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Econ 210a: Spring 2011: January 19, 12-1: Why We Study Economic History

Econ 210a: Spring 2011: January 19, 12-1: Why We Study Economic History:

The four required articles for "Why We Study Economic History" together make up a morality play. The hope is that you will read them and thereafter swear to pay a great deal of attention to the history of the economy and of what economists have said lest you wind up like, well, like Eugene Fama--a very smart guy trying to think important issues through over a weekend and getting them wrong.

R.G. Hawtrey's 1925 Economica article is two things. First, it is a piece of analytical backing for the British Treasury's early interwar position that expansionary fiscal policy had no role at all to play in dealing with Britain's interwar high unemployment problem. Second, it is an attempt to do the macroeconomics of nominal (and real) spending determination without thinking hard enough about what the determinants of money demand are. Hawtrey believes that spending is proportional to money-holdings without there being any systematic relationship between (a) the predictability of an organization's spending and the money holdings wanted to back £1 of annual spending flow, or (b) the short-term opportunity cost of holding money and the money holdings wanted to back £1 of annual spending flow. Hawtrey, however, we can excuse: he is one of the first people to try to think these issues through systematically.

John Hicks's 1937 Econometrica paper is there to show how Hawtrey ought to have done his analysis: Hicks does nominal spending determination in a three-good model--money, bonds, and currently-produced commodities--and does it correctly. Second,

These papers are on the reading list to set you up for Eugene Fama's 2009 weblog post, which is also two things. First, it is an attempted political intervention into the debate about the proper shape of macroeconomic policy in early 2009. Second, it is howlingly, stunningly, appallingly wrong. As best as I can see, Eugene Fama believes not just that changes in government purchases cannot alter nominal GDP, but that nothing can alter nominal GDP. There is nothing in his model that distinguishes the government from any other entity, and thus by the time he has gotten to the end of his argument he has proved to his satisfaction that the flow of nominal spending through the economy must be at all times invariant to everything.

The fascinating thing from my perspective is not that Fama is dumb: he is not dumb--far from it. But in this piece he appears to be not very... wise, not very... well-read, not very... curious about the world. It is impossible for anybody who had ever read Hawtrey and Hicks and remembered anything at all from them to ever make the basic analytical mistake that Fama makes. And it is impossible for anybody who has looked at nominal spending over any time period to advance a model in which nominal spending is invariant to everything without immediately concluding that something would be very wrong.

And these three papers then set you up for Paul Krugman's diagnosis--a controversial diagnosis--about why economists did so badly at recognizing the vulnerabilities that were going to produce our current macroeconomic downturn and then advising governments on how to deal with it.

Last on the reading list for "Why We Should Study Economic History" are the two optional articles: R.M. Solow's and D.N. McCloskey's briefs for how taking economic history seriously innoculates you against the kinds of errors exhibited by Fama and chronicled by Krugman.