I’ve expanded my series on refuted economic doctrines to include an approach I think has been rendered largely obsolete by the global financial crisis (along with earlier developments). I’ll give the short version here, and point to a longer post at my blog, which might be better for more technical points.
New Keynesianism (as with most other attachments of the word “New” to left/progressive terms in the 1980s and 1990s) was a defensive adjustment to the dominance of free market ideas such as new classical macroeconomics, and to the apparent success of a policy regime in which active fiscal policy played a minor role at most. The New Keynesians sought a theoretical framework, based on minimal deviations from rationality and market efficiency assumptions, that would justify medium-term macroeconomic management based on manipulation of interest rates central banks, and a fiscal policy that allowed automatic stabilisers to work, against advocates of fixed monetary rules and annual balanced budgets.
But now that both the intellectual foundations of post-1970s economic liberalism (most notably the efficient markets hypothesis) and the policy framework that brought us the Great Moderation have collapsed, there is no need for such a defensive stance. The big question for the crisis and after is how to develop and sustain a Keynesian system of macroeconomic management that can deliver outcomes comparable to those of the Bretton Woods era, while avoiding the excesses and imbalances that brought that system to an end in the 1970s.
{ 38 comments }
bert 05.09.09 at 2:26 pm
Have a look at this blast of ad copy. Saatchi has been pushing amendments in the Lords for a different measure of inflation. A particular flavour of CPI targeting can be pinned on Gordon Brown, apparently, and with it blame for all our troubles.
I mention it because Saatchi inadvertently points up the messy history of those “fixed monetary rules”. The early Thatcher governments fought a series of internal battles over the appropriate measure of money supply. Nigel Lawson’s resignation was all about the abandonment of monetary targeting. Inflation targeting was half-embraced through an exchange-rate peg to the Deutschmark. Then after Black Wednesday, it was officially embraced – first by Ken & Eddie in the mid nineties, then by the Brown/Balls arrangements of 1997.
At no point in this thirty-year stretch was there a solid consensus on the right measure to target. Indeed Goodhart suggested that you invalidate a measure merely by using it to run your policy.
There was however a consensus that active fiscal policy was wrong, and also that policy shouldn’t target employment. This was enough to rally a coalition.
New Keynesianism was a tactical ceding of ground to it, a pattern made familiar by New Labour and New Democrat concessions across a bunch of different policy areas. The crisis has reversed this trend, but there’s not yet any dominance of the policy debate of the sort that neoliberals enjoyed. Old Keynesianism failed as a political program, and was discredited by its failure. By burying New Keynesianism, you’re not resurrecting the old sort.
What’s needed is a distillation of Keynesian insights into a new political program.
For example, the old program promised full employment. Is that a promise it’d be smart to reintroduce?
Find a functioning formula, which squares the perceived self-interests of a serviceable majority, and you’ll have a fulcrum to move the world.
(At least for the next five or ten years, or until the next clusterf**k.
Maybe thirty years if you’re very very lucky.)
Stuart 05.09.09 at 2:43 pm
Surely the problem with Keynesian economics is that governments claim to be following Keynesian policies in recessions/depressions, but then usually turn into Monetarists (or something else) during the boom years when the Keynesian policy would be to reduce government spending (to both pay back the debt accrued in the bad years, and to avoid competing with booming private industry and causing wage inflation).
lemuel pitkin 05.09.09 at 3:32 pm
Why not add neoclassical economics to the list?
lemuel pitkin 05.09.09 at 3:38 pm
Or to be a little more direct: Which of *your* doctrines have been refuted by the crisis, John?
bob mcmanus 05.09.09 at 6:31 pm
Lemuel, JQ has been posting for months, here and at his own blog, a series of refuted economic doctrines. I would not give Quiggin credit for or ownership of those docrines, but part of the point of this post is that some tools have been abandoned and that that makes the remodeling more difficult. I’m giving him the benefit of the doubt.
