Lucas and Krugman

I thought that this post by Paul Krugman required a response. It's related to a Lucas interview in the WSJ which, if nothing else, tells you why Krugman's assertions about the "moral failure" of non-Keynesian macroeconomists are absurd.

Krugman's blog post mainly tells us that his deficit in macro-knowledge persists. First, Krugman appears to think that Lucas's only contribution to 20th-century macroeconomics was "Expectations and the Neutrality of Money," in particular the signal-extraction money-surprise story about the non-neutrality of money. Then, Krugman states:

In the 1980s, the Lucas project failed — pure and simple. It became obvious that recessions last too long, and there are too many sources of information, for rational confusion to explain business cycles. Nice try, with a lot of clever modeling, but it just didn’t work.

Money surprises were a tiny part of the "Lucas project." While I think a widely-held view now is that the money-surprise mechanism is unimportant in explaining aggregate fluctuations, the lasting contribution from "Expectations and the Neutrality of Money" is a methodological one. And that methodological contribution is not only the use of rational expectations in a general equilibrium context - very useful in itself - but the use of explicit and consistent economic theory in a macroeconomic context. Further, the "Lucas project" also involved pathbreaking work in asset pricing, monetary economics, economic growth, and dynamic contracts under private information, among other things. Some failure!

Krugman seems to like New Keynesian economics, but:

I find NK economics useful, if only as a way to check my logic, although it’s not really clear if it’s any better than old-fashioned Keynesianism.

Judging from the output, I'm not sure there are any serious checks on Krugman's logic, but we'll give him the benefit of the doubt and assume that he actually grinds through Eggertsson and Krugman whenever he writes a blog post. However, if we take "old-fashioned Keynesianism" to be what is in the General Theory, or in an IS-LM model, then it is hard to argue that Woodford-style New Keynesian economics does not dominate. In its explicit form, New Keynesian economics in fact adheres to the "Lucas project." You can see exactly what is going on - there are optimizing agents, explicit preferences, endowments, and technology, and a well-defined equilibrium concept, in a dynamic context. The General Theory is close to impossible to decipher, and IS-LM is static, with a load of hidden assumptions.

Krugman does not like Prescott economics, and thinks that was a failure too. And he states:

But the math was impressive, and RBC became a self-contained, self-replicating intellectual world.

This is quite a mischaracterization, as RBC was ultimately neither self-contained, nor self-replicating. People built on the basic neoclassical growth model in work in monetary economics, economic growth, optimal taxation, commitment to economic policy, heterogeneous-agent incomplete markets models, etc. Indeed, New Keynesian economics, which is Krugman's logic-checker, evolved directly from RBC models - basic Woodford is RBC + Dixit-Stiglitz + Calvo pricing.

Krugman finishes with this:

But the descendants of the Lucas project know that Keynes was wrong — it’s what their teachers and their teachers’ teachers have been saying all these years. They cannot accept anything resembling a Keynesian explanation without devaluing everything they’ve done with their intellectual lives.

Actually, the descendants of the "Lucas project" are serious economic scientists, who would not say anything so outlandish as "Keynes was wrong." I think modern macroeconomists in general think of Keynesian economics as a small part of macroeconomics - just another friction. Whether Keynesian ideas are useful or not is an open question. There are many holes in Keynesian economics that need to be filled before serious macroeconomists can in fact take Keynesianism seriously. But I don't think anyone finds Keynes threatening. That's just silly.