Friday, October 13, 2017

Rethinking Macroeconomic Policy

I had the pleasure of attending “Rethinking Macroeconomic Policy IV” at the Peterson Institute for International Economics. I highly recommend viewing the panels and materials online.

The two-day conference left me wondering what it actually means to “rethink” macro. The conference title refers to rethinking macroeconomic policy, not macroeconomic research or analysis, but of course these are related. Adam Posen’s opening remarks expressed dissatisfaction with DSGE models, VARs, and the like, and these sentiments were occasionally echoed in the other panels in the context of the potentially large role of nonlinearities in economic dynamics. Then, in the opening session, Olivier Blanchard talked about whether we need a “revolution” or “evolution” in macroeconomic thought. He leans toward the latter, while his coauthor Larry Summers leans toward the former. But what could either of these look like? How could we replace or transform the existing modes of analysis?

I looked back on the materials from Rethinking Macroeconomic Policy of 2010. Many of the policy challenges discussed at that conference are still among the biggest challenges today. For example, low inflation and low nominal interest rates limit the scope of monetary policy in recessions. In 2010, raising the inflation target and strengthening automatic fiscal stabilizers were both suggested as possible policy solutions meriting further research and discussion. Inflation and nominal rates are still very low seven years later, and higher inflation targets and stronger automatic stabilizers are still discussed, but what I don’t see is a serious proposal for change in the way we evaluate these policy proposals.

Plenty of papers use basically standard macro models and simulations to quantify the costs and benefits of raising the inflation target. Should we care? Should we discard them and rely solely on intuition? I’d say: probably yes, and probably no. Will we (academics and think tankers) ever feel confident enough in these results to make a real policy change? Maybe, but then it might not be up to us.

Ben Bernanke raised probably the most specific and novel policy idea of the conference, a monetary policy framework that would resemble a hybrid of inflation targeting and price level targeting. In normal times, the central bank would have a 2% inflation target. At the zero lower bound, the central bank would allow inflation to rise above the 2% target until inflation over the duration of the ZLB episode averaged 2%. He suggested that this framework would have some of the benefits of a higher inflation target and of price level targeting without some of the associated costs. Inflation would average 2%, so distortions from higher inflation associated with a 4% target would be avoided. The possibly adverse credibility costs of switching to a higher target would also be minimized. The policy would provide the usual benefits of history-dependence associated with price level targeting, without the problems that this poses when there are oil shocks.

It’s an exciting idea, and intuitively really appealing to me. But how should the Fed ever decide whether or not to implement it? Bernanke mentioned that economists at the Board are working on simulations of this policy. I would guess that these simulations involve many of the assumptions and linearizations that rethinking types love to demonize. So again: Should we care? Should we rely solely on intuition and verbal reasoning? What else is there?

Later, Jason Furman presented a paper titled, “Should policymakers care whether inequality is helpful or harmful for growth?” He discussed some examples of evaluating tradeoffs between output and distribution in toy models of tax reform. He begins with the Mankiw and Weinzierl (2006) example of a 10 percent reduction in labor taxes paid for by a lump-sum tax. In a Ramsey model with a representative agent, this policy change would raise output by 1 percent. Replacing the representative agent with agents with the actual 2010 distribution of U.S. incomes, only 46 percent of households would see their after-tax income increase and 41 percent would see their welfare increase. More generally, he claims that “the growth effects of tax changes are about an order of magnitude smaller than the distributional effects of tax changes—and the disparity between the welfare and distribution effects is even larger” (14). He concludes:
“a welfarist analyzing tax policies that entail tradeoffs between efficiency and equity would not be far off in just looking at static distribution tables and ignoring any dynamic effects altogether. This is true for just about any social welfare function that places a greater weight on absolute gains for households at the bottom than at the top. Under such an approach policymaking could still be done under a lexicographic process—so two tax plans with the same distribution would be evaluated on the basis of whichever had higher growth rates…but in this case growth would be the last consideration, not the first” (16).

As Posen then pointed out, Furman’s paper and his discussants largely ignored the discussions of macroeconomic stabilization and business cycles that dominated the previous sessions on monetary and fiscal policy. The panelists acceded that recessions, and hysteresis in unemployment, can exacerbate economic disparities. But the fact that stabilization policy was so disconnected from the initial discussion of inequality and growth shows just how much rethinking still has not occurred.

In 1987, Robert Lucas calculated that the welfare costs of business cycles are minimal. In some sense, we have “rethought” this finding. We know that it is built on assumptions of a representative agent and no hysteresis, among other things. And given the emphasis in the fiscal and monetary policy sessions on avoiding or minimizing business cycle fluctuations, clearly we believe that the costs of business cycle fluctuations are in fact quite large. I doubt many economists would agree with the statement that “the welfare costs of business cycles are minimal.” Yet, the public finance literature, even as presented at a conference on rethinking macroeconomic policy, still evaluates welfare effects of policy using models that totally omit business cycle fluctuations, because, within those models, such fluctuations hardly matter for welfare. If we believe that the models are “wrong” in their implications for the welfare effects of fluctuations, why are we willing to take their implications for the welfare effects of tax policies at face value?

I don’t have a good alternative—but if there is a Rethinking Macroeconomic Policy V, I hope some will be suggested. The fact that the conference speakers are so distinguished is both an upside and a downside. They have the greatest understanding of our current models and policies, and in many cases were central to developing them. They can rethink, because they have already thought, and moreover, they have large influence and loud platforms. But they are also quite invested in the status quo, for all they might criticize it, in a way that may prevent really radical rethinking (if it is really needed, which I’m not yet convinced of). (A more minor personal downside is that I was asked multiple times whether I was an intern.)

