Deep down, economists are mean “SOB´s”

Miles Kimball and Noah Smith elaborate on the upheavals at the Minneapolis Fed I “:The shakeup at the Minneapolis Fed is a battle for the soul of macroeconomics—again”:

The Saltwater macroeconomists believed that recessions were economic failures, and that monetary policy was important in fighting them. Led by Michael Woodford, they adopted the tools and language of the Freshwater economists, and managed to convince many of their Freshwater brethren to reluctantly agree that monetary policy can, in fact, boost the economy.

“By adopting the tools and language of the freshwater economists…” means that “money” was taken out of the picture. It´s “Interest & Prices”. To me that´s one of the reasons (together with the inflation target ‘obsession’) that the economy remains depressed more than four years on.

A few months later, at the end on 2008, America tumbled into its biggest economic slump since the Great Depression, soon followed by much of the rest of the world. Freshwater macroeconomists were left scratching their heads. How could this calamity represent the efficient outcome of a well-functioning economy? But the Saltwater New Keynesians—who included Fed chairman Ben Bernanke—had an answer: the economy had malfunctioned, and America needed the Fed to get us out of the hole. Bernanke and the Fed responded first by extraordinary measures to contain the financial crisis that was the immediate source of trouble, then lowering interest rates to zero and beginning an unprecedented campaign of Quantitative Easing.

See, since there´s no “money”, the economy, not monetary policy, had malfunctioned!

In any case, speculating on the reasons for what ultimately might boil down to simple personality conflicts is not our purpose here. Nor do we seek to offer any judgment on Kocherlakota’s personnel decision, which could have far-reaching impacts on the relationship between central banks and universities and the type of employment contracts offered by Fed banks. Instead, we want to highlight the tectonic shifts in economics itself. From that perspective, the shakeup may turn out to be part of the understandable rebalancing of macroeconomics in the Saltwater direction, as economists try to comprehend the Great Recession and figure out how to avoid an encore.

God forbid! Because the ‘liquidity trap’ idea also reduces to (almost) nothing any role for monetary policy. And a “Great Stagnation” is becoming the ‘thing of the future’!

PS I wrote a short post on Kocherlakota´s decision. In a private exchange I said this:

I hate when people go on a “conversion” trip and do what he´s trying to do. The Minneapolis Fed has a long and important research history. Just as the St Louis Fed was the “house of monetarism”, the MN Fed was the “house of RBC”.I think the freedom to pursue research is important and NK is trying to stifle that freedom (“it´s either my way or the highway”!)

HT Travis V

5 thoughts on “Deep down, economists are mean “SOB´s”

  1. Marcus,

    Right, it’s a dumb column. Remember: deep down, Noah Smith is a liberal partisan. So the column distinguishes between naive freshwater types who believe in the EMH and “sophisticated” saltwater types who reject the EMH.

    Except……..both groups of people are wrong. Freshwater types are wrong about easy / tight money and saltwater types are wrong about the EMH. The correct view is that tight money combined with downward nominal wage rigidity are the root cause of high unemployment. That doesn’t refute the EMH. In fact, the stock market and TIPS markets anticipated the severity of this recession far more quickly than academics ever did.

  2. I had a different viewpoint of the “purge” at first blush. I am not aware of the material involved in the matter, but if the people involved were telling Kocherlakota that monetary policy was limited it what it could do to mitigate the unemployment crisis and the best thing for everyone would be to keep a lid on inflation, hence his repeating it over and over as economic conditions kept getting worse I can sympathize with his doing something about that. It’s just speculation on my part, however. If there is anything to it, I am happy that at least in some small way what goes around comes around. I was beginning to feel that no one would ever be held accountable for this disaster.

  3. Easy to have mixed feelings about this…I hate to see people squished if they are sincere in their economic and political beliefs…anymore than I would like to see a Market Monetarist canned as he would not bow down before tight money or a gold standard…

    It may be that having a “school of thought” or tradition is inherently dangerous, and that precludes diversity…maybe the best tradition is no tradition and a pragmatic “what works?” approach…

  4. Given Minnesota Macro is such a hotbed of Hallucinogenic Business Cycle Theory (HBC) I thought this might be a good time to review the Wikipedia entry on HBC:

    “Hallucinogenic Business Cycle Theory (or HBC Theory) is a class of psychedelic macroeconomic models in which business cycle fluctuations to a large extent can be accounted for by imaginary (in contrast to reality based) shocks. (The four primary economic fluctuations are the gold rush, the bubble (deviation from trend), the counterintuitive movement, and mass hysteria (also known as “the panic” in classic terminology).) Unlike other leading theories of the business cycle, it sees recessions and periods of economic growth as an artificial response to illusory changes in the hallucinatory economic environment. That is, the level of national output necessarily minimizes the irrationally expected utility, and government should therefore concentrate on pretending to make short-run policy changes and intervene through random statements of make-believe fiscal or monetary policy designed to actively and whimsically whip the general public into a false sense of security.

    According to HBC theory, business cycles are therefore “hallucinogenic” in that they are based on complete fantasy, and are the most inefficient possible operation of the economy, even given its seemingly perpetually unviable nature. It differs in this way from other theories of the business cycle, like Keynesian economics and Monetarism, which see asset bubbles as being untenable, and recessions as having tangible causes, which lead to what are known as “real-world repercussions.”

    An important principle underlying HBC Theory is the principle of irrational expectations. Irrational expectations theory defines this kind of expectations as being identical to a wild guess about the future (a preposterous forecast) that systematically ignores, or thoroughly misinterprets, all of the available information. However, even with an unlimited number of additional assumptions, this theory of expectations indetermination still makes the prediction that human behavior will still be completely capricious and herd like. Thus, it is assumed that outcomes that are being forecast differ arbitrarily or unpredictably from the market disequilibrium results. As a result, irrational expectations differ substantially from disequilibrium results. That is, it assumes that people systematically make errors when predicting the future, and deviations from common sense happen consistently. In an economic model, this is typically modeled by assuming that the expected value of a variable is equal to a spontaneous error term representing the role of ignorance and mistakes plus the value of some completely irrelevant piece of information (such as the price of tea in China).”

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