Macroeconomics: what is it good for? [a response to Diane Coyle]
Diane Coyle is not just one of the UK's most eminent "public intellectuals", but also simply one of the most impressive people I know; how she manages to run her own economic consultancy, serve as Vice-Chair of the BBC Trust and as a member of the Migration Advisory Committee, write a book every year or two and tweet constantly is completely beyond me. So I take it very seriously indeed when she disagrees with me, as she did (semi-) publicly in this blog last week. I promised a response, and here it is. [Warning: longish, and occasionally nerdy.]
The origin of the argument was a twitter exchange about Niall Ferguson's Reith Lecture about government debt and intergenerational equity. I pointed to the fact that Ferguson clearly lacked any understanding of macroeconomics, as demonstrated by his debate with Paul Krugman three years ago (more on this below); therefore, while he might or might not have interesting things to say about history, no-one should pay any attention to what he said on economic issues. I should note that the lecture itself more than confirmed my views: while intergenerational equity is an important issue, Ferguson adds nothing to the debate. Indeed, by exaggerating to the point of self-parody, he detracts from the serious arguments of those who think we should worry about these issues (my colleague Martin Weale and Simon Wren-Lewis for example). His lecture also contains at least one embarrassing factual error that would not have been made by anyone who either understood the subject to start with, or bothered to do the most basic research.
Diane's blog addresses a slightly different point from the credibility, or otherwise, of Professor Ferguson. Essentially that she is arguing that macroeconomists (and macroeconomics) have so little credibility in general that it is no longer possible for someone like me, or Professor Krugman, to dismiss the arguments of those who disagree with us on the basis of either macroeconomic theory or empirical evidence; and that therefore macroeconomics has - and deserves - little influence on policy. She contrasts this very sharply with microeconomics, arguing that macroeconomics "does not stand on the same kind of increasingly sound empirical footing." She goes on to make three specific points:
a) "although macroeconomists will insist that there are known scientific facts, they do not appear to agree on what these are"
b)" the discussion among macroeconomists is so shouty"
c) "all economists need to do far, far better at explaining their work to the general public"
and concludes by asking
Can some of the macroeconomists out there agree about what they agree is empirically well-founded, including the policy implications, and let us know?
The first point is clearly the most important, and needs to be answered to address the final question. So let me start there. Diane is clearly correct that there's far less consensus about the "right" underlying model of the macroeconomy than there is about some aspects of microeconomic analysis (the impact of trade or migration, say). Diane and I were both at a recent Oxford conference on the latter, attended by many of the leading researchers in the UK (and a few from abroad) working on migration-related issues; and the degree of consensus, both about what the research shows and what the key questions are, is very large.
But that doesn't mean that there isn't a fair measure of agreement among most of us who work on macro policy as to "how things work" and hence the basic tradeoffs. As I set out at some length here, there is a consensus running from Paul Krugman, through me and most other UK economists, to the IMF, on the mechanisms by which fiscal policy affects demand; the legitimate discussion is about the magnitude of the impacts and the extent of the tradeoffs.
But "what do we think about the impacts of fiscal policy?" is in my view a bit too general a question to address Diane's point about "what is empirically well founded?". So let me give two much more specific examples. The first is about the impact of very large deficits on long-term interest rates when short-term interest rates are at or near the zero lower bound. Here's Niall Ferguson, in May 2009:
only on Planet Econ-101 (the standard macroeconomics course drummed into every US undergraduate) could such a tidal wave of debt issuance exert "no upward pressure on interest rates".
And here's the man from Planet Econ-101 himself, Paul Krugman, also in May 2009
So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap.
As we all know, since then both the US and UK have had deficits running at historically extremely high levels, and long-term interest rates at historic lows: as Krugman has repeatedly pointed out, the (IS-LM) textbook has been spot on. Empirically (and theoretically) well-founded? Definitely. As Simon Wren-Lewis points out here
Recent developments have in many ways been a vindication of the basic Keynesian model that lies at the heart of any undergraduate macro course
The policy implications are of course not unambiguous - the conclusion isn't "borrow as much as possible" - but the implication that, when you have excess (desired) private saving, government borrowing won't push up long-term interest rates is obviously important. So score one for macro 101. Of course, there were economists, not just people like Ferguson, arguing the contrary in public; but generally not on the basis of a different analytical framework, with the result that their analysis was confused at best. See for example my debate with David Smith here, where David begins by explaining that low interest rates reflect "market confidence", and ends up by saying that they reflect the "fragility of the banking system."
