course that the promised recovery has not occurred. But if Nouriel is Sir Isaiah Berlin's fox, who knows many things, let me try this morning to be the hedgehog who knows one big thing, and that one big thing is that what we are experiencing is a single, unified, global crisis of the economy and of the financial system. It is not a cluster of distinct and separated events; a subprime crisis in the United States; a public debt crisis in Greece; a bank crisis in Iceland; a real estate bust in Ireland and Spain; nor are there distinct U.S. and European crises, nor can the financial be separated from the real, nor is Germany a country to which crisis has not yet come with the suggestion that there might be some separate way out. There is one crisis, only one crisis, a deeply interconnected crisis of the world system. This crisis has, I think, three deep sources going back not twenty years but forty years to the early 1970s and the end of what we sometimes call the "golden age," the "glorious thirty" years in the immediate aftermath of the second World War.
The first of the three deep sources is, I think, the rising real cost of the resources that we use, of energy and of everything that we use energy for. This was a problem that emerged in the 1970s and was then submerged again; it was deferred by new discoveries, by the geopolitical situation, and by the financial power of the western countries, which because of the debt crisis in much of the rest of the world had the effect of suppressing demand for these core resources. But this is a problems that can no longer be avoided or deferred. The cost of energy is roughly twice of what it was a decade ago and the future is far more uncertain. Both of these factors, cost and uncertainty, place a squeeze on the surplus or profitability in regions, continents, and countries that are importers of these resources. And as we confront, as we must, the problem of climate change and as we begin, as we must, to pay the price of climate change this problem is going to become more difficult. That's just an economic reality that we have to cope with as we face the imperative before us.
The second great underlying issue it seems to me is technical change, the particular character of which in our time is quite different from what is was before. If you take the digital revolution together with globalization, the ease of transnational manufacturing and also to some degree the outsourcing of services, we find we live in an era where technology is radically labor-saving. It supplants workers. One thing that we can say without too much exaggeration is that the computer and the many associated technologies that have derived from it are now doing to the office worker what a century ago the internal combustion engine did to the horse.
And the third great source of our problem is ideological. It is the neo-liberal idea that has given us deregulation and de-supervision; that has given us the notion that markets can function on their own without breaking down or blowing up. It is this notion as applied especially to finance. This is the great illusion of the last generation, and it fostered a form of economic growth that was intrinsically unstable and unsustainable. Why? Because it was based on declining standards for loans and on lax accounting of the proceeds of those loans. Or to put it in simple terms, it was based upon financial fraud, on the most massive wave of financial fraud that the world has ever seen. And the world has seen a lot of financial fraud. It was known to be such to the lenders at the time. This was true of housing loans in the United States made by the tens of millions that were known to the lenders as "liar's loans," as "ninja loans," no income, no job, no assets; as "neutron loans" destined to explode leaving the building intact but destroying the people. This was known at the time. These were loans that had to be refinanced or they would default.
It was also true of loans to the public sector, for example Greece. The fact that Greece had a weak public sector and a weak tax system was not a state secret before the crisis. It was something that was known on both sides of these transactions. This was equally true of commercial real estate in Ireland and of housing in Spain. You simply had to go and observe what was going on. Not to mention the acquisitions of the Icelandic Banks. It's a fundamental fact, I think, that's visible everywhere you look but not spoken of in polite society especially when economists address audiences of bankers. I trust you will indulge me since I am addressing an audience of unionists and friends and speaking this frankly to you, as I think it is very important.
Rising inequality is often linked to these phenomena. But I think we should be clear about what the linkage is. It is not the case that inequality rose and people compensated for it by borrowing more so they could have a higher standard of consumption. This is not what happened. It certainly did not happen in the United States. What happened was, is that the lenders went out to find new markets often fostering fraudulent loans on low-information borrowers, poor borrowers, inner city home owners, for example, forcing those loans to be refinanced so that the recipient only saw a fraction of the debt with which they were ultimately saddled. And the inequality arose from the booking of fees on those loans. This is how bankers get rich. They make their money in this way. And you can see this in their tax statements and you can see it in the geographical distribution of income gains in the United States.
