I posted Cochrane’s response to Krugman last week and in the interim this site has become the link to source. I tried to be as neutral in the posting as possible, but some may have interpreted as implicit support for Cochrane’s position. This is not the case. Indeed, at the time I wasn’t sure how I felt about either piece. Here are my thoughts as of now.
Tone
Krugman’s piece was, well, Krugman. A little abrasive and not particularly charitable to his adversaries, but smart and well reasoned nonetheless. Cochrane’s response, seemed to me, a bit out of scale to what Krugman wrote in the NYT Magazine. Now, if you’ve been following Krugman you know he has said much worse about those associated with Freshwater Macro.
Undoubtedly, this history of antagonization influenced Cochrane’s tone. Still, it felt like an escalation and that is unfortunate. I realize that this could be read as “rewarding” Krugman for being consistently rough around the edges. Its like Krugman’s caricatures don’t count because he’s always painting the other side in a bad light.
From the point of view of encouraging a civil discourse, however, I think that’s the correct approach. There are economist specific fixed effects. And, economists who are consistently abrasive already suffer an implicit discounting of their statements. Krugman often complains that he will never be forgiven for being “right too soon” about George Bush. This is probably correct and is simply another way of saying he will never escape the implicit discounting associated with his style.
Substance
Beginning with Eugene Fama’s post arguing that the stimulus could not work because it violated basic adding up constraints I have been deeply puzzled. The probability that I understand macro on a deeper level than Fama or Cochrane is low. Yet, it seems to me that basic error is being made. Fama and Cochrane appear to either be assuming that prices adjust seamlessly throughout the entire economy or that increases in the demand for money do not reduce the total quantity of transactions. Both of these seem to be naive assumptions.
However, given our premise, that it is unlikely I understand something Fama and Cochrane do not, the logical conclusion is that I am missing something about their argument. Yet, when I look at how the crisis unfolded I am struck by how well the basic model I was working with performed.
In the spring of 2008, I told my graduate seminar class that if we had not already had the Great Depression that it would be starting now. Luckily I noted, we had learned many of the lessons and Ben Bernanke would not allow a general failure of the financial system if it could be avoided.
In the days after Lehman’s fail, just over one year ago, I wrote a letter to my colleagues in the School of Government telling them we were walking a fine line. The money market appeared to be shutting down and there was a non-trivial chance that Western Capitalism was about to collapse. This, I felt, could almost certainly be avoided but we should not delude ourselves about the risks we faced.
In October of 2008 I advised North Carolina officials that they were about to see an unprecedented drop in retail sales and that this would lead to massive losses in sales tax revenue. Credit was being cut and households who were spending more than they took in were going to have adjust rapidly.
All of these things seemed to be confirmed by events and they were all based on a vulgar New Keynesian model of the economy with a special role for the financial sector. I didn’t think any of these forecasts were particularly prescient. Indeed, I thought I was simply translating the conventional wisdom. Apparently not.
Cochrane argues that economists should not have been able to predict this crash. However, it seems to me that much of it was predicted. Zingales and others have argued that the panic which gripped the Fed and Treasury actually precipitated the worst of the crisis. Academically I can’t rule this out.
There is a basic identification problem here. If one side thinks that panicking causes crises and the other thinks that foreseeing a crisis causes panic there might not be a lot we can do to sort this out, save for the type of randomized experiments we could never justify actually performing on real economies.
In short, what puzzles me is how different the views of esteemed economists were from a pedestrian analysis. If they are right why did things happen the way I and others thought they would happen? Were we just lucky? If we are right, how is it that Fama and Cochrane are missing basic points about the economy?
11 comments
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Monday ~ September 21st, 2009 at 9:29 am
malcolm
Of course Cochrane “knows” macroeconomics. He just chooses to believe
that the underlying assumptions of his models make sense. It’s his beliefs
you should question and not what he “knows.” His priors, however, appear to be unaffected by a dose of reality.
Monday ~ September 21st, 2009 at 10:01 am
prufrock
I would not disregard the hypothesis that the “freshwater” economists you mentioned are so out of touch because