Of course, some countries - all, not coincidentally, members of the eurozone - that have high deficits have indeed seen interest rates soar. So a second, and equally policy-relevant, example is "what drives the possibility of a sovereign debt crisis?". Here the economic theory was set out very clearly by Paul De Grauwe, of the University of Leeuwen, for example here (and versions of this paper were circulating as far back as mid-2010):
This separation of decisions [in a monetary union] – debt issuance on the one hand and monetary control on the other – creates a critical vulnerability; a loss of market confidence can unleash a self-fulfilling spiral that drives the country into default. Suppose that investors begin to fear a default by, say, Spain. They sell Spanish government bonds and this raises the interest rate. If this goes far enough, the Spanish government will experience a liquidity crisis, i.e. it cannot obtain funds to roll over its debt at reasonable interest rates... It doesn’t work like this for countries capable of issuing debt in their own currency. To see this, re-run the Spanish example for the UK. If investors began to fear that the UK government might default on its debt, they would sell their UK government bonds and this would drive up the interest rate. After selling these bonds, these investors would have pounds that most probably they would want to get rid of by selling them in the foreign-exchange market. The price of the pound would drop until somebody else would be willing to buy these pounds. The effect of this mechanism is that the pounds would remain bottled up in the UK money market to be invested in UK assets.
The economic theory underlying this verbal explanation is clear and convincing. And so is the empirical evidence. Not only have Japan, the US and the UK all failed to experience self-fulfilling liquidity crises resulting from their very large deficits, so has every other developed country that issues debt in its own currency. This contrasts, of course, with the eurozone experience; and it is precisely what theory predicts. It is quite rare that an economic theory - macroeconomic or microeconomic - is so clearly and comprehensively vindicated so quickly. Again, the policy implications are not that we (or the US) can or should expand our fiscal deficit without limit. But they are very clear that we should ignore the ratings agencies, and that anybody who is still arguing that the current path of fiscal consolidation - and the economic damage it has done - was necessary to preserve "market confidence" has chosen to ignore the evidence.
So I think that we have at least two examples where both macroeconomic theory and the empirical evidence are very clear: I hope Diane will accept that I've met her challenge, and that these are clear counterexamples to her broader argument. And, to repeat, this isn't hindsight - the Krugman-Ferguson bust up was in 2009, and De Grauwe first outlined his thesis before the eurozone crisis had spread beyond Greece.
I will deal with Diane's other points more quickly. Is the debate too "shouty"? I can be fairly blunt when I think those with some influence on policy are behaving incompetently, as in my discussion of the European Commission here. And when it comes to the ratings agencies, as set out here, I think their behaviour has been so damagingly incompetent as to justify fairly strong language. But I don't think that I (or other UK economists who share broadly my views on macroeconomic policy, like Simon Wren-Lewis or John Van Reenen) are either rude or personalised in our debates with those who disagree with us on near-term macro policy; see, for example, my recent discussion with Chris Giles here. More nerdy than shouty.
What about Paul Krugman (the one economist Diane names)? Well, "shouty" implies volume at the expense of argument and analysis: I suggest reading this (on the G20 two years ago) and drawing your own conclusions. It's blunt, and arguably rude: "utter folly posing as wisdom". But it's based on a clear and coherent analysis, which incidentally was correct.
Finally, on explaining better, so as to have more impact; of course. But this (as Diane recognises) is about economics in general, not just macro. Take immigration again, a subject Diane and I have been discussing for years, and where we (along, as noted above, with most economists who have looked at the issues in the UK context) are in violent agreement on the economic evidence and analysis, set out by me most recently here. Unfortunately, the fact that we agree on the theory and the evidence does not mean we can convince the public (and hence politicians). Arguably, of course, this problem with science, including social science, in the public and political debate extends well beyond economics, and certainly beyond the scope of this column. I address some of these issues on how economists, especially in government, can hope to influence policy in a positive direction in this earlier post.
To conclude, I agree with many of the points made by Diane in her recent Tanner lecture about the current state of economics and the need for a fairly radical rethink in some areas. I too would like to see academic economists engaging more with policy relevant questions, and new approaches to macroeconomic modelling. But overwhelmingly I think the mess the global economy is now in is the consequence not of listening to macroeconomists, but ignoring the credible ones. A year ago, I gave a presentation to a group of government economists. I concluded with a slide entitled "So who should we listen to" which consisted of a list of macroeconomists and topics:
- Paul Krugman on fiscal policy in a liquidity trap
- Martin Wolf on financial balances
- Richard Koo on balance sheet recessions
- Simon Wren-Lewis on the policy implications of the New Keynesian model
- Adam Posen on lessons from Japan
- Paul De Grauwe on sovereign debt and the eurozone
These people don't agree with each other about everything or all the time. But they are coherent, credible, and taken together frame a sensible macroeconomic policy debate. If our government, and those of other countries, had followed my advice in that slide we'd all be a lot better off.
[Update: Diane now has a further, related post on "tribes of [macro-]economists", which is well worth reading also, and which I think is broadly accurate. Certainly I would accept her assignment of me to "tribe 3" - "a third group of macroeconomists are often really microeconomists who feel compelled to try to make a sensible contribution to the policy debate because they are so exasperated by [City commentators]". Other members include Ian Mulheirn, John Van Reenen and sometimes Tim Harford.]