And when the extent of the fraud could no longer be concealed then there was panic and collapse. This happened both in the United States and Europe and it did damage to the financial structure that was, let me suggest to you, essentially irreversible. It destroyed the underlying basis for economic growth that had sustained us for some time. That is to say it destroyed the housing finance market in the U.S. and it destroyed the sovereign credit market in Europe. And because in Europe it destroyed the sovereign credit market, the effects fell on public services and on dependent populations. Millions of jobs of course were also lost in both continents. That was the collateral damage.
These matters have not gone away. And if you wish to ask why we did not experience the predicted recovery over the last five years, I think the answer is because they didn't go away and will not go away.
So we need to ask, how do we deal with them? And the basic choice is between two principles. It's between all-in-it-together or everyone-for-themselves. That's the choice. So while all of the wealthy resource-using, computerized finance-capitalist economies have been hit by the same forces, they have not all been hurt in the same way. The institutions that are available do matter, they have an effect. Here I want to say something you may find surprising, which is that actually my country, the United States, has enjoyed a certain advantage.
And what was it? People have often said that the U.S. has a flexible labor market. This was not it at all. In the United States real wages did not fall in the crisis, actually in the first year they went up. Labor markets did not adjust. We did not restore employment. The employment population ratio was five percentage points lower than it was a decade ago. No, what happened in the U.S. was something quite different.
This is actually my real voice, I'm not sure water will do any good. [Laughter]
What happened in the United States was that we had a very flexible and effective system of public transfer payments which rose rapidly in the crisis. Unemployment insurance, early retirement under social security, disability, lower tax collections, and then on top of that, the expansion package, the stimulus package, the Keynesian policy that came into effect very quickly. And these things broke the fall in incomes and preserved living standards to a very substantial degree.
Now this was also true in parts of Europe as it was I'm sure here. The automatic stabilizers came into effect. It was true in northern Europe. I was in Finland two days ago and they said basically they had a large fall in output but no fall in income. But it was not true everywhere in Europe.
And the second key fact lies in the difference in the underlying debts. In the United States these were largely private debts. And private debts are either paid down -- mortgages are amortized – or they are defaulted, in which case people have to leave their homes but they leave their debts with their homes. They are not pursued afterwards by and large. In one way or another, those debt problems are resolved over time—painfully—but over time they tend to diminish. But with public debt, with sovereign debt, it's not so easy and that of course is the issue here in Europe. Sovereign debts are perpetual until they are forgiven and written off, that is to say, until there is a meeting of minds between the debtors and the creditors on what has to be done. And we've had this experience in the United States with Latin America. It's not news to us.
It is fashionable to say that the U.S. is a free market economy with practically no welfare state. I am sure you have heard that many times, but the facts are actually otherwise. If you look at the numbers, we spend about six percent of our personal income on public pensions. I guess it's about seven percent on public healthcare and another ten or so, on the private side. Overall in 2008, public transfer payments were about fifteen percent of personal income and they went up rapidly in the crisis. So my point is that in this respect the United States, which is a very large continental economy, is as an economy not entirely like Germany but more like Germany than like Greece or Spain.
We do have a system that can sustain and that we can finance. Notwithstanding all you hear about budget deficits, that's obvious. The United States government does not have a financing problem. The simplest evidence for this is the long-term interest rate which is at an historic low in spite of the size of the deficit and the public debt. And again that worked to break the shock of the crisis. We did not recover but we did not fall apart. Why not? Because fundamentally we are working with national institutions that were built a long time ago in the New Deal and the Great Society, and fundamentally those institutions are still there. Deposit insurance, social security, Medicare, Medicaid, and grants-in-aid from the federal government to the states and cities. It's a tested model and it works.
Now what is the situation in Europe? In Europe of course you have national institutions that were built, very strong ones, on essentially the same tradition of social solidarity and social insurance, and that of course is especially true in northern Europe. It is the critical tradition of any successful society in the modern world—of the ability to react to stress. But it's not the case for your continental institutions which were built later in a different time. Those institutions are neo-liberal. I regret to say they are built on ideas that were exported from the United States to a large degree. I apologize to you for that. Your problem was that you accepted the exports and you're paying for them now. You impose arbitrary budget and debt ceilings. You gave your central bank a monetarist price stability charter straight out of the University of Chicago, very different from the one, the dual mandate for full employment and price stability, which is in the legal statutes governing the U.S. Federal Reserve. I mention that all the time because I was a very young member of the staff of the House Committee on Banking when that statute was written and I was actually the person who drafted it.
