Economics: Old and Older

In a piece in Project Syndicate, that left wing blog which seems to be a watering hole for economists and others espousing their political versions of reality, springs forth a defense of the economics, both old and older.

Skidelsky, a defender of Keynes and other left leaning purveyors of the art of economics states:

A decade ago, two schools of macroeconomists contended for primacy: the New Classical – or the “freshwater” – School, descended from Milton Friedman and Robert Lucas and headquartered at the University of Chicago, and the New Keynesian, or “saltwater,” School, descended from John Maynard Keynes, and based at MIT and Harvard. Freshwater-types believed that budgets deficits were always bad, whereas the saltwater camp believed that deficits were beneficial in a slump. Krugman is a New Keynesian, and his essay was intended to show that the Great Recession vindicated standard New Keynesian models.But there are serious problems with Krugman’s narrative. For starters, there is his answer to Queen Elizabeth II’s now-famous question: “Why did no one see it coming?” Krugman’s cheerful response is that the New Keynesians were looking the other way. Theirs was a failure not of theory, but of “data collection.” They had “overlooked” crucial institutional changes in the financial system. While this was regrettable, it raised no “deep conceptual issue” – that is, it didn’t demand that they reconsider their theory.

 I believe there was and is a fundamental problem. Economics works best when looking backward. It fails almost continuously looking forwards. It can collect and analyze existing facts, yet it cannot use the facts in any predictive manner. Take the classic example of unemployment as predicted by Romer. She said we would drop to 5% in just a short while. It took nine years. Did unemployment eventually get there? Yes, but time is as important as the end point. 

The Government under the last Administration threw ten trillion dollars at the problem, doubling the debt, and far exceeding anything that FDR ever contemplated. But when did the stock market respond, after a new Administration came. Was it in response to any new policy, perhaps.

Skidelsky continues:

Krugman comes close to acknowledging this: New Keynesians, he writes, “start with rational behavior and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges.” Such tweaks enable New Keynesian models to generate temporary real effects from nominal shocks, and thus justify quite radical intervention in times of emergency. But no tweaks can create a strong enough case to justify sustained interventionist policy. The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times. Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved. They regard the financial sector as neutral, not as fundamental (capitalism’s “ephor,” as Joseph Schumpeter put it).

Tweaking is what you do when the theory and data do now comport. Macro-economists should admit that their  theories are pure speculation. Inherent in the macro world are the effects of externalities that all too often dominate the result. Radical uncertainties are pandemic in the current world environment. That demands leadership not economics.