I was interested to read A Balanced Debate About Reforming Macroeconomics by Joseph E. Stiglitz. A professor at Columbia University and a Nobel Laureate in Economics, Stiglitz is on the "liberal" neo-keynesian side of the policy fence.
The most remarkable aspect of the recent conference at the IMF on Macro and Growth Policies in the Wake of the Crisis was the broad consensus that the macroeconomic models that had been relied upon in the past and had informed major aspects of monetary and macro-policy had failed. They failed to predict the crisis; standard models even said bubbles couldn't exist -- markets were efficient.
Even after the bubble broke, they said the effects would be contained. Even after it was clear that the effects were not "contained," they provided limited guidance on how the economy should respond. Maintaining low and stable inflation did not ensure real economic stability. The crisis was "man-made." While in standard models, shocks were exogenous, here, they were endogenous [i.e. arising from within the system itself].
There was even remarkable consensus about many elements of policy in responding to the crisis: fiscal policy can work; we need to be wary of empirical studies based on circumstances markedly different from the current situation (where households are overleveraged, where interest rates have reached the zero lower bound, etc.).
There were large areas of consensus for the longer run: central banks will focus on more than just inflation, especially financial stability; but there will be a real challenge in developing an integrated approach.
The ultimate objective of a central bank is to stabilize the real economy, and financial and price stability both need to be seen as instruments toward this and other ultimate objectives. In achieving real stability, much stronger financial regulation will be required -- both because of agency issues and the pervasiveness of externalities, self-regulation cannot be relied upon. Real stability will require a full range of tools for capital account management, including cross-border regulations on capital flows.
It is remarkable that after well over 100 years of theories about how to manage economies, economists are once again gathering together to examine their blatant failures. But it is truly astonishing that there was so much faith in the Invisible Hand that the Federal Reserve thought it could run the economy by focusing almost exclusively on the rate of inflation. I have been reading Robert Skidelsky's Keynes: Return Of The Master. Consider this passage from page 44—
To the non-economist, these [theoretical] debates may seem to have little or nothing to do with the crisis and how to get out of it. This is to ignore their influence on policy. The policy regime that followed the Reagan-Thatcher revolution reflected to a large extent the ideas of the New Classical economists.
[My note: "New Classical economists" — the Chicago school, with their efficient markets, etc. as opposed to the "New Keynesians" as Skidelsky calls them. These are the clowns whose failures the IMF conference Stiglitz attended was meant to address. Neither school of thought anticipated or understands the crisis.]
... Consumer price stability became the main, and often the only, goal of macroeconomic policy, and monetary policy was considered sufficient by itself to ensure macroeconomic stability.
Concern with credit, banking, asset prices, and financial stability was downgraded. Budgets should be balanced and debt-to-GDP ratios stabilized, since rising debt threatened the solvency of governments, and all deficits did was to raise interest rates and thus 'crowd out' more efficient private activity. To apply these policies one needed independent central banks with mechanical rules—like the so-called Taylor Rule, devised in 1993 by the economist John Taylor for relating interest-rate changes to projections of inflation.
Efficient market theory also lay behind the extensive deregulation of the last twenty years: the repeal of the Glass-Steagall Act, the acceptance of bank self-assessment of risk, the failure to regulate the market for derivatives.
This passage may appear to be, as Skidelsky intended, a straightforward elucidation of economic theoretical failures, but it is not. In fact, Skidelsky has got the world exactly ass-backwards. The assumption made here is that "New Classical" macroeconomic theory, as expressed in policy, drove the "Reagan-Thatcher revolution" in subsequent years. It was this revolution which delivered us to the sorry fate we enjoy today. Here is the reality—
- Politics always drives policy. Economic theories are always post hoc (after the fact) rationalizations of pre-conceived agendas. Any policy, no matter how unfair or crazy, will always find economists to support it. Thus are careers established, good salaries made, high appointments in government achieved. Economics is always the handmaiden of politics, not the other way around. Note well that the adoption of "New Classical" macroenomic theory followed the "Reagan-Thatcher revolution" according to Skidelsky. Governments after Reagan simply continued or implicitly endorsed the same policies.
It is absurd for Skidelsky to assert that "the repeal of the Glass-Steagall Act, the acceptance of bank self-assessment of risk and the failure to regulate the market for derivatives" was due to the general acceptance of efficient market theory. Plainly, all of these outcomes—which Stiglitz and the rest say must now be corrected through theoretical revisions— were due to the free rein given to banks and others by the influence of these special interests on political policy, a phenomenon also known as rampant corruption. What did Senator Dick Durbin (D-Ill) say about Congress and the banks?
And the banks — hard to believe in a time when we're facing a banking crisis that many of the banks created — are still the most powerful lobby on Capitol Hill. And they frankly own the place.
It's bad enough that macroeconomics is not a science and relies on a caricature of Human Nature in its formulations. (Those who take a more nuanced view of human behavior, like Hyman Minksky, are completely ignored.) Here in the Real World, economic theories always serve political ends. A moment's reflection will tell you that it can not be any other way. If macroeconomics were a science like physics, there would no policy options at all. Ultimately, economic policy will determine where the money goes and who is on the receiving end. This alone should be sufficient to persuade you that macroeconomics is merely politics in disguise.
The "Reagan-Thatcher revolution" led directly to a society in which wealth & income inequality is greater than at any time since the late 1920s. It led to globalization and "free trade" under which America's manufacturing base shrank and shrank, median incomes declined, and American jobs went overseas. And so on. The list of disasters is very long.
I suppose it is trivial to say that academic economists do not live in the real world. As Stiglitz said, standard models said bubbles couldn't exist! However, the damage their theories rationalize can not be easily undone. In the case of our independent Federal Reserve, mistaken theories are applied directly to "manage" the economy. These Fed economists believe their own bullshit! We have seen where that got us, and where it's taking us now.
Macroeconomic theory is an utter failure. It has always been this way, and it always will be this way. The IMF can hold conferences from now until Doomsday, but don't expect anything to change.
Glenn Greenwald's insight into the minds of the True Believers:
http://www.salon.com/news/wall_street/index.html?story=/opinion/greenwald/2011/03/27/koch
and mine, which will hopefully give you a laugh break:
http://witsendnj.blogspot.com/2011/03/koch-victims-vindicated-in-weekly.html
Posted by: Gail | 03/27/2011 at 02:42 PM