Thursday, May 01, 2014

The Argument on the Left: Does the Great Recession Justify a Paradigm Shift? (Part 1)

-- Posted by Neil H. Buchanan

When I was in graduate school back in the early 1980's (yikes), a friend and I were doing what many graduate students at that time did.  We were complaining about the ridiculous turn that the economics profession had recently taken, including a fetishistic reliance on ever-more-abstract mathematics, and a narrowing of acceptable theoretical approaches to building economic models.  This was the heyday of the "rational expectations" revolution, which saw even the supposedly liberal economics departments in the U.S. insisting on hiring only young men (yes, almost exclusively men) who accepted rational-actor models, and who generally disdained anyone who criticized their models for being unrealistic.

During this particular conversation, I offered the grim idea that, one day, after a real-world catastrophe had inevitably exposed the economics profession's inherent fraudulence, there would be renewed room for people who were willing to write and talk about economic policy in realistic ways.  It might require years of working in the wilderness, I admitted, but at some point, the people who had continued to fight the good fight would be needed.

Remember, this is a conversation between two grad students who had, until they took a break to have this conversation, been trying to figure out whether a particular matrix was positive hemi-semi-definite.  (I am not making that up.)  We needed to think about something else, and we were young and naive.  Moreover, there was a basis for predicting that the future would play out in the way that I imagined it might.  After all, the Great Depression had turned the world of economics upside down, with people who had rejected Keynesian-style ideas suddenly finding Keynes to be the man of the hour.  Before long, the economics profession on both sides of the Atlantic had abandoned its pre-Depression faith in laissez-faire theory, because world events had provided a decisive repudiation of the idea that the government could do nothing to improve upon untrammeled markets.

Of course, this academic openness turned out to be short-lived.  The very success of Keynesian policies allowed the lessons of the Thirties to fade, so that by the Seventies and Eighties, pre-Keynesian policies had been repackaged as "new classical economics," and a generation of graduate students was being told that the Keynesian paradigm was "ad hoc," or "not based on deep parameters," or "insufficiently grounded in individual maximization," or whatever.  Even liberal-leaning economists started to play by the academic right's rules, so that by the Nineties we had a Democratic president -- very much at the behest of his blue chip academic advisors -- dismantling financial regulations and bragging about balancing the federal budget.

With the inevitable economic collapse having played out from 2008 onward, and with a "new normal" that looks an awful lot like long-term stagnation, it is no surprise that the people who never bought into the new classical orthodoxy now want their moment in the sun.  (I am not one of them, of course.  Because of a growing interest in interdisciplinarity that simply could not be pursued from within the confines of an economics department, I happily moved on to the legal academy.)

The debate among rival camps of left-leaning economists is now precisely about whether the Great Recession is a reason to reject the ex ante orthodoxy to which most mainstream nominal Keynesians subscribed for decades, in favor of what amounts to the academic equivalent of a shadow government that is finally ready for its close-up.  As one who has no current stake in this fight, I find the debate fascinating.

On one side is Paul Krugman and his high-prestige allies, including people like Larry Summers, Janet Yellen, and Simon Wren-Lewis.  Each of these scholars attained academic positions at the very top departments during the rise of new classicism, and Summers and Yellen have served at the top levels of Democratic administrations (with Yellen now chairing the Fed).  On the other side is a loosely defined group of people, recently given voice by the estimable Tom Palley, who is a "heterodox" economist of renown who has been doing important work for many years outside of the academic mainstream.  (One of Palley's posts is here.  Krugman's riposte is here.)

This debate is, in part, about ideas, but it is also about personnel.  That is, there are two ways for a paradigm change to happen: (1) The existing order is swept out, replaced by those who saw the truth all along, or (2) The people who got it wrong see the light, changing their ways and moving forward with important lessons learned.

On the latter point, it is worth remembering the details of the historical precedent to which I alluded earlier in this post.  John Maynard Keynes was not some mere struggling academic, suffering for his craft while waiting for his moment to arrive.  He was as much of an insider as one could possibly be, holding positions at Cambridge University and advising British politicians as a well-known man of letters.  Moreover, the people who became the leaders of Keynesianism from the 1930's onward were not a group who had been academically marginalized.  They were largely younger academics and graduate students who were adept enough to see a new way forward.  They were, however, also joined by highly placed academics who had been skeptical of Keynes prior to the Great Depression, but who used their positions at Cambridge and elsewhere to remain relevant in a Keynesian world.  (Lionel Robbins, of the London School of Economics, is an instructively complicated example.)

This point should not be underestimated.  If the hope of those on the outside of the power structure is that "our moment has come," then there is bound to be a great deal of disappointment.  (My impression of Palley specifically, by the way, is that this is NOT his belief, nor is it what appears to motivate him.)  During that long-ago conversation with my graduate school classmate, he said, "Look, even if the economy completely tanks, Larry Summers will still be an economics professor at Harvard.  And he's intellectually agile enough to try to make lemonade out of lemons (or maybe even lemons out of lemonade), even though he's currently very much embracing the dominant paradigm.  When the deluge comes, he'll come through it just fine."

To a large extent, Krugman's argument is pretty strong evidence that my friend was right.  Like Summers, Krugman made his bones in the face of the rational expectations revolution.  Being mathematically adept, Krugman was able to play within the confines of the new orthodoxy, producing work that won him the highest awards, even while sufficiently holding onto a sense of reality that allowed him to see that what he was doing was not The Only Way to Do Economics.  Krugman even mentions Yellen and Summers specifically to show that they have been open-minded about some heterodox approaches.

That at least half of the economics profession has not even reconsidered the orthodoxy is not Krugman's fault.  In fact, he has been indefatigable in upbraiding his colleagues for failing to notice simple reality.  But even if that huge bloc of dead-enders did not exist, there would still be no general changing of the guard in the economics profession.  My friend was right.  The insiders will stay inside, and everyone else can only hope that the conversation on the inside improves.

In tomorrow's post, I will return to the substantive question of whether the Great Recession should actually lead to an embrace of heterodox approaches within that conversation, or whether (per Krugman) it does no such thing.


David Ricardo said...

An excellent post here, which among other things illustrates the basis of flight of individuals such as Mr. Buchanan from formal economics study. The problem of course is not with the discipline of economics, (except for its maniacal descent into useless advanced mathematical models), but with people. There is no real debate left about the efficacy and accuracy of aggregate demand based economic theory, analysis and policy. The only questions are how much fiscal policy to apply and the most efficient policies with respect to government spending and tax reduction, efficiency being defined as policies which deliver the most bang (i.e., increases in employment and growth) for the policy buck.

The problem is that the conclusions of AD based economics and institutional study, such as

1. Increasing the monetary base will not increase inflation or stimulate the economy near the lower interest rate bound.
2. The financial system is different than other industries because of the externalities in its impact on the economy and needs to be regulated even in a laissez faire economy.
3. Deficits are beneficial during recessions.
4. A more equal distribution of income is necessary for high economic growth because it is middle income consumers whose spending drives investment.
5. Targeted government spending is more effective than tax cuts for the wealthy to stimulate the economy

result in policy that violates the ideological beliefs of conservatives. And some of these conservatives are highly educated economists who put ideology above logic and whose career ambitions for high level positions in a Republican administration cause them to spew nonsense.

And so the nation has a faith based economic policy, and the results are lower growth, higher unemployment and greater inequality of income, wealth and opportunity. We know what to do, the public and the government are just not capable of doing it.

Bob Hockett said...

Thanks for these thoughtful posts, Neil. I've a two-post response. Here is the first:

Something that I find somewhat curious in the gentlemanly debate between Krugman and Palley is the absence of any reference to Irving Fisher on the one hand, and to Keynes' view of the shape of the MPC (marginal propensity to consume) curve on the other. The reasons these absences are curious, I think, are these:

1) Fisher's account of the role of private debt buildups both in fueling credit-fueled asset price bubbles and in prolonging the debt-deflationary slumps that follow their bursting remains by far the most acute and, I think, influential account that there is. It figures very much into Minsky's, Palley's, and other 'heterodox' understandings of crisis dynamics, while also figuring prominently in much of Krugman's own popular writing on the subject. But nobody ever says whether Fisher is 'orthodox' or 'heterodox.' On the one hand, he was certainly orthodox in his time - indeed, he was and is reckoned by all who know of him as the premier American economist of the early 20th century and the founder of highly mathematized models on the American scene. On the other hand, very few people seem to mention him by name any longer, or even to know who he was. So which is he, ortho or hetero? If he's the former, then many 'post-Keynesians' might be taken to be as orthodox as Krugman or, e.g., John Geanakoplos. If he is hetero, then folk like the latter might not be quite as 'mainstream' as they or others tend to think that they are.

(A collateral curiosity in this connection is Krugman's false suggestion in the recent debate that the entirety of what we've just been through is attributable simply to shadow banking, which is not only incorrect but also inconsistent with his own appeals in other writings to Fisher's model. The latter does assign unregulated maturity transformation a critical role, but not the exclusive role or even the principal 'starring' role.)

... continued with next post ...

Bob Hockett said...

... continued from previous post ...

2) Central to the 'heterodox' economists' attention paid the role of wealth and income inequality in generating secular stagnation and financial volatility, I think, is Keynes' view of the propensity to consume's diminishing in wealth. Wealth's skewing to the top of the distribution, if Keynes' view of the MPC is correct, will tend to result in consumer demand's falling further and further short of what is necessary to absorb growing national income, hence will both (a) place limits on that growth itself, and (b) induce greater and greater investment-dependence, hence volatility-inducing financialization, in the economy. It is easy to trace this dynamic through what we have recently experienced, and so the heterodox economists can justly claim to have been unsurprised by what we have just experienced. But is Keynes' characterization of the MPC any less orthodox than was Irving Fisher? Krugman in other writings has questioned the empirical accuracy of the Keynesian MPC, but that is not to characterize the idea itself as heterodox. Indeed, as a straightforward entailment of the diminishing marginal utility of money, it would seem to be just as 'marginalist' and hence methodologically orthodox as any other proposition of 'mainstream' economics. Why, then, do Krugman and Palley not focus on this matter, as well as on how best to understand Fisher, in hopes of determining whether there ought be more 'heterodoxy' in economics classrooms?

A final point here, which I suppose I could add on as a third point of curiosity (I note this at the end as a sort of after-thought solely because it has been discussed before (especially in 2008-09):

3) Also central to the 'heterodox,' 'post-Keynesian' view of financial and then macroeconomic dysfunction, of course, is the idea of radical uncertainty, which, as we know, Keynes developed in his dissertation and later published as the Treatise on Probability. But much the *same* view figured prominently in the dissertation and, later, monograph written and published by a darling of the orthodox - Frank Knight, who took his Ph.D. here at Cornell. Insofar as the Keynes view and the Knight view on uncertainty as distinguished from risk are very close if not indeed the same, it would seem that here too the orthodox and the heterodox line up as one. So is a focus on radical uncertainty in one's model orthodox or heterodox?

I am tempted to conclude, then, that where the real differences between orthodox and heterodox lie are in respect of emphases and associated methodological nuance rather than fundamentals. And surely no one, not even Krugman, would wish to deny that where our most recent calamity is concerned, those labeled 'heterodox' did a great deal better than those labeled 'orthodox' in emphasizing the right elements and accordingly looking in the right directions.

Thanks again!


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