Economic Nonsense

In 1991, Paul Krugman published "Increasing Returns and Economic Geography," which the Nobel Prize committee cited in 2008 in support of Krugman's Nobel Prize in Economics. The paper is basically an exercise in normal economics. There are optimizing consumers and firms; there is a Dixit-Stiglitz monopolistic competition structure; there is an equilibrium in which prices adjust to equate quantities supplied and demanded in each market. If Krugman had submitted the paper for the 1991 SED meetings, I'm sure he would have been on the program, in spite of the absence of dynamics in the model. Indeed, no one would have had a problem calling Krugman's work macroeconomics - it fits well within the set of what modern macroeconomists like to think about.

Fast forward to 2012, and we all know what Krugman stands for, and he's been even more vociferous about these things over the last week or so than usual. One of his blog posts was this one, which is his response to some policy discussion in Britain about the state of macroeconomics. Part of what is in that piece, and other recent ones, is the argument - which we have heard from Krugman many times before, and will likely hear ad infinitum - is that the Hicksian IS-LM model is "spectacularly successful." I don't know whether to laugh or cry when I read things like that. How could anyone think of that crude tool as a success in this context? What could Krugman be thinking? Does the IS-LM model tell us what a financial crisis is, and what the policy response to such an event should be? Does it tell us what quantitative easing does? Does it tell us the extent of inefficiency in the US economy that monetary or fiscal policy might correct? Does it help us understand sovereign debt problems? Does it help us understand how to regulate the financial system? Of course not! Get a life, Krugman!

Krugman asks:

So why the sense that macroeconomics is a mess?

The answer to that question is, of course, that Krugman is doing a great job of propagating the fiction that it's a mess. But it's not. When I went from session to session at the recent SED meetings, I got the sense of a group of productive, young (for the most part), and thoughtful macroeconomists, working on, and making progress in understanding, the key economic problems of our time. Here's an example. In the Friday, 4-6 PM session on Macro/Labor, there are a couple of papers - one by Violante and coauthors, and the other by Alvarez/Shimer. The Violante paper makes some progress in defining what "mismatch" is, and measuring the extent of it. The Alvarez/Shimer paper is a study of how human capital accumulation matters for unemployment in the context of sectoral realloaction. Both papers are highly topical and teach us something about what is going on currently in the US economy.

The first key point is that macroeconomists are not in disarray. They are pursuing their research programs in a sound and coherent fashion, debating the issues, and making progress.

In case you were concerned about Krugman's focus on modern macroeconomists, he doesn't have much use for theorists either:

The other thing I’d like to say is that the notion that microeconomics is in much better shape is questionable, to say the least. I mean, it’s not as if the assumptions underlying standard micro theory are, you know, true – utility maximization? Really? Micro is consistent in a way macro is not, but for the most part it’s best viewed as a metaphor that’s helpful as long as you don’t take it too seriously.

The truthiness of utility maximization? I know I have to explain that to an Econ 101 student, but not to Paul Krugman. The first thing Krugman does in laying out the model, on page 488 of this paper is to specify a utility function, which is the objective function for all the individuals in Krugman's fictitious environment. Apparently he didn't feel the need to footnote that, and make excuses for, you know, the lack of truthiness.

The second key point is that modern "macroeconomists" do not actually think of themselves as different from "micreconomists." It's all economics, using the same set of tools - the tools that the 1991 Krugman could use to great effect.

Now, after insulting most of the economics profession, Krugman would like us all to sign on to his Manifesto for Economic Sense. For the most part, I think monetary policymakers do a good job of absorbing economic research and applying the ideas. For example, the FOMC is not perfect, but there are some good minds in the room when the committee meets. Fiscal policy leaves a lot to be desired. But injecting a dose of Krugmanite IS-LM into the mix is not going to help. I don't know about you, but I'm not signing up.