Now I could flog my favorite policy prescriptions, like ELR or somehow including asset inflation in inflation measures, but I imagine the N-Ks need more technical justifications yo give to the CB’s and fiscal authorities. I think we now have the math and processing power, need better and quicker numbers, and go to a disequilbrium macrodynamics. I think monetary policy has shown its inadequacy (DeLong seems to want to control asset bubbles with interest rates), so we have to move to automatic stabilizers that are more dynamic yet politically plausible. We can’t adjust marginal income tax rates quickly and easily to meet macrodynamic needs (one of the failures of the 60s), so maybe a VAT tax financing some kind of flexicurity. I think we need to move the inflation target to 3-5%.
I do think we need to take the gov’t share of GDP up permanently to at least 40% of GDP to reduce the volatility, or create a rule that as capital/finance’s share of GDP and productivity rises, taxes and social spending rises, and as labour’s share rises, gov’t spending declines.
bob mcmanus 05.09.09 at 6:42 pm
And the 60s & 70s need serious analysis. That the shocks (war, oil, demographics) weren’t countered well may be a political problem. Bush just wasn’t willing to raise taxes in 2002-03, and I am not sure what the Fed or CEA could have done to counter. This is why I think we need more gov’t, instead the the less gov’t helping flexibility and re-allocation of factors of the neo-liberals. I think we will run into bad politics (eg regulatory capture) more often than bad economists.
lemuel pitkin 05.09.09 at 7:44 pm
Lemuel, JQ has been posting for months, here and at his own blog, a series of refuted economic doctrines.
I know. I’ve been reading them.
But John Q. *also* identifies himself as a practitioner of neoclassical economics. Which means he endorses — in principle, anyway — a methodology resting on assumptions that are every bit as flawed as the ones he rightly criticizes here.
John Quiggin 05.09.09 at 8:19 pm
LP, I take pretty much the Lakatos view of scientific research programs. So, to refute neoclassical economics (taken here as a synonym for mainstream, encompassing Keynesians macro, game theory, behavioral economics and so on) you need a superior alternative. I’ve taken a look at Austrian economics on my blog, and I plan a piece on Marxist economics, and my conclusion is that neither fits the bill.
So, in the way I use these terms, the crisis calls for a readjustment within mainstream/neoclassical econ (back to Keynesian macro, and with a stronger case for intervention in micro terms) rather than a switch to a competing program.
That’s not to say that there aren’t errors in my own thinking that have been or will be shown up by the crisis. Feel free to point them out. But I doubt that I’ll be convinced by an existence argument of the kind you offer in #7.
StevenAttewell 05.09.09 at 11:19 pm
I generally agree with Bob and Bert that full employment, through a “social Keynesian” mechanism of “employer as last resort” is a good move, both in terms of policy and politics.
However, it’s true that Keynesianism Classic (as opposed to “new Keynesianism”) needs some additions to deal with the problems already identified with inflation and the disincentive to turn down during the boom.
In regards to inflation, one thing that has struck me is the relative success experienced by the U.S and the U.K during WWII in combining full employment with low inflation – which means it is in fact possible to square the circle. The question is whether it can be done without the wartime policy measures/political arrangements extant at the time. One thing that does come to mind is actually Keynes’ proposals for dealing with wage inflation by giving out bonds instead of cash for wage increases – thus deferring spending without incurring the negative effects to income/wealth that come with wage cuts; workers get “Future Bonds” that will mature in X years, and make a bit of profit at the same time. (You could also enhance these bonds by doing some government matching and tying them to certain objectives, by allowing them to be turned in for a retirement annuity, a first home, or a full college education, etc. thereby accomplishing both short and long-term economic objectives) This method does require a solid compact between government and labor that government will make good on future income growth and that labor will avoid pushing for immediate cash wage increases, but it’s doable. A guarantee of full employment and the right to a job is a powerful inducement towards cooperation.