If there is a Rethinking Macroeconomic Policy V, I also hope that there will be a session on teaching and training. The real rethinking is going to come from the next generations of economists. How do we help them learn and benefit from the current state of economic knowledge without being constrained by it? This session could also touch on continuing education for current economists. What kinds of skills should we be trying to develop now? What interdisciplinary overtures should we be making?


  1. So, a conference supposedly open minded about rethinking macro, which has zero Post-Keynesians presenting about MMT, which is an already extant rethinking of macro which has clear explanations and solutions for all of the issues under discussion...

    Goes to show you that economics is still a religion for most of these morons, and not anything even approaching a science. That they wouldn't invite a Post-Keynesian presenter, even if just to repudiate their views in a public forum, is pathetic.

  2. Not interested in watching these idiots babble at all. The answers are already clearly explained by MMT. They are wasting everyone's time trying to protect their pathetic reputations, while destroying potential wealth every day by holding to these absurdly empirically untenable positions. - Owen

  3. It's obvious why they are so averse to considering MMT... it's been around for decades, so giving it any credence requires admitting that as "leaders" in economics they have been stupid enough to catastrophically mislead economic policymakers even though real scientists have been trying to get through to them since at least 1993, when MMT became clearly established (although precursors existed long before). It's not as though hundreds of economists do not support Post-Keynesian perspectives and MMT, they even have their own journal, the RWER... they just get categorically ignored because these bigwigs have their reputation on the line. It's very very sad.


  5. Forget this target fussing
    And this expectations paralysis
    Let's find out

    Just what happens when we push back down into
    The UE zone originally called maximum employment
    Want to keep up the climb back to so called neutral policy setting for the short safe rate ?


    Use fiscal deficit thrust
    Now both Blanchard and summers admit debt burdens are manageable long run

    Go for it !

    What's the down side ?

    Unless you believe in a vicious non linear surprise wage rate explosion awaiting us down there..somewhere

  6. The bogs author I guess has moved on to another summit of the notables of macro
    No time to consider

    Just go for it !
    Using fiscal injectors to plumb the darkness beneath the play it safe zone

    Thesis :

    A tacit wage rate path target
    with the steepest ....sustainable ....Climbing rate
    Is the overt policy objective
    of a pro job class (wage earne based )
    Macro policy package

    Maybe we can't be. Explicit about this
    And use an up front
    wage rate path target
    But at least we can explore what such a target entails
    And how to proxy it with acceptable "cover targets "

    The analogy to finding and covering
    Sustainable "wage rate repression " macro policies
    Widely in use today around the global by CBs
    Is too obvious to need demonstration
    Beyond a mere pointed index finger

  7. This should have been the first comment

    Very fine post

    You are part of the new generation


    Don't pull your punches

    New Policy however motivated
    often creates the pre conditions for building or at least
    Validating new better models

    And yes deeply considered intuition
    till both empirically contradicted
    And formally refuted
    Is the Best guide to new policy
    It's rare a new model discovers a new policy path

  8. When non-thinkers rethink
    Comment on Carola Binder on ‘Rethinking Macroeconomic Policy’

    This is the track record of economics: provably false
    • profit theory, since 200+ years,
    • Walrasian microfoundations (including equilibrium), since 140+ years,
    • Keynesian macrofoundations (including I=S, IS-LM), since 80+ years.

    The four main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, materially/formally inconsistent and all got the foundational concept profit wrong.#1

    Economics is a failed science or what Feynman called a cargo cult science: “They’re doing everything right. The form is perfect. ... But it doesn’t work. ... So I call these things cargo cult science, because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential.”

    What is entirely missing among economists is scientific competence. The familiar research programs have produced nothing but proto-scientific rubbish but neither orthodox nor heterodox economists have any clue of how to get out of the mess: “There is another alternative: to formulate a completely new research program and conceptual approach. As we have seen, this is often spoken of, but there is still no indication of what it might mean.” (Ingrao et al.)

    This is why rethinking-this-and-that-and-everything is all the rage.#2 It cannot produce anything worthwhile for obvious reasons. Those economists who in their Econ101 youth unthinkingly swallowed supply-demand-equilibrium, which is one the worst proto-scientific idiocies of all time, are in NO position to perform the necessary paradigm shift: “A new idea is extremely difficult to think of. It takes a fantastic imagination.” (Feynman)#3

    Carola Binder maintains: “The fact that the conference speakers are so distinguished is both an upside and a downside. They have the greatest understanding of our current models and policies, and in many cases were central to developing them. They can rethink, because they have already thought, and moreover, they have large influence and loud platforms. But they are also quite invested in the status quo, for all they might criticize it, in a way that may prevent really radical rethinking (if it is really needed, which I’m not yet convinced of).”

    Obviously, Carola Binder is still in a hallucinatory state. The only thing the Blanchard’s and Summers’ and Bernanke’s and the rest of the rethinking-macro crowd can do for the advancement of economics is to get out of the way.

    Egmont Kakarot-Handtke

    #1 Where modern macroeconomics went wrong

    #2 New Economic Thinking, or, let’s put lipstick on the dead pig

    #3 Fact of life: your econ prof is scientifically incompetent

  9. I would have included “helicopter money” on the agenda. Prof Simon Wren-Lewis at Oxford has been writing about it. I feel certain that helicopter money will be on the agenda one day.

    Cheers, Kien

  10. Please continue this great work and I look forward to more of your awesome blog posts. Trade

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