And you also allowed your banks to over-leverage under the disastrous Basel II arrangements, relying on alleged capital buffers to provide stability. What's wrong with that? Straightforwardly, if the capital buffers are not backed by accurate accounting, they don't exist. And if you aren't supervising the accounting you don't know what's there and what's not.
But most of all, your politics imposes a dysfunctional austerity on the debtors who cannot pay and cannot escape their debts. And your leaders, Europe's leaders, justify this by confusing surpluses with virtue and deficits with vice, an easy transfer to economics from religion, pretending that one can exist without the other, which actually if you were Catholic you would know is not the case. In fact, in economics deficit and surplus are simply the accounting counterparts of each other and you cannot erase the deficits without also erasing the surpluses. In Germany, you, even a few years ago wrote the so-called "debt brake" into your constitution—a balanced budget except in times of severe economic crisis. What is that? It's a constitutional provision that you will always have a severe economic crisis. What a foolish thing to have done, I have to say. [Applause]
I was going to say I was sorry to have to be harsh in those remarks but I can see that's not necessary.
Now in the U.S., as well, these core social institutions are under threat. They have been under threat for years and that threat is acute at the moment. We have the so-called fiscal cliff, a contrived crisis, a reactionary device to force cuts in the programs that have so far survived thirty years of Reaganism-- cuts in Social Security, Medicare and Medicaid, as well as other public spending. But it has not happened yet and there is actually some good political news. I think the reelection of the President by a decisive margin and the results in the Senate were a defeat delivered by the American public to the neo-liberal vulture capitalist ethos. And the President, who was perhaps not as brave as some of us would have liked in his first term – okay that is a very kind remark – has already moved to assert some moral leadership in these matters which he had not done before. The battle is a matter of defense; the case is very clear cut; the people have spoken. I will not predict victory but the position is much better on these core issues than it was a month ago.
But you in Europe, and especially you my friends in Germany, have a much harder task. Europe is moving from stop gap to stop gap, from hypocritical half measure to hypocritical half measure, from false assurance to false assurance as the situation gets worse. Eventually the debtors-turned-victims will rebel but they lack moral standing, political power, and the economic capacity to save Europe. That can only come from here. Solidarity is the prerogative of the strong.
In 1919 in a book entitled, "The Economic Consequences of Peace," John Maynard Keynes addressed his countrymen. He wrote, "If the European civil war is to end with France and Italy abusing their momentary victorious power to destroy Germany, and Austria Hungary now prostrate, they invite their own destruction also being so deeply and inextricably intertwined with their victims by hidden psychic and economic bonds." And again much later in the book, "The policy of reducing Germany to servitude for a generation of degrading the lives of millions of human beings and of depriving a whole nation of happiness should be abhorrent and detestable. Abhorrent and detestable, even if it were possible, even if it enriched ourselves, even if it did not sow the decay of the whole civilized life of Europe."
I make no defense of the government in Greece, nor of the property speculators in Spain, Ireland, or the banks in Iceland or anything else you might name. But the flaws and follies at these agencies as I said before were not secret. They were known to those who lent to them just as the fraudulence of the housing loans were known in America to those who were making them. It was common currency. Responsibility is joint, mutual and sustained.
And we know because we have seen it elsewhere, everywhere from 19th century Germany to 20th century American to post-war Europe and the 21st century in China, that economic integration concentrates economic activity, particularly high income activity. Successful banks, advanced technology, machinery making, don't occupy all that much space. This is the principle of increasing returns. Germany is a big beneficiary of this principle inside Europe and indeed in the whole world. You yourself are representative of the world's most successful industrial activity. You're the architects of that. But we also know that relations between a wealthy exporter and a less wealthy importer cannot be regulated on commercial banking terms indefinitely. Nor can surpluses be maintained while deficits are exorcised. It's a mathematically impossibility. The rules of double entry bookkeeping are known to every shopkeeper and cannot be ignored by political leaders.
So what is the alternative? It must first involve a comprehensive restructuring of the debts. There is the Yanis Varoufakis-Stuart Holland "Modest Proposal" which I think is a very good starting place. It insists on three elements. They are: first, a common pool of Maastricht-compliant bonds; second, an European Investment Bank- funded New Deal program—an investment program—a reconstruction program, let us call it a Green New Deal and marry the challenge of economic reconstruction to the challenge of dealing with our larger energy and climate problems; and third a common, an independent banking authority with the authority to supervise and the authority to restructure, as required, including to downsize and rationalize the financial sector. This is something that we should have done in the United States when we had the political opportunity in 2009.