In regards to the disincentives, I think the problem is that in general the electorate likes spending and doesn’t likes tax increases, and in general doesn’t think very clearly about the relation between the two. One way to get around this may be to construct visible links between increased taxes and popular social objectives – such that special surcharges intended to decrease spending pressure go into special trust funds for long-term programs. For example, you could have a special fund for Climate Change, another special fund for Social Security Improvement, another for High-Speed Rail, and so on. This way, you both decrease consumer spending and defer government spending, while simultaneously enhancing public investments in long-term infrastructures.
Lupita 05.09.09 at 11:40 pm
The big question for the crisis and after is how to develop and sustain a Keynesian system of macroeconomic management that can deliver outcomes comparable to those of the Bretton Woods era, while avoiding the excesses and imbalances that brought that system to an end in the 1970s.
The outcome during the Bretton Woods era in Africa was colonialism and in Latin America military dictatorships. My point is, in many places of the world how to go back to that era is not the question at all. The same goes for the neoliberal era.
How much of the outcome in the 1st world since the end of WWII was due to hard work and innovation and how much to being on the right side of financial, political and military hegemony? What will become of rich countries without the benefits of agricultural subsidies, reserve currencies, favorable trade agreements, military might, dodgy AAA ratings, client states, the IMF, World Bank, and UNSC? Those are the elephant size questions in the room.
Tinker with your fiscal and monetary policies all you may. The game is over.
a 05.10.09 at 6:24 am
“Which of your doctrines have been refuted by the crisis, John?”
The equity premium seems to have bit the dust.
John Quiggin 05.10.09 at 6:56 am
“The equity premium seems to have bit the dust.”
On the contrary, the only real casualty here is the idea (most prominently put forward in Dow 36 000) that any equity premium is irrational, because buying and holding stocks always outperforms buying and holding bonds over any period of more than 20 years. I posted on this a while back.
The empirical basis of the equity premium puzzle, the observation that the return to stocks greatly exceeds that to bonds over the past century, remains intact, as does the puzzle of explaining why this is so.
a 05.10.09 at 7:41 am
“The empirical basis of the equity premium puzzle, the observation that the return to stocks greatly exceeds that to bonds over the past century, remains intact, as does the puzzle of explaining why this is so.”
So the equity-premium advocates used to be able to scratch their heads with, “Over a 20-year period, stocks outperform bonds.” Whoops, their bad. Now they are reduced to saying, “Over a 50-year period, stocks outperform bonds,” using only 100 years of data.
Do you *really* still think there’s a puzzle there?
John Quiggin 05.10.09 at 7:54 am
As I already pointed out, the only people who pointed to the 20-year period version of the puzzle were those who didn’t know much about the data. In particular, people who paid attention only to the US were unaware that stocks had underperformed bonds for long periods in overseas markets, without violating the general pattern of long run outperformance.
The general puzzle remains, as I said. “Mistake” explanations have lost their appeal, while the suggestion that the good performance of shares was a once-off lucky draw (implicit in your comment) looks more promising. But I doubt you’ll find majority acceptance of that explanation on the basis of the data as it stands.
Robert 05.10.09 at 10:57 am
Good grief. One would think that an Aussie economist had heard of Geoffrey C. Harcourt. But no, the only alternatives for Quiggin are Marxism and Austrian economics, not that his blog posts on those were lettered.
John Quiggin 05.10.09 at 11:48 am
Robert, of course I know Geoff Harcourt and I’ve read and enjoyed a fair bit of his work in the past. But, if I have taken your implication correctly, I assume you are claiming that an alternative to mainstream economics, capable of providing vital insights into the current crisis, can be derived from study of controversies in capital theory (Cambridge v Cambridge, Sraffa v Hayek, and so on). I very much doubt this, but feel free to point me in the right direction.
