What Was Mainstream Macroeconomics? ...Bueller?
By Arnold Kling
I mention Scott Sumner a lot on this blog. Why? Because I see him as sticking up for mainstream macroeconomics. I myself have been pushing a non-mainstream idea, sort of a muddle between Leijonhufvud and Hayek that I call the Recalculation Story. But in the press and in the left-wing blogosphere, mainstream macro is nowhere to be found. It has gone into hiding.
Instead, we have had a “stimulus” and a “jobs summit” that are filled with what I once called Folk Keynesianism. In 2006, I complained
The idea that the economy needs consumer profligacy is not nearly as entrenched among scholars as it is among journalists, politicians, and other citizens. In fact, there is a strong case to be made that we would be better off if we had less consumer spending and more saving.
The scholarly consensus (SC) at that time was that monetary policy was the best tool for stabilizing the economy. The SC has been a no-show in the public discussions of macroeconomics. It was not defeated in debate. There was no confrontation in which folk Keynesians stood up, denounced SC, and demonstrated the superiority of their views. Instead, the SC simply disintegrated.
The SC would say that the Fed has the tools to fight the recession. It would say we do not need and never have needed a “jobs summit.” We simply needed a more expansionary monetary policy.
The only argument that I have seen in favor of the shift from the SC to folk Keynesianism is the “liquidity trap” argument. That is, monetary expansion becomes ineffective when nominal interest rates are zero. However, that argument is quite weak. Years ago, Ben Bernanke pointed out that if the interest rate falls to zero in the Federal Funds market, the Fed can expand the money supply by purchasing assets in other markets, such as long-term bonds or mortgage securities. If nothing else, subsequent events have shown that what he proposed in theory can be put into practice.
The two contenders matched here are the credit-cycle view and the quantity-theory view of cyclical fluctuations. The credit-cycle view explains cyclical movements in output as a consequence of speculative booms leading to unsustainable levels of asset prices and leveraged levels of asset holdings followed by credit busts that depress economic activity through the impairment caused to the functioning of financial intermediation from insolvencies and deleveraging. The quantity-theory view explains significant cyclical movements in output as a consequence of monetary disorder deriving from the introduction by central banks of inertia in adjustment of the interest rate to shocks.
I myself have been pushing the credit cycle view–the folk-Minsky model. Hetzel, like Sumner, argues instead that the problem was a monetary contraction.
the absence of a funds rate reduction between April 30, 2008, and October 8, 2008 (or only a quarter-percentage-point reduction between March 18, 2008, and October 8, 2008), despite deterioration in economic activity, represented a contractionary departure from the policy of LAW [lean against the wind] with credibility. From mid-March 2008 through mid-September 2008, M2 barely rose while bank credit fell somewhat (Board of Governors 2009a). Moreover, the FOMC effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members. In May 2008, federal funds futures had been predicting a basically unchanged funds rate at 2 percent for the remainder of 2008. However, by June 18, futures markets predicted a funds rate of 2.5 percent for November 2008.
I am prepared to offer pushback against the Sumner-Hetzel viewpoint. However, it really deserves the status of the “null hypothesis.” In a more reasonable world, everyone would be starting from the presumption that Sumner and Hetzel are correct. Those of us arguing folk-Minskyism and telling the Recalculation Story should be the ones fighting an uphill battle to bring our ideas into the policy debates. That this is not the case, and that SC is now on the fringe, is one of the most remarkable stories of this whole macroeconomic episode.