What Happened to the Government's Duty to Iron Out the Business Cycle?
To me it is a mystery. But Paul Krugman has some ideas:
The strange death of Keynesian policy: Instability of the Samuelsonian synthesis: So far I’ve argued that Keynesian analysis... is an excellent tool for understanding the mess we’re in. Where simple Keynesian models seem to conflict with common sense, with the wisdom of practical men, the Keynesian models are right and the wisdom of the practical men entirely wrong.
So why are we making so little use of Keynesian insights...? Why are we having to have the old arguments all over again? For it does seem as if all the old fallacies are new again. By all means let us condemn famous men. There is no excuse for the timidity of Barack Obama, the wishful thinking of Jean-Claude Trichet, and the determined ignorance of almost everyone in the Republican Party. But watching the failure... I find myself believing... that this failure has deep roots.... I now suspect that the kind of moderate economic policy regime economists in general used to support – a regime that by and large lets markets work, but in which the government is ready both to rein in excesses and fight slumps – is inherently unstable....
Let me start with the intellectual instability. The brand of economics I use in my daily work... was largely established by Paul Samuelson back in 1948.... It’s an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasises the way the economy can develop what Keynes called “magneto trouble”, requiring policy intervention.... It’s a deeply reasonable approach – but it’s also intellectually unstable. For it requires some strategic inconsistency.... When you’re doing micro, you assume rational individuals and rapidly clearing markets; when you’re doing macro, frictions and ad hoc behavioural assumptions are essential.... [E]conomists were bound to push at the dividing line between micro and macro – which in practice has meant trying to make macro more like micro.... And if the attempts to provide “microfoundations” fell short? Well, given human propensities, plus the law of diminishing disciples, it was probably inevitable that a substantial part of the economics profession would simply assume away the realities of the business cycle, because they didn’t fit the models.
The result was what I’ve called the Dark Age of macroeconomics....
To this intellectual instability, add political instability. It’s possible to be both a conservative and a Keynesian; after all, Keynes himself described his work as “moderately conservative in its implications.” But in practice, conservatives have always tended to view the assertion that government has any useful role in the economy as the thin edge of a socialist wedge.... I’ve always considered monetarism to be, in effect, an attempt to assuage conservative political prejudices without denying macroeconomic realities. What Friedman was saying was, in effect, yes, we need policy to stabilise the economy – but we can make that policy technical and largely mechanical, we can cordon it off from everything else. Just tell the central bank to stabilise M2, and aside from that, let freedom ring! When monetarism failed... it was replaced by the cult of the independent central bank.... And this worked for a while.... But this, too, was unstable. For one thing, there was bound to be a shock, sooner or later, too big for the central bankers to handle without help from broader fiscal policy. Also, sooner or later the barbarians were going to go after the monasteries too; and as the current furore over quantitative easing shows, the invading hordes have arrived.
Last but not least, there is financial instability. As I see it, the very success of central-bank-led stabilization, combined with financial deregulation – itself a by-product of the revival of free-market fundamentalism – set the stage for a crisis too big for the central bankers to handle. This is Minskyism: the long period of relative stability led to greater risk-taking, greater leverage, and, finally, a huge deleveraging shock....
So the era of the Samuelsonian synthesis was, I suspect, doomed to come to a nasty end. And the result is the wreckage we see all around us....
[S]teady upward progress was probably too much to expect, especially in a field where interests and prejudices run as strong as they do in economics. And there may yet be scope for Keynesian ideas... the crisis shows no sign of ending... the policies of what I call the pain caucus are visibly failing.... There may be another chance to return to the ideas that should have been governing policy all along. So since I’m in England, here’s my advice to economists (and policy makers) frustrated – as I am – by the inadequacy of policy responses and the intellectual regression of too much of our profession: Keep calm and carry on. History will vindicate your persistence.
