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.]


Matthew Montagu-Pollock's picture

I suppose the puzzlement of 'lay economists' (this one has a PPE degree) comes when we read e.g. Chris Giles' Financial Times interview with David Miles (today June 25), and hear that this 'most dovish' member of the Monetary Policy Committee (MPC) doesn't see any case for fiscal stimulus, and is still urging more QE, in the middle of what seems evidently a liquidity trap.

Plus the fact that when you talk to old-style IS/LM economists, they feel utterly marginalized within university economics faculties.

The odd thing, is that the now dominant economic mainstream isn't making its case publicly, although it has persuaded conservative politicians. The 'public forum' anti-Keynesian case is otherwise dominated by Austrian eccentrics. So we hear loud voices repeating the IS/LM orthodoxies we imbibed in 101, but what the other side really thinks is difficult to discern.

Your list of people who make sense, is my list too. But the fact that a) they aren't on the MPC; ii) they aren't mainstream in the universities; iii) they are disagreeing with an ivory tower orthodoxy which, oddly, leaves the public defence of its views to politicians and eccentrics who have zero credibility, means the idea that there is some kind of 'central macro consensus' doesn't ring true.

James's picture

My education ended at A Level so I belong I suppose to that general public that economists need to explain themselves to. In 2006 I came to the decision that if I wanted to use my vote responsibly, I should try to understand what actually lay behind the economic slogans the parties toss at each other. I have two observations

As for the facts, while there is often more than one way to interpret stats, data is more impressive when used as the soil from which the argument grows, rather than as a flattering adornment to an ideology.

"all economists need to do far, far better at explaining their work to the general public" Just yes. You are not too bad Jonathan, neither is Martin Woolf. Tim Harford writes well, and I wish we could clone Paul Krugman for use over here. Our politicians and media are of course lamentable, being slaves to soundbite culture, especially the Labour party & the BBC. If I had been relying on them, I would not have known that there was an intellectually coherent case against government policy until really quite recently.

Lastly macroeconomics is not just an intellectual academic discipline, so the discussion should be shouty, and for the same reason that all political argument is, because it matters. If anything you are mostly too polite. So please don't worry about decorum, create a stir, and chuck a few hand grenades into the debate. This should be debated more, not less.

Don't have one's picture

I would say missing on that list are Randal Wray on monetary economics and Steve Keen on debt dynamics. Although Steve Keen would probably agree with Diane Coyle on the state of macroeconomics.

EliRabett's picture

It's a bit far afield, but the shouty problem arises from a basic change in political debate which has spread to economics and science in general, that politics determines facts. The current mess is an excellent example, with, among others, the Germans deciding that the Greek mess is a moral failure that must be punished, even if it involves destroying the innocent and eventually themselves.

The austerian analysis has clearly failed, but you will never get them to admit it. One is indeed reminded of Max Plancks description of how new science is accepted only when the adherents of the old die. Unfortunately in this case, they are going to take a load of bystanders with them.

JLD's picture

I have to disagree with your claim to have answered the questions in the strongest possible terms.

First, let's agree on a defintion of science.

Can we agree that a statement is not scientific if it is too vague to be tested, either by experiment or observation in the way Feynman describes in his Messenger lectures which are published by Microsoft as the TUVA project?

Second, can we agree that the "science" must be able to predict or forecast, also as descrbied by Feynman?

If so, there is nothing to macro that is science. It cannot predict or forecast what to do now. Nor can the theories be stated with sufficient detail to be tested, by either experience or observation.

To be precise, it is commonly assumed that Romer did some calculation on a napkin of the needed size (and presumably shape of the stimulus) which was rejected by Summers.

If there were a science to what you were about, you, yourself, would have on your blog such a calculation, which day by day would be showing the "loss" collectively, by the failure to act.

This could be easily shown, as Wolfram has many mathematical projects on line of similar calculations.

here is a simple example, in operation

James's picture

That's just a semantics. Of course economics and other social sciences are not pure science, but that does not mean they are useless. Here is a more complete demolition of your argument

Agog's picture

JLD - I don't think macroeconomics was being claimed to be the kind of science you would apparently like it to be. The economy is big and complicated and therefore hard to forecast - think about Feynman thinking about turbulence.

But that's not to say that knowledgeable people can't point out unsustainable trends, or policies that are likely to be counterproductive. See Martin Wolf's criticisms of the UK ConDem coalition during 2010, or Dirk Bezemer's 'No one saw this coming' paper outlining who predicted the 2007-8 crash and why. The key is an understanding of the constraints: accounting and human behaviour.

Zorblog's picture

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Zorblog's picture

The third point of Diane Coyle looks far more relevant than the two other ones: "all economists need to do far, far better at explaining their work to the general public".
They should in particular explain "econ 101". If they had done it before, people such as Krugman would have less trouble making himself heard now. He's well able to dismiss the arguments of those who disagree with him on the basis of theory or evidence, but that's of little use if no one's listening.

Peter's picture

From the viewpoint of a layman who reads econoblogs as a hobby a lot of this looks political. This is Krugman's conclusion also.

What are the goals and priorities of macroeconomic policy? Ferguson and Coyle point towards policies that increase government debt as being unfair towards younger generations. But what about other metrics like unemployment and the output gap of the national economy is producing and could be producing if it was running at potential without runaway inflation?

Right now in America and the UK future generations (not to mention Spain or Greece!) are being harmed by needlessly high rates of unemployment. An economy running at full capacity without a large output gap would be able to devote more resources to social problems like those surrounding immigration issues.

