Re-Thinking Economics

There are two excellent articles out looking at the disaster of macroeconomic theory.

First, Brad DeLong looks at the history in an article entitled "The Retreat of Macroeconomic Policy".

Second, Paul Krugman looks at the inherent instability of any attempt to find a synthesis of micro- and macro-economics in an article entitled "The Instability of Moderation". He examines three sources of instability: intellectual instability, political instability, and financial instability.

These are excellent articles and deserve very careful reading and re-reading.

I appreciate the social concern of DeLong:

There were three reasons [why governments were indifferent to unemployment and long dragged-out recessions], all of which vanished by the end of WWII.

First, there was a hard-money lobby: a substantial number of rich, socially influential, and politically powerful people whose investments were overwhelmingly in bonds. They had little personally at stake in high capacity utilization and low unemployment, but a great deal at stake in stable prices. They wanted hard money above everything.

Second, the working classes that were hardest-hit by high unemployment generally did not have the vote. Where they did, they and their representatives had no good way to think about how they could benefit from stimulative government policies to moderate economic downturns, and no way to reach the levers of power in any event.

Third, knowledge about the economy was in its adolescence. Knowledge of how different government policies could affect the overall level of spending was closely held. With the exception of the United States’ free-silver movement, it was not the subject of general political and public intellectual discussion.

But, he notes, that all changed between WWI and WWII. Activist government prevented the next Great Depression... until now.

Thus, I would confidently lecture only three short years ago that the days when governments could stand back and let the business cycle wreak havoc were over in the rich world. No such government today, I said, could or would tolerate any prolonged period in which the unemployment rate was kissing 10% and inflation was quiescent without doing something major about it.

I was wrong. That is precisely what is happening.

How did we get here? How can the US have a large political movement – the Tea Party – pushing for the hardest of hard-money policies when there is no hard-money lobby with its wealth on the line? How is it that the unemployed, and those who fear they might be the next wave of unemployed, do not register to vote? Why are politicians not terrified of their displeasure?

Economic questions abound, too. Why are the principles of nominal income determination, which I thought largely settled since 1829, now being questioned? Why is the idea, common to John Maynard Keynes, Milton Friedman, Knut Wicksell, Irving Fisher, and Walter Bagehot alike, that governments must intervene strategically in financial markets to stabilize economy-wide spending now a contested one?

It is now clear that the right-wing opponents to the Obama administration’s policies are not objecting to the use of fiscal measures to stabilize nominal spending. They are, instead, objecting to the very idea that government should try to serve a stabilizing macroeconomic role.

...

Still, here we are. The working classes can vote, economists understand and publicly discuss nominal income determination, and no influential group stands to benefit from a deeper and more prolonged depression. But the monetarist-Keynesian post-WWII near-consensus, which played such a huge part in making the 60 years from 1945-2005 the most successful period for the global economy ever, may unravel nonetheless.

Here is the quick synopsis of Krugman's views:

Brad DeLong writes of how our perception of history has changed in the wake of the Great Recession. We used to pity our grandfathers, who lacked both the knowledge and the compassion to fight the Great Depression effectively; now we see ourselves repeating all the old mistakes. I share his sentiments.

But watching the failure of policy over the past three years, I find myself believing, more and more, that this failure has deep roots – that we were in some sense doomed to go through this. Specifically, I now suspect that the kind of moderate economic policy regime Brad and I both support – a regime that by and large lets markets work, but in which the government is ready both to rein in excesses and fight slumps – is inherently unstable. It’s something that can last for a generation or so, but not much longer.

Krugman has turned fatalistic. He sees a flaw in human nature which will thwart attempts to realize rational government or sound economics. We are doomed to fail because of a flaw in our character. We have lost the Samuelson synthesis:

It’s an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasizes the way the economy can develop magneto trouble, requiring policy intervention. In the Samuelsonian synthesis, one must count on the government to ensure more or less full employment; only once that can be taken as given do the usual virtues of free markets come to the fore.

Consequently we are doomed to an economic "dark age" because of the three instabilities which he discusses in detail. Sadly this lead to:

In the end, then, the era of the Samuelsonian synthesis was, I fear, doomed to come to a nasty end. And the result is the wreckage we see all around us.

Funny... As a kid I was raised in an era of boundless optimism but my teachers felt sorry for themselves because they had been forged in the Great Depression to learn virtues of moderation and satisfaction within a constrained set of possibilities. They all felt jealousy for my generation, those who came of age in the 1960s. But history is a jokester. The generation of 1960s ended up fighting for its ideals and getting its head busted in. Soon after the baby boom hit the workplace and unemployment grew, stagflation hit the econonmy, and times grew grim. This was tough for a generation raised on optimism and endless horizons. The great economic and social advances of the post-WWII generation died as politics turned rancid and strongly to the right. The rich rose both in power, in wealth, and in esteem. (I can still picture those TV shows "Lifestyles of the Rich and Famous". Unlike the Charlie Chaplin movie which made the feasting of the rich as the poor watched from outside into a grim morality tale. In the 1980s the feasting of the rich was turned into a carnival and everybody else was told to "just wait" for soon riches would fall on their head in the infamous "trickle down" economy of Ronald Reagan.) Since the grim 1970s, through the over-the-top 1980s, to the grim early 1990s, to the bubble economy of the dot.com late 1990s, to the grim early 2002, to the bubble economy of the Wall Street bank manufactured "real estate boom", to the now dismal Great Recession, things have stalled for everyone but the top 1%. They have made out like bandits. (Hold it... they were bandits!)

These essays by DeLong and Krugman deserve careful reading and time spent contemplating what it "means" for all of us. It isn't good. There is no post-WWII "good times" looming in our futures. It isn't at all clear how we can get the bony vise-like hands of the ultra-rich off our necks and get an economy that delivers goods to the real workers. There has been 30 years of "productivity increases" with no corresponding wage increases. The difference was pocketed by the rich and they have no intention to stop their extorting their extravagant "share" of the economic pie.