links for 2010-06-28
A Week in Which the Ten Year Bond Rate Drops Below 3% Is Not a Week to Call for Austerity...

The Basic Story of "Modern" Macroeconomics as a Failed Research Program

Paul Krugman:

Learned Helplessness In Macro: the basic story of “modern” macro runs like this:

  1. Lucas and his disciples agree that the economy looks Keynesian — that is, it surely looks as if monetary and fiscal policy have real effects — but argue that an equilibrium approach with imperfect information can explain why, while rejecting Keynesian policy implications. And they ridicule Keynesian economics.

  2. By 1980 — three decades ago! — it is already clear that the Lucas project has failed. Equilibrium models with imperfect information cannot, in fact, explain key facts about business cycles, especially the way recessions persist even though everyone knows that they’re in a recession.

  3. Rather than admitting that they went down the wrong track, however, the advocates of freshwater macro double down; they decide to forget about what they used to know about the apparent effects of demand shocks, and explain the business cycle in terms of real shocks.

  4. This approach also falls short; in an attempt to rescue the models, ever more epicycles are added, and whatever clarity may once have existed gets lost.

  5. Freshwater economists declare that the business cycle is deeply puzzling, and that we need much more research before we can make policy recommendations.

In short, what we’re looking at is learned helplessness. Economists who didn’t go down this path, who didn’t flush everything the profession had learned between 1936 and 1973 down the memory hole, aren’t especially baffled by the situation we’re in now; on the contrary, it looks like an extreme version of a fairly familiar event, and policy recommendations aren’t hard to make.

It’s only if you’re committed to a failed research project — a project that failed a generation ago, but refused to admit it — that you’re baffled.