Common Sense and Macroeconomics

This WSJ article by Stephen Moore was ridiculed by Paul Krugman and David Glasner as anti-intellectual, and Noah Smith used the article in an attempt to ridicule Ed Prescott.



Moore's basic argument is that Keynesian economics does not satisfy the rules of common sense, whatever that is, and he gives some specific examples. Moore's discussion is somewhat confused. In particular, he seems to think that modern macroeconomics and Keynesian economics are synonymous. He also argues that, in analyzing unemployment insurance we should only be thinking about the incentive effects, and apparently not about why the government should be supplying the insurance, the role of UI as a transfer, or how the financing of the transfer could matter. However, it's not surprising to me that Moore is confused, and I have some sympathy for the poor guy.



Indeed, one could get the idea from reading the blogosphere that modern macro is dominated by the legacy of Keynes, when the truth is that most practicing macroeconomic researchers are not spending their time thinking about multipliers and the paradox of thrift. There are indeed ways in which Old Keynesian economics - basic Keynesian cross and IS/LM - defies common sense, i.e. the common sense that comes from standard microeconomics.



What is common sense anyway? It has to be something most of us possess, clearly. Don't put your hand in a fire. Don't cross the street without looking both ways. The latter piece of information came to me along with: Don't run out between parked cars. There were no parked cars where I lived. Everyone parked in the driveway or the garage. Therefore, that did not apply to me. Looking both ways before crossing the street must also not apply to me. When I was 8 years old, I crossed a highway without looking and was run over by a car. I have looked carefully ever since.



When I first took economics, here is what common sense was for me. It was the tail end of the hippy era and I thought that people in suits were greedy bad people out to steal from the poor. Rent control was a good thing as it took money from greedy landlords and gave it to poor apartment-renters. Wage and price controls seemed like a good way to control inflation, though I did not quite understand what it was that was inflating. And so on.



In microeconomics, my professor convinced me that a simple supply/demand apparatus determining equilibrium prices was a useful way to think about price determination, and he showed us how this apparatus could be used to make sense out of actual prices and quantities that I could observe. Greedy people could actually be getting rich and performing a useful social function. Rent controls could actually harm everyone - rich and poor - in the long run. Wage and price controls could screw up the allocation of resources in a severe way. There is no free lunch. Everything comes at a cost.



Then I took macroeconomics which, in terms of the machinery I had built up in taking micro, made little sense. If competitive equilibrium with market-clearing prices was so useful in microeconomics, why couldn't we do that in macro? What is this paradox of thrift? What's this nonsense about the multiplier free lunch? Why did I have to un-learn all the micro I had learned in order to do macro? It took another 6 or 8 years and many readings and re-readings of work by Lucas, Wallace, Prescott, and others, before everything finally made sense.



There is nothing easy, natural, obvious, or common-sensical about Keynesian economics. If you try to do it properly, or try to turn it into a story, you come up with more questions than you can answer. Why would we think that firms would shut their doors or would-be workers would remain unemployed because of an unwillingness to lower their prices and wages, respectively? Why would a firm, faced with an increase in customers, increase its output and not its price? Why would many economists, faced with phenomena that appear very un-Keynesian, and with plenty of sophisticated tools available, revert to the rustiest old contraption in the shop?