The Wallaces

Some Truths About Macro-Economics Modeling in Recessions

(posted 12/27/2011) - I have been following Professor Paul Krugman's New York Times column (Conscience of a Liberal) over the past year during which the divergence among Austrian, Neo-Classical, and Keynesian centric economist's world view has become more and more obvious.

The following 2009 opinion pieces from Krugman (Keynesian), Cochrane (Neo-Classical), and Murphy (Austrian) lend credence to the term "the dismal science" as an approbation for the economics profession.

What I find interesting is that these 2+ year old arguments seem to be even more pertinent now -- as all of Europe stands on the brink of massive recession and the US continues to hover in stagnation mode.

Krugman's 2009 op-ed is entitled "How Did Economists Get It So Wrong?." It is written for lay-readers (non-economists by profession) and includes Krugman's view of the evolution of the dominant schools of macro-economic thought. It observes that these schools dismiss the use of Government Fiscal Policy during recession. Krugman believes this is a mistake, and takes the profession to task for this failure.

Here's the NYT article link.

Professor John Cochrane's response is visceral in its ad-hominem attack on Krugman. It is clear there is no collegial respect here -- Cochrane clearly believes Krugman beneath contempt. So, obviously Krugman struck a nerve. Try and read the article for it's rebuttle qualities however, and you may be left wanting...

Here is the link.

In case you think Cochrane was a bit thin-skinned in taking personal umbrage to Krugman's critique of their common profession; try this little screed from a "Distinguished" professor of economics, David K. Levine.

Open Letter to Paul Krugman. Yow! Hit a nerve much?

Not directly mentioned by either Krugman or Cochrane, and dismissed by both as a lesser school of thought, are the followers of Ludwig Von Mises (the Austrians). Here is Austrian School economist Robert P. Murphy's take on both Krugman and Cochrane (hint: he thinks they are both idiots).

Here's the link.

OK, I assume if you've reached this point in my blog you've perused the above author's comments and perhaps have noticed that the only one who seems at all interested in using economics as a means to direct government policy (monetary and fiscal) is Krugman. I think that is a telling point.

The other academics are angry at Krugman for, among other things, saying that the profession hasn't helped government navigate the shoals of recession. They believe (based on their theories and their models prior to the 2008 recession) that government should not have a monetary or fiscal role in minimizing recession/stagnation.

Krugman argues cogently for the classic Keynesian position that when the central banking system of a sovereign nation has lowered intra-bank rates to zero during a recession, the next step is government fiscal stimulation (employer of last resort) to move the economy forward by borrowing on future revenue streams and employing folks to to get the economy past the recessionary shock.

I'd really like to see Cochrane, Levine, and Murphy explain why their models absolutely preclude the use of sovereign fiscal policy to ameliorate recessions during a liquidity trap (bounded monetary policy). I think the last two years have been very kind to the descredited thoughts of John Maynard Keynes!

Updated 12/31/2011 -- I was trying to get a handle on the utility of Dynamic General Equilibrium models (specifically of the Stochastic ilk) which have been so influential in the teaching of macroeconomics since the early 70's. This WikiPedia page airs the dirty little secret that Macroeconometric modeling may have taken a severe wrong turn a while back -- and the policy decisions based on these models may be backfiring during recessionary shocks!

Here's the link: DSGE Modeling in Economics (with critique citations).

Here's a great summary of macroeconomic thought as it applies to real policy decision making!