Robert 05.10.09 at 1:01 pm
No. Harcourt’s latest book, The Structure of Post-Keynesian Economics: The Core Contributions of the Pioneers, confines discussion of reswitching and capital-reversing to an eight-page appendix at the rear. Quiggin apparently is ignorant of the existence of Kaldor’s succession of growth models, Joan Robinson’s models of metallic ages, or Paul Davidson’s emphasis and formalization of the distinction between models set in logical and historical time, etc., etc.
Tim Worstall 05.10.09 at 3:17 pm
Stuart #2 seems to have the nub of the problem. At least as far as I’m concerned.
Part of that Keynesian macroeconomic management is that we should have fiscal boosts when growth is below trend. Politicians love this. The flip side is that we should have fiscal contraction when growth is above trend. Politicians hate this.
So if, for public choice reasons, 50% of Keynesian macroeconomic management simply cannot happen (or if you prefer, is extremely unlikely to happen), is it actually a useful guide to real world action?
StevenAttewell 05.10.09 at 5:43 pm
Tim:
I disagree; it’s simply that politicians haven’t found a political solution to selling fiscal contraction. I would submit that a political solution exists, which is to establish strong ties between fiscal contraction and socially popular aims; you could think of Clinton’s “Save Social Security First” as a proto-example, in that provided a politically sale-able (everyone likes Social Security) rationale for essentially sequestering a huge sum of money for the future instead of spending it.
Kevin Donoghue 05.10.09 at 7:00 pm
Why so grumpy, Robert? Even if John Quiggin really is as ignorant as you claim (which I doubt), he is still streets ahead of some well-known Chicago profs whose illiteracy has been documented by Paul Krugman and Brad DeLong.
Hidari 05.10.09 at 7:18 pm
‘LP, I take pretty much the Lakatos view of scientific research programs. So, to refute neoclassical economics (taken here as a synonym for mainstream, encompassing Keynesians macro, game theory, behavioral economics and so on) you need a superior alternative. I’ve taken a look at Austrian economics on my blog, and I plan a piece on Marxist economics, and my conclusion is that neither fits the bill.’
My legion of fan will be aware that I only have one thing to say when economics is mentioned. However, to please that one fan, I will reiterate it.
In terms of looking at other schools that might replace neo-classicism (and god knows it needs replacement) what about looking at the historical school.
If we are looking about modern schools what about behavioural economics, evolutionary economics, and experimental economics generally?
Also: why do ‘we’ actually need, a single overarching theory to unify the field? Sociology hasn’t had one for twenty years, and it’s still staggering along, (if scarcely flourishing). This is particularly important as neo-classical economics would have been fine if it had been kept as an interesting addendum to real economics, a sort of fantasy about how things would work if they didn’t work they way they actually did. It’s precisely as a meta-theory that neo-classicism fails, and fails spectacularly.
Hidari 05.10.09 at 7:31 pm
http://www.paecon.net/PAEtexts/Hodgson1.htm
bert 05.10.09 at 8:38 pm
Worstall, you focus on fiscal boosts and fiscal contraction. What about monetary boosts and monetary contraction? Greenspan’s reputation has taken a dive because he neglected a big part of his job. He even concocted a rationale for himself, regarding the inherent difficulty of spotting a bubble until after it bursts. There he is, enormously powerful and uniquely insulated from political pressure, and not even he can dab on the brakes.
I think you’ve found a powerful argument that it’s tricky to smooth out the economic cycle during an upswing.
But you’ve found no kind of argument at all that fiscal policy shouldn’t be used.
And not even the beginning of an argument that Keynes can’t be a “guide to real world action”.
Walt 05.10.09 at 9:27 pm
Stuart and Tim: You’re putting the cart before the horse. The job of economists is to come up with true accounts of the economy. The job of economists is not to come up with false accounts of the economy to better manipulate politicians into wise behavior.
John Quiggin 05.10.09 at 10:50 pm
Robert, you do seem rather grumpy. I’m not trying for a comprehensive survey of economic thought in blogpost form here. I’m looking at ideas that appear to have been refuted by the financial crisis, and conversely at alternatives that might help provide a way forward.