Now, these matters are necessary but I don't think they go all the way to addressing the needs.
I think that the statement made by the Executive Board of IG Metal on the 9th of October, "Change of Course in European Solidarity," is a marvelous document that sets out basic principles that are required for going further to develop a sustainable architecture. So you already know the answer on how to change course, but let me give you some ideas.
Professor Rubery yesterday offered an excellent proposal: A common unemployment insurance fund for Europe. That would support those people who specifically are the most damaged victims of the crisis. Why not?
Let me add to this another idea. A pension union—a European Pension Union to ensure that people who have worked their entire lives, retire decently on the standard of Europe as a whole and not on the past productivity of their own impoverished countries. Perhaps, later on, there could be a topping up scheme for wages on the model of the earned income tax credit in the United States; maybe a continental minimum wage. These are low-impact, easy-to-administer, old-fashioned devices, and they bypass weak and ineffective governments in the periphery. They stabilize incomes, employment, and purchasing power. They can work to save your markets even as they save the countries in which they have their most important effects.
Your document shows that you, as unionists, understand how the principle of solidarity works. It states in general terms what reforms are required and that you are ready to act on the great challenges of inequality, energy, and climate that face and plague us all.
Let's look at this problem with a very hard eye. What will happen if we do not succeed? I think there is a model. It's not so long ago; it's not so very far away. It's Yugoslavia, which was in its day, a very successful middle income country. My brother, as it happens, served as the first United States Ambassador to Croatia from 1993-1998. He told me early on this was not age old ethnic conflict, but new crimes committed for political and economic reasons. That's what kicked off those wars. And when the violence starts in an advanced, in a developed country, it moves quickly and the fractures are not clean. And I can assure you that if you talk to people in certain parts of Europe, and Greece particularly, you can hear already the anxieties that you could have heard in Yugoslavia in the early 1990s.
If you don't like that model, and of course none of us can possibly stand to see this happen, well there's another one also not far away, not long ago, that's the Czechoslovak model-- a civilized, orderly, negotiated divorce. It would be better. But I have to ask, does any country anywhere in the world enjoy the sane, secure, farsighted moral leadership that Czechoslovakia happened to have had at that time?
So I think you came to the right judgment in this document. You came to the right judgment that Europe must be saved.
Let me thank you again for inviting me and for your patience in listening to my remarks. I make them to you again as leaders of one of the world's great unions because the union movement rests on solidarity and courage. And I do so in the spirit of remarks made by Abraham Lincoln to the United States Congress in December of 1862, when he wrote, "I trust you will perceive no want of respect yourselves in any undue earnestness I may seem to prescribe."
Lincoln went on, by the way, to close with what is one of the great texts of American political history. So if you will permit me I'll read just a little more of it. He wrote, "We can succeed only by concert. The dogmas of the quiet past are inadequate to the stormy present. As our case is new, so we must think anew and act anew. We must disenthrall ourselves, and then we shall save our country...
"Fellow-citizens, we cannot escape history. We will be remembered in spite of ourselves. No personal significance or insignificance can spare one or another of us. The ...trial through which we pass, will light us down, in honor or dishonor, to the latest generation... We say we are for the Union. The world will not forget that we say this. We know how to save the Union. The world knows that we do know how to save it. We—even we here—hold the power, and bear the responsibility. The way is plain, peaceful, generous, just—a way which, if followed, the world will forever applaud."
It is your Union of course that is at issue today, but it is yours, you created it. It may be lost. It will not be saved on its own. I congratulate you again on the leadership you are showing and will continue to show. And I wish you well and I thank you again.
Posted: 18 Dec 2012 09:24 AM PST
Paul Krugman, quoted below, started this off (or perhaps better, continued an older discussion) by claiming the state of macro is rotten. Steve Williamson, also quoted below, replied and this is Simon Wren-Lewis' reply to Williamson (remember that, as Simon Wren-Lewis notes below, he has defended the modern approach to macro).
This pretty well covers my views, and I think this part of the Wren-Lewis rebuttal gets at the heart of the issue: "You would not think of suggesting that Paul Krugman is out of touch unless you are in effect dismissing or marginalizing this whole line of research." I am also very much in agreement with the "two unhelpful biases" he notes in the last paragraph, and have been thinking of writing more about the first, "too much of an obsession with microfoundation purity, and too little interest in evidence," particularly the lack of interest in using empirical evidence to test and reject models. (Though there are ways to get around this problem, it may be that such tests have fallen out of favor in macro since we only have historical data to work with, and it's folly to build a model with knowledge of the data and then test to see if the model fits. Of course it will fit, or at least it should. That would explain why there appears to be a greater reliance upon logic, intuition, and consistency with micro foundations than in the past. It seems like today models are more likely to be rejected for lack of internal theoretical consistency than for lack of consistency with the empirical evidence):
The New Classical Revolution: Technical or Ideological?, by Simon Wren-Lewis:
Paul Krugman: The state of macro is, in fact, rotten, and will remain so until the cult that has taken over half the field is somehow dislodged
The cult here is freshwater macro, which descends from the New Classical revolution. In response
Steve Williamson: "At the time, this revolution was widely-misperceived as a fundamentally conservative movement. It was actually a nerd revolution." "What these people had on their side were mathematics, econometrics, and most of all the power of economic theory. There was nothing weird about what these nerds were doing - they were simply applying received theory to problems in macroeconomics. Why could that be thought of as offensive?"
The New Classical revolution was clearly anti-Keynesian..., but was that simply because Keynesian theory was the dominant paradigm? ...
I certainly think that New Classical economists revolutionized macroeconomic theory, and that the theory is much better for it. Paul Krugman (PK) and I have disagreed on this point before. ...

But this is not where the real disagreement between PK and SW lies. The New Classical revolution became the New Neoclassical Synthesis, with New Keynesian theory essentially taking the ideas of the revolutionaries and adapting Keynesian theory to incorporate them. Once again, I believe this was a progressive change. While there is plenty wrong with New Keynesian theory, and the microfoundations project on which it is based, I would much rather start from there than with the theory I was taught in the 1970s. As SW says "Most of us now speak the same language, and communication is good." ...
I think the difficulty that PK and I share is with those who in effect rejected or ignored the New Neoclassical Synthesis. I can think of no reason why the New Classical economist as 'revolutionary nerd' should do this, which suggests that SW's characterization is only half true. Everyone can have their opinion about particular ideas or developments, but it is not normal to largely ignore what one half of the profession is doing. Yet that seems to be what has happened in significant parts of academia.
SW likes to dismiss PK as being out of touch with current macro research. Lets look at the evidence. PK was very much at the forefront of analyzing the Zero Lower Bound problem, before that problem hit most of the world. While many point to Mike Woodford's Jackson Hole paper as being the intellectual inspiration behind recent changes at the Fed, the technical analysis can be found in Eggertsson and Woodford, 2003. That paper's introduction first mentions Keynes, and then Krugman's 1998 paper on Japan. Subsequently we have Eggertsson and Krugman (2010), which is part of a flourishing research program that adds 'financial frictions' into the New Keynesian model. You would not think of suggesting that PK is out of touch unless you are in effect dismissing or marginalizing this whole line of research.[2]
I would not describe the state of macro as rotten, because that appears to dismiss what most mainstream macroeconomists are doing. I would however describe it as suffering from two unhelpful biases. The first is methodological: too much of an obsession with microfoundation purity, and too little interest in evidence. The second is ideological: a legacy of the New Classical revolution that refuses to acknowledge the centrality of Keynesian insights to macroeconomics. These biases are a serious problem, partly because they can distort research effort, but also because they encourage policy makers to make major mistakes.[3]
Footnotes
[1] The clash between Monetarism and Keynesianism was mostly a clash about policy: Friedman used the Keynesian theoretical framework, and indeed contributed greatly to it.

[2] It may be legitimate to suggest someone is out of touch with macro theory if they make statements that are just inconsistent with mainstream theory, without acknowledging this to be the case. The example that most obviously comes to mind is statements like these, about the impact of fiscal policy.

[3] In the case of the UK, a charitable explanation for the Conservative opposition to countercyclical fiscal policy and their embrace of austerity was that they believed conventional monetary policy could always stabilize the economy. If they had taken on board PK's analysis of Japan, or Eggertsson and Woodford, they would not have made that mistake.
Update: Noah Smith also comments.

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