Ignoring Ben Bernanke

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The Great Macro Debate never ends. Reader Adam Ozimek writes, quoting me being snotty about rational-expectations macroeconomics:

“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.”

But you are ignoring contributions by Bernanke which have no doubt influenced his policy-making. I’m sure you are familiar with 1983 paper “Nonmonetary effects of the financial crisis in the propagation of the Great Depression”. In it Bernanke specifically states that one of the papers important contributions is that preserves the rationality of agents but explains the depth and length of the depression. This conclusions of this paper underlie a lot of the future work that Bernanke would do on depression prevention, and his understanding of the importance of credit intermediation surely influenced his poilcymaking in this downturn.

Am I missing something?

I replied that I didn’t really think of Bernanke as being in the rational expectations tradition. He’s part of the MIT crowd that, starting the mid-1970s, internalized the rational expectations critique of Keynesianism and monetarism, but then immediately began finding ways around it. (Paul Krugman was part of this crowd, too, but didn’t focus so much on macroeconomics.) Adam responded:

I think that you are going too far in trying to paint rational agent models as being removed from the world of policy-influencing economists …

Bernanke does say in his paper that the “reconciliation of the obvious inefficiency of the depression with the postulate of rational private behavior remains a leading unsolved puzzle of macroeconomics, these two virtues alone provide motivation for serious consideration of this theory”. So this is modern macro research that is not just in the rational expectations tradition, but is motivated by the preservation of rational agents.

Bernanke may not have spent his academic career building representative agent models and deriving euler equations, but rational agents were clearly a central part of this influential and famous theory of his.

Adam has a point. The real-business-cycle continuation of rational expectations may be looking a bit like a dead-end (although one never knows), but economic models based upon rational agents are here to stay. I doubt, however, that policymakers around the world really needed Bernanke’s 1983 paper to come to the conclusion that Hey, we should keep the banking system from collapsing. Historical experience was enough to convince them of the need for that. I once asked Bo Lundgren, one of the architects of the Swedish bank rescue of the early 1990s, if he and his colleagues had consulted Bernanke’s work at the time. “Yes, yes,” he said briskly, before gushing at length about the book that he said had most informed his approach, American historian Susan Estabrook Kennedy’s The Banking Crisis of 1933.