My throwaway line that some people at the University of Chicago “reeeeaaaally didn’t like Paul Krugman’s article about the state of macroeconomics” has gotten so much traffic, thanks to a link from Krugman, that I feel obliged to go a bit deeper. My observation was occasioned by a conversation with a couple of mild-mannered, open-minded finance professors who aren’t directly involved in the debates at the heart 0f Krugman’s article. They mainly just thought Krugman was being rude and unscholarly.
I don’t think they’re entirely wrong about this, but the sudden discovery in Hyde Park that economist Krugman moonlights as a sharp-penned polemicist seems a little, well, belated. Wounded complaints about Krugman’s popular writings go way back. Here’s Robert Kuttner, in 1996:
Krugman has become the most prolific policy entrepreneur of them all. He may be peddling fatalism rather than activism, but he is no less a peddler. Alas, Krugman’s earlier counsel is correct. It is very difficult to be both a conscientious academic and an effective policy entrepreneur. There aren’t enough hours in the day, and you begin to make mistakes. Your own glibness becomes your worst enemy. In his high-professor role, Krugman equates “anecdote” with unscientific. This apparently leads him to conclude that when in anecdotal, policy-entrepreneur mode, you don’t need to look things up. And as for intellectual cheap shots, well, you can read him yourself.
What’s different is that Kuttner was arguing that “the career of Paul Krugman epitomizes, if in extreme form, how the conventions of the economics profession work to block a resurgence of liberal activism.” Now the Chicagoans are irked that Krugman, whose blog is called “The Conscience of a Liberal,” has become willing to upend the conventions of the economics profession to push a particular politico-economic agenda. That in itself is an interesting switch, and I wish Krugman had more directly confronted his transformation from guy who extolled “the scientific-mathematical outlook that is arguably the true glory of our civilization” to guy who writes that “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.”
But none of that is really relevant to Krugman’s main complaint, which is that the macroeconomic approach incubated at Carnegie Mellon in the 1960s and birthed at the University of Chicago in the 1970s—rational expectations—has proved to be something of a dead end. I wrote a whole book making this point about rational expectations’ sister theory in finance, the efficient market hypothesis, and the Chicagoans I talk to all claim to more or less like the thing. So I’m a little confused as to why they’re so offended by Krugman’s article. I guess I’m just more polite than he is.
What are the substantive complaints with Krugman’s piece? Mark Thoma has the definitive collection of responses and counterresponses, but I’ll go with Chicagoan John Cochrane’s “How did Paul Krugman Get It So Wrong?” to keep it simple. Apart from Krugman’s rudeness, these appear to be Cochrane’s main issues:
1) Nothing about the crash violated the efficient market hypothesis:
The central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going—neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics.
That’s not quite right. The central empirical prediction of the efficient market hypothesis, as laid out by Eugene Fama at the 1969 annual meeting of the American Finance Association, was that markets would move over time in accordance with the Capital Asset Pricing Model. That is, risky stocks would outperform less-risky ones, with the risk that mattered being something called beta—the correlation of a stock’s movements to those of the overall market. Fama and Ken French concluded in 1992 that this wasn’t so, leaving over only the theory that Cochrane describes above. But in the meantime, finance professors of an efficient markets bent had sold Wall Street on the idea that financial risk could be measured and tidily contained. Oops! Also, a number of smart people did predict that the real estate boom of the early 00s was a bubble that was bound to collapse. They may just have been lucky, of course, but I dunno …
2) This wasn’t a crisis of free financial markets:
The centerpiece of our crash was not the relatively free stock or real estate markets, it was the highly regulated commercial banks.
Depends what you mean by “centerpiece.” The crisis began in the real estate markets, then metastasized into a run on the lightly regulated shadow banking system of securitization and derivatization, then finally spread to commercial banks. The stock market was a comparative bastion of calm and rationality, that’s true. But to say that financial markets in general weren’t part of the problem is an awfully strange reading of the events of the past two years.
3) Macroeconomists actually have been making progress over the past couple of decades:
Macroeconomists have not spent 30 years admiring the eternal verities of Kydland and Prescott’s 1982 paper. Pretty much all we have been doing for 30 years is introducing flaws, frictions and new behaviors, especially new models of attitudes to risk, and comparing the resulting models, quantitatively, to data.
I’m sure Cochrane is right that macro research has continued apace. And I know from my own reading that Krugman’s piece left out lots of interesting finance work that’s been done on bubbles and crashes and the like. But has any of this contributed significantly to economic policymaking? Not that I know of, not yet. That may be the policymakers’ fault, not the economists’. But the standard policy prescription of economists in the rational expectations tradition is that government shouldn’t try to do anything about macroeconomic fluctuations. While I think that may be the right course (albeit one that is never really followed) in reaction to a garden-variety recession, I’m not so sure in the case of a potential global depression caused by a huge financial shock. And here’s the thing: As best I can tell, modern macro models of almost all stripes don’t really take the financial sector and its influence into account. Which is why Krugman and many others find themselves grasping back to Keynes.
4) Grasping back to Keynes is regressive and unscientific:
Science that moves forward almost never ends up back where it started. Einstein revises Newton, but does not send you back to Aristotle. At best you can play the fun game of hunting for inspirational quotes, but that doesn’t mean that you could have known the same thing by just reading Keynes once more.
Sorry, but that isn’t going to cut it. Macroeconomics just isn’t a science on par with physics. I’m willing to buy that some parts of microeconomics are awfully science-like, but macro seems way too entwined with cycles in intellectual and political fashion to take itself quite that seriously. This isn’t because macroeconomists are dummies, or evil, or anything like that. It’s just that modeling the whole economy is really hard—almost certainly impossible, in fact.
5) Too much math ain’t the problem:
The problem is that we don’t have enough math. Math in economics serves to keep the logic straight, to make sure that the “then” really does follow the “if,” which it so frequently does not if you just write prose. The challenge is how hard it is to write down explicit artificial economies with these ingredients, actually solve them, in order to see what makes them tick. Frictions are just bloody hard with the mathematical tools we have now.
I don’t think Krugman was saying economists should stop doing math. He was simply warning that math can blind, and in this quote Cochrane seems to make the case for him. Are “frictions” really the key to understanding the economic events of the past couple of years? I don’t know, but Cochrane’s particular mathematical approach seems to compel him to focus on them.
In policy terms, this debate mainly comes down to whether fiscal stimulus makes sense or not. I’d be the first to agree with Cochrane that Krugman’s vigorous pro-stimulus arguments are based more on hunches and guesswork and politics and history than on any kind of rigorous economic model. I’ve been even less impressed, though, with anti-stimulus arguments that claim to be based on rigorous models but are utterly devoid of historical perspective, curiosity and common sense. That’s probably partly a result of my bias as a non-economist semi-intellectual, and I do agree that it’s interesting that Krugman has gone from berating the likes of me to courting us. But I think this disdain for on-the-ground economic reality is something that Cochrane and his intellectual allies are going to have to confront if they don’t want to slide into complete irrelevancy.