Charles M. Smith's picture

I am afraid we cannot agree. Is string theory science? How do we determine exactly how many dimensions exist? did that particle exceed the speed of light or was the experiment flawed? Science is comprised of a fairly broad spectrum of models, suitable for the phenomenon under consideration.

Macro is like this. There are facts such as the unemployment rate, the interest rate,government revenue, etc. There are models of how certain behavior by either a central bank (monetary policy) or the government (fiscal policy) would impact these facts. From the model explanations of the past may be constructed and predictions about the future made. When governments and central banks do things, which they inevitably do (including failing to act) we can then test the models. Either they work or they need revision. All of this can be done with a fairly appropriate level of precision, often assigning probabilities and ranges for the results.

Sounds a bit like particle physics. (Alright, just a bit.)

Macroeconomics is not natural science, as human beings are involved. Yet it produces testable models which are, perhaps, of more importance than those of natural science.

anhho's picture

Dear professor,

Am I right to add one point that even when the economy is not in a liquidity trap, government spending by borrowing might also not crowd out private one. That is when government spending goes to projects that help to facilitate business activities such as infrastructure and transportation, the lower cost of production therefore might cancel out the higher cost of borrowing faced by private sector.

Thank for your defense of economics, and thank to the acceptance of professor Coyle.

Keshava's picture

What was the factual error from Professor Ferguson's Reith Lecture?

CharlesJ's picture

Dear Sir,
You claim that "as Krugman has repeatedly pointed out, the (IS-LM) textbook has been spot on." and then go on to quote Simon Wren-Lewis:
"Recent developments have in many ways been a vindication of the basic Keynesian model that lies at the heart of any undergraduate macro course"

I should point out that Keynes would never have agreed with the IS-LM model, for the simple reason that IS-LM explicitly shows the supply and demand curves as seperate and independent, which is exactly what Keynes said was not the case - they are infact interdependent - and he would say that to beleive otherwise would be a fallacy of composition.

I would also say that for Krugman to say the following about financial crowding out is also wrong:

"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."

Every time the government spends, all the money it spends flows through the economy, and whatever is not taxed away, ends up pooling in people savings accounts and on company balance sheets - ready to be invested again - this is why there is no such thing as financial crowding out; you just have to follow where the money goes.

As for the liquidity trap arguement - even Hicks backed away from this. In a true liquidity trap as described by Hicks, investors only hold cash, and shun even government bonds - this is clearly not what is going on. We have a balance-sheet recession, not a liquidity trap.

Kind Regards

CharlesJ's picture

I also have a problem with Paul De Grauwe's explanation of why the UK has such low government interest rates. First, the bond markets are well aware that there is no default risk, given that the UK state (BoE or Treasury) can create currency at will.

In addition to this you then could look at government debt from, say, a pension fund's perspective. When gilt yields are low, their price is high, meaning they hold a valuable asset which they can leverage or use as collateral. If gilt yields were to then fall, the asset value would fall, but this would be off-set by a higher yield.

It's a win-win for any investor holding UK government debt. In the EZ this all goes wrong with step one, i.e. Greece CAN default because it does not issue its own currency.

Martijn's picture

Small factual error: the university where Paul De Grauwe works is in Leuven, which in the UK is best known under its French name Louvain. 'Leeuwen' is Dutch for 'lions'.

Postkey's picture

Someone seems to think Krugman is 'redefining' the 'liquidity trap'?

'According to that column, a classic liquidity trap occurs when “a zero short-term interest rate isn’t low enough to restore full employment”. Krugman – who won the Nobel economics prize in 2008 – is widely regarded as the USA’s most articulate and effective spokesman for Keynesian ideas. For those uninitiated in macro-economic theory his words are taken as gospel. However, the trap called “classic” by Krugman is no such thing.
Krugman talks about the “short-term interest rate”, by which he means the interest rate set by the central bank. Yet, Keynes’ trap arises when increases in the quantity of money cannot push nominal bond yields beneath a certain level (which must be above zero) because investors have perverse expectations about the price of bonds. Krugman’s trap holds when the central bank cannot, by increasing the monetary base, cut the short-term interest rate beneath zero. That leads to an unacceptably high real interest rate if people are concerned about falling prices. Krugman’s trap is not at all a classic trap originating in the debates of the 1930s. It is an entirely new trap that he has invented. Keynes’ trap is implausible and certainly does not exist today.
Modern Keynesians are untrustworthy, if they can so wilfully misunderstand and misrepresent their supposed intellectual hero. The supposed “liquidity trap” is a plaything of left-wing intellectuals, not an argument for the subversion of a hugely successful capitalist economic system. In the form suggested by Keynes the liquidity trap does not exist today. In the form suggested by Krugman, his so-called liquidity trap does not invalidate monetary policy because monetary policy can still be effective using instruments other than short-term interest rates.'

Christian Gormsen's picture

As a microeconomist, I think the apparent consensus is mostly due to self-selection according to interest, which is correlated with policy views.
There is only one macroeconomy, but infinitely many possible microeconomies. If you're internationally minded and can support businesses, you select into international trade (like me).
If you care about the unemployed you become a labor economist.
If you like math more than people you go into game theory, perhaps mechanism design.
All these countless fields have little interaction, and develop policy consensus based on this self-selection. For example, the people that self-select into international trade are pro free trade (and many of us erroneously supported the euro).
In macroeconomics, the issues that researchers debate are the same, and disagreements become public. I'm not sure that's bad for the discipline, but it seems to deadlock policy.

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