In this context, as I’ve mentioned, the most interesting post-Keynesian ideas seem to me to be those following Minsky on financial instability and, at a more abstract level, ideas about uncertainty, unforeseen contingencies and so on. But, if you think other ideas are more important, why don’t you write something about them, rather than sniping.
Hidari, I’m certainly not excluding behavioral economics – that’s exactly the approach Akerlof and Shiller are advocating (although there’s a bit of inside-baseball controversy about whether this or that approach is “really behavioral economics”). Experimental economics is absolutely mainstream – Vernon Smith got the Nobel for it not long ago. As regards the other approaches you mention, I haven’t seen anything on these lines that’s been very useful in understanding the current crisis, but feel free to point me in the right direction.
Robert 05.11.09 at 9:18 am
John, so have you been reading Shackle? Do you understand what contribution of Davidson’s I was previously alluding to? I am not arguing these ideas are more important than Minsky’s. I am just demonstrating than one can find more than Minsky in the alternative that is Post Keynesianism.
I could go on, as I will demonstrate by turning to the Cambridge-Cambridge debate. Suppose the cost-minimizing technique varies continuously along the so-called factor price frontier. Pasinetti pointed out that the value of capital to worker need not vary continuously in such a case. This suggests exploring the application of bifurcations, complex dynamics, and catastrophe theory to capital theory. And Rosser has done this.
And Post Keynesianism is only one alternative. Institutionalism, which lies, in some sense, between the Historical Schools and Evolutionary Economics, is another. And there are more.
I suppose Quiggin could find ideas to rip out of their context here and to use as epicycles for neoclassical economics. But I’m with Pitkin in comment 3.
Hidari 05.11.09 at 9:50 am
‘Institutionalism, which lies, in some sense, between the Historical Schools and Evolutionary Economics, is another.’
My understanding is that Hodgson, who wrote the piece that I linked to, describes himself as an Institionalist.
It’s an interesting point that JQ raises though. I can well imagine what the Austrian school and Marxists are making of the current crisis. But what ARE other, ‘heterodox’ schools saying? What is the view of the Institutionalists, and EE (Evolutionary Economics)?
Hidari 05.11.09 at 9:52 am
That should of course have said Institutionalist.
Hidari 05.11.09 at 10:06 am
http://en.wikipedia.org/wiki/New_institutional_economics
Kevin Donoghue 05.11.09 at 2:40 pm
Suppose the cost-minimizing technique varies continuously along the so-called factor price frontier. Pasinetti pointed out that the value of capital to worker need not vary continuously in such a case.
Good for him and I regret giving up on his book and chucking it out when I moved house. But if I hadn’t, would I really be any wiser about how “how to develop and sustain a Keynesian system of macroeconomic management that can deliver outcomes comparable to those of the Bretton Woods era”, which is what John Quiggin is interested in?
I’m all for a more coherent approach to economic modelling, but let’s not forget that one reason IS/LM held sway for so long is that it enabled readers of the FT to understand the opinion pieces. Not only that, but the Treasury model builders could use beefed-up versions of it for simulating the effects of different policies. Likewise, Friedman’s accelerationist model enabled officials of modest brainpower to see why inflationary policies could only reduce unemployment for a while. Indeed the main reason why Keynes had such a large readership in his day is that he found wonderfully simple ways of expressing his main ideas – parables about buried banknotes, casinos etc. The Post-Keynesian school doesn’t follow his lead in that respect.
Sebastian 05.11.09 at 7:02 pm
I have to agree with #2. There aren’t many real live politicians who are Keynesian during the economic expansion. Government action has a very strong ratchet effect. It sticks around for the same reasons as stupid farm subsidies (or maybe it is exactly the same problem as stupid farm subsidies). So if the general Keynesian explanations are correct, I suppose the poltical/economic question you should be analyzing is how to practically enact them on the expansion side.
I’m also a little confused by the framing of “The big question for the crisis and after is how to develop and sustain a Keynesian system of macroeconomic management that can deliver outcomes comparable to those of the Bretton Woods era, while avoiding the excesses and imbalances that brought that system to an end in the 1970s”. Maybe I’m reading too much into it, but it seems like you were saying that the Bretton Woods era was essentially pretty good, up until the stuff at the end which made it untenable.
But isn’t that exactly the same thing you could say about the late 1980s through 2005? It seems that was at least as successful during the non-crisis years as Bretton Woods.
And really, which years are you counting as the good years of Bretton Woods? The Marshall Plan years which propped it up immediately post-war? The balance of payment crisis years 58-68? How many good years did it really have as a system?
(Again I just have popular-level understanding, so I’m raising questions which I admit may have obvious answers to formal economists).
Kevin Donoghue 05.11.09 at 7:48 pm
Sebastian,
As to the differences between the Bretton Woods era and the post-Reagan era: take a look at the first graph (the blue line) in this Krugman post. (The rest of the post isn’t so relevant, though it’s not irrelevant either.) Now you may not see anything there that bothers you, but as a regular reader you know a bit about John Quiggin’s politics, so you can probably see what bothers him. It bothers me too, not so much because I care about equality for its own sake (I don’t begrudge the “Cork mafia†their yachts in the least), but because the Dubya era brought home to me a truth which Machiavelli knew: when the rich get very rich they don’t just settle for wealth, they want to buy power as well.
As for your last paragraph, there are times when laymen should stay out of economists’ arguments but I think this post is about a topic which is too important to be left to the economists: how does their conventional wisdom get established and what, if anything, does that have to do with empirical validity?
BillC 05.11.09 at 11:58 pm
When was neoclassical economic theory proven true in any useful way such that it deserves to be treated in the way described in post #8?
Robert 05.12.09 at 12:00 am
I take one political implication of the complex dynamics I point to in 26 to be that counter-cyclical fine-tuning, either with fiscal or monetary policy, is unreliable. Keynes-Keynesian policy was more concerned with institution-building, anyways. I am thinking of such matters as the Glass-Steagall act, automatic stabilizers such as unemployment insurance, and the Bretton Woods agreements themselves (although Keynes compromised there).
bert 05.12.09 at 1:24 am
Automatic stabilisers may be institutionalised. But they operate at any given moment as part of an overall macroeconomic policy framework. And, since they are both automatic and countercyclical, they put a pretty big hole in the argument that fiscal policy is a uniquely bad instrument.
Of course, I understand the argument about deficit-financing leading to mounting deficits. And it makes sense to worry about unfunded liabilities when you’re thinking about how to manage your public finances. But I bridle somewhat when I hear these arguments coming from movement-conservative (Norquist variant) taxcutting headbangers. Dick Cheney told Paul O’Neill that “Reagan proved deficits don’t matter”. We can have a civilised conversation about Keynesian profligacy when I see conservatives honestly trying to figure out what the fuck happened with that one.
Tim Worstall 05.12.09 at 12:00 pm
“The job of economists is to come up with true accounts of the economy.”
Sure. In composing that true account, should we not include the actual, as opposed to desired, incentives facing politicians?
Robert 05.13.09 at 9:05 am
Michal Kalecki was indeed prescient. Not having the intellect of Mr. Worstall, I fail to see how agreeing with Kalecki can imply that Keynes did not have a true account of the economy.
By the way, Joan Robinson and her colleagues had worked out a theory of stagflation by the early 1960s. Post Keynesians were advocating some sort of incomes policy, maybe a Tax-based Incomes Policy, in the 1970s.
dsquared 05.13.09 at 9:36 am
At the end of the day, although Paul Davidson does write some good stuff, if you look at the final chapter of his books, his actual policy prescription is pretty thin. It involves a prices & incomes policy to control inflation, and constant easy credit for everything else (I have occasionally joked in the past that Davidson is actually a Friedmanite who advocates a k% monetary growth rule – he just thinks that k should be a big number).
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