Liveblogging World War II: December 31, 1944: Bulge
Morning Must-Read: Duncan Black: Does Anybody Remember MOOCs?

Nighttime Must-Read: Paul Krugman: The Volcker Disinflation

Wingnuts gotta nut. And Krugmans gotta Krug. I score this for Krugman, 6-0, 6-0, 6-0:

Paul Krugman: Keynesians and the Volcker Disinflation: "Right-wing economists like Stephen Moore and John Cochrane--it’s becoming ever harder to tell the difference--have some curious beliefs....

... One... is that the experience of disinflation in the 1980s was a huge shock to Keynesians, refuting everything they believed. What makes this belief curious is that it’s the exact opposite of the truth. Keynesians came into the Volcker disinflation... with a standard... model.... And events matched.... Cutting inflation would require a temporary surge in unemployment. Eventually, however, unemployment could come back down to more or less its original level; this temporary surge in unemployment would deliver a permanent reduction in the inflation rate, because it would change expectations.... [That's] what the Volcker disinflation actually looked like.... It was the other side of the macro divide that was left scrambling for answers. The models Chicago was promoting in the 1970s, based on the work of Robert Lucas and company, said that unemployment should have come down quickly.... Those models were unsustainable in the face of the data. But... most of those guys went into real business cycle theory--basically, denying that the Fed had anything to do with recessions. And from there they just kept digging ever deeper into the rabbit hole...

The lessons everyone serious who does forecasting drew from the Volcker Disinflation were three:

  1. Talk is cheap, and so credibility is hard to establish. Shifting expectations rapidly and substantially requires real policy régime change--which is much more than just announcing: "this time we really are serious!"

  2. As a consequence, expectations in the real world are going to be either anchored or adaptive in the absence of real policy régime change.

  3. The adaptive-expectations Phillips Curve is relatively flat: you need big shifts in unemployment to reliably generate small shifts in current inflation.

Lucas drew a different set of lessons from the Volcker Disinflation et sequelae:

The main finding that emerged from the research of the 1970s is that anticipated changes in money growth... are not associated with the kind of stimulus to employment and production that Hume described.... The importance of this distinction between anticipated and unanticipated monetary changes is an implication of every one of the many different models, all using rational expectations, that were developed during the 1970s to account for short-term trade-offs.... The discovery of the central role of the distinction between anticipated and unanticipated money shocks resulted from the attempts... to formulate mathematically explicit models... addressing the issues raised by Hume. But... none of the specific models... can now be viewed as a satisfactory theory of business cycles.... Much recent research has followed the lead of Kydland and Prescott (1982) and emphasized the effects of purely real forces on employment and production...

Whenever I read this, I can only think that Lucas uses "finding", "are", and "discovery" in a manner of which Inigo Montoya would disapprove.

Lucas seems to say that rational-expectations monetary models of the business cycle had their chance, failed, and so it is time to move on to rational-expectations real models of the business cycle in which recessions come about because of engineers' losses of knowledge how to produce things efficiently--the Great Forgetting theory--of workers' reduced desire to work--the Great Vacation theory--or of a sudden increase in the depreciation rate on capital--the Great Rusting theory.

Moving backward, and dropping the straitjacket of the rational-expectations representative-agent framework was just not considered.