Macro Debates and the Relevance of Intellectual History

One of the interesting things about the ongoing economic crisis is the way it has demonstrated the importance of historical knowledge. This is only the second global financial crisis serious enough to drive interest rates down to the zero lower bound in most major economies; making sense of it has depended crucially on knowing something about the first.

But it’s not just economic history that turns out to be extremely relevant; intellectual history — the history of economic thought — turns out to be relevant too.

Consider, in particular, the recent to-and-fro about stagflation and the rise of new classical macroeconomics. You might think that this is just economist navel-gazing; but you’d be wrong.

To see why, consider John Cochrane’s latest. Cochrane has opened his mind a bit over the past five years; in 2009 he was asserting that accounting identities implied that shortfalls in demand can’t happen and that a potential role for fiscal policy was a fairy tale nobody believed in. Now he’s at least aware that New Keynesian economics exists, even if he still seems to have trouble understanding that the case for fiscal policy doesn’t depend on second-round effects on consumption, and still puts scare quotes around the word “demand”.

But what’s interesting about Cochrane’s current argument is that it effectively depends on the notion that there must have been very good reasons for the rejection of Keynesianism, and that harkening back to old ideas must involve some kind of intellectual regression. And that’s where it’s important — as David Glasner notes — to understand what really happened in the 70s.

The point is that the new classical revolution in macroeconomics was not a classic scientific revolution, in which an old theory failed crucial empirical tests and was supplanted by a new theory that did better. The rejection of Keynes was driven by a quest for purity, not an inability to explain the data — and when the new models clearly failed the test of experience, the new classicals just dug in deeper. They didn’t back down even when people like Chris Sims (pdf), using the very kinds of time-series methods they introduced, found that they strongly pointed to a demand-side model of economic fluctuations.

And critiques like Cochrane’s continue to show a curious lack of interest in evidence. After all, we’ve had a series of big natural experiments in recent years: a quadrupling of the monetary base, massive deficits, extreme austerity measures. The results of all these natural experiments have been consistent with a Keynesian view, inconsistent with any kind of supply-side view. And there has also been an explosion of empirical work.

In short, you have a much better sense of what’s really going on here, and which ideas remain relevant, if you know about the unhappy history of macroeconomic thought.