Junk Macroeconomic Science
By Arnold Kling
Several days ago, Greg Mankiw linked to a list of top economists according to some objective criteria related to published work. I was familiar with most of the top 150, at least to the point of being able to identify their main field of contribution. In the top 25, there was only one economist with whom I was unfamiliar. His (I assume it’s a he) name is Jordi Gali.
Coincidentally, the other day I received a review copy of a book by Gali, enthusiastically blurbed by Mankiw among others. I think that the book is junk.
It is a graduate textbook in New Keynesian economics. What that means in practice is a bunch of mathematical modeling utterly divorced from reality. As David Colander points out in his The Making of an Economist, Redux, contemporary graduate students are forced to suffer through this in spite of the fact that many of them, as well as many of their professors, suspect that it is worthless.
I will lay out my own views on macro now.There are two essential features of macroeconomics.
1. Financial markets and investment depend on subjective perceptions of risks and opportunities.
I have talked about the risk disclosure problem, which is that financial intermediation works by disguising risks. When people perceive that it is working well, the cost of investment falls and we have a boom, or possibly even a bubble. When people lose faith in financial intermediation, we can have a crash.
Keynes spoke of “animal spirits” of entrepreneurs. He contrasted that with a propensity to hoard among those who are averse to risk. His story was of an excess desire to save among the hoarders relative to the animal spirits of the entrepreneurs. There is much about Keynes that I reject (the liquidity trap, for example), but I have always liked the “animal spirits” story. It is mostly overlooked in textbooks nowadays.
2. Labor markets adjust slowly to sudden shifts in demand.
There is a perpetual need for people to change jobs. Societies start out with the majority of workers in agriculture, and the trend is to migrate to jobs in cities. For the past fifty years in the United States, the share of manufacturing production work has declined. These gradual, normal adjustments in the labor market reflect the fact that demand grows faster than productivity in some sectors (health care, education) while productivity grows faster than demand in other sectors (foodstuffs, manufactured goods).
On the other hand, there can be sudden, unexpected shifts in labor demand. Think of the dotcom crash of 2000, which suddenly lowered the demand for web developers and “business development” shmoozers. In theory, wages for these occupations should have fallen and the relative wages of other occupations should have risen, with little or no net drop in employment.
In practice, relative wages adjust slowly. It may be possible for the monetary authorities to speed the process of relative wage adjustment by engineering an inflation surprise. That is, you increase the rate of money creation, leading to more inflation, causing real wages to fall where needed. Maybe. My confidence in that mechanism is actually pretty low.
3. “Fiscal policy” is an unfortunate excuse for vote-buying.
Running a government deficit means redistributing wealth away from future taxpayers toward current taxpayers. On net, this makes people feel wealthier. This would be a good thing if the economy were suffering from severe, protracted high unemployment. In practice, however, deficit spending is used as a cynical political tactic. It is a stain on macroeconomics that this crude vote-buying is dignified with the name “fiscal policy.”
Having a large government sector helps to insulate the economy from macroeconomic fluctuations, primarily because government employment is not subject to sudden changes in market demand. But temporary increases in spending or cuts in taxes are exercises in politics, not in good economics.
4. The central bank matters more as a lender of last resort than as a monetary authority.
Financial markets are large and complex. There are many substitutes for money. When the financial markets are operating reasonably smoothly, the central bank has to work really hard to generate either high inflation or disinflation. Central banks certainly have done this. In the U.S., the central bank facilitated inflation in the 1970’s. However, for most of the past twenty years, many central banks have kept inflation at modest levels.
When financial markets threaten to unravel, a lender of last resort may be able to mitigate the damage. This is the context in which I view recent moves by the Federal Reserve in the U.S. Only time will tell whether my support for these policies is warranted. But it is consistent with my view of macro.
5. Remember that much of macroeconomics is anti-economics.
In real economics, work is a “bad.” There is no such thing as a shortage of jobs. Instead, there are unlimited wants. We should be rooting for high productivity that enables people to choose a mix of consumption goods and leisure that they prefer.
In real economics, saving does not hurt the economy. Saving allows individuals to smooth their consumption. It allows businesses to accumulate capital, raising worker productivity. We should be rooting for high saving, rather than worrying about consumers being in the mood to spend.
In real economics, government spending that is financed by borrowing is typically not a good thing. We should be rooting against deficit spending.
In real economics, borders and currencies do not matter. We should not be rooting for a weak dollar to give us a “trade surplus.” Instead, we should be rooting for unimpeded trade, in order to gain from specialization and comparative advantage.