You have got to be kidding. There’s been enormous deflation. Ah, economists…

this really isn’t true – Fisher had a very well developed analytical theory of the reasons why excessive debt impeded investment and as I say, Bernanke and Stiglitz recognised this and do not make the same claims of originality for the financial accelerator literature that you do.

But I beg to differ: when you’re defending something new (see last one), you rock; and when you’re attacking some historical stuff, you don’t. IMHO, of course – ‘all acronym explanation’ chapters are good for conversations with economists I guess but that’s as exciting as discussions amongst SW engineers (for lack of a funnier analogy).

the paper by Edge stops its analysis on 2004, which kind of misses the point. And that is, while DSGE models might be quite good at forecasting the macroeconomy when it is on a steady state growth path, the test is whether they can forecast, or even just explain after the fact, abrupt movements in the business cycle.

I hope the Fed’s economists will soon release a paper on how their DSGE models, calibrated to data up to mid 2007, have gone in forecasting the past two years.

Let me clarify – I do not think tractability is the reason that many researchers consider one friction at a time. Models with multiple frictions, multiple sectors, multiple shocks and so on are essentially just as tractable as those with one friction, one sector, etc. That is, solving and simulating multiple friction models and computing optimal policy responses is straight-forward. The reason most researchers consider one friction at a time is for clarity and focus only. Frameworks with multiple frictions have not resulted in dramatic interactions like the complete “breakdown classical equilibrium” you anticipate.

Regarding price rigidity – it would appear that the relevant prices have moved to clear these markets. We just don’t like where they have cleared. There is no doubt that many prices move sluggishly and that these movements have consequences. The question is whether sluggish price adjustment has important macroeconmic consequences. Ask yourself this – would the current situation be greatly improved if more prices were adjusted? If not, then you probably don’t put much weight on the importance of nominal rigidity for the current crisis.

To dsquared:

Fisher, like most observers of the time, was aware (at an intuitive level) of the dangers of excessive amounts of debt. Debt-deflation deals with the effects of inflation or deflation on real indebtedness. When deflation occurs, the real value of debt, or real indebtedness, rises which could exacerbate the problems associated with debt -assuming that debt has bad effects to begin with.

The financial accelerator (and similar contributions) aim at explaining why excessive debt and other financial frictions hinder investment in the first place with the hope of developing policies and institutions to address these frictions. Fisher’s debt deflation theory does not really contribute to this understanding but instead takes credit market frictions and their associated maladies as an assumption. Regarding the current situation, there hasn’t been sharp deflation (or inflation) recently so debt-deflation has probably not played a role.

Modern economics is much more in favor of central planning than one might think. Since we are all rational actors with complete information seeking to optimize the same utility function, a central planner will be making exactly the same decision in each case as would any system of distributed actors. A similar argument can be made from corporate governance – one never sees calls to break up large companies, even ones whose revenues exceed the GNP of many nations, on the grounds that their internal control structures (almost universally top-down with a central control) is inefficient.

Debt deflation definitely has something to do with the financial accelerator—if nominal debts immediately readjusted for changes in the price level, then economic shocks wouldn’t have as negative an effect on balance sheets and therefore creditworthiness. They may not trigger the initial bank run, but they prolong it.

There are lots of examples like this, which I’m sure you’re aware of, but I do think it would be helpful to the chapter (and book). I recognize this is a preliminary draft and you do make mention to specific articles, but at least for me, using specific references expands and supports the argument. Regardless, the chapter reads well and is an excellent overview of the arc of macro and some of its blind spots. Will you be mentioning any heterodox economists who are entirely out of the fresh or saltwater?

Hear, hear. Some economists need to make up their mind whether they are scientifically studying the behavior of actual economies of human beings, or doing a branch of mathematics about the behavior of idealized theoretical entities (something like game theory with a lot of players). The results of the latter have proved to be of very, very limited fruitfulness as tools for doing the former.

First while I have little experience practicing economics, I should say that I find all this khunian rhetoric (“everything has changed with the crisis”) either exaggerated or misleading. I don’t think that current economic theory, interpreted in a suitable large and plural way, is discredited with the crisis. The so called “New institutional finance” (both models of credit rationing and financial accelerator) as described by Knoop in this book (http://www.amazon.com/Modern-Financial-Macroeconomics-Panics-Crashes/dp/1405161817) fit rather well in the picture of the current crisis. Balance sheet effects of financial crises are nothing new; they are the main element of the New Institutional Finance and were one of the pillars of the third generation of currency crises as developped by,… Krugman! (http://sapir.tau.ac.il/papers/sapir_conferences/Krugman.pdf). So, like Barry Eichengreen (http://www.nationalinterest.org/Article.aspx?id=21274) I think one must separate the failure of economist to predict the crisis, which might be traceable to sociological dynamics and feedbacks of optimism, and the suitability of the conceptual framework. The elements of the reasoning, I believe, were just there, while it is true that most economists (though not all, Shiller or Kenneth Roggoff are an example) failed to predict it.

Secondly, again, my impression might be flawed, but I do not think that new keynesians failed to integrate imperfection in a whole framework. The point is, however, that many imperfections have analogous effects- either staggered wages or efficiency wages in its many formulations hypothesis produce the very same effect of wage rigidity- so the general framework does not need to be so particularised. Another point is that, as Concerned Economist pointed out, when you introduce a and b, you get a combination of both. Finally, I believe there were efforts in that very direction. This paper of Stiglitz and Greenwald http://www.bad-sports.com/~rajith/Teaching/MAFE502/Bruce(23-26).pdf for instance, proposed, as soon as at the beginning of the nineties, a model with the basic ingredients of wage and price rigidity and credit market rationing. A standard textbook, such as Carlin and Soskice (“Macroeconomics imperfections, institutions and policies”) proposed a similar approach with its three equations model which does not relies on DSGE.

To sum up, I believe that the post fails to address the pluralism of the new keynesian approach and makes a caricature of it.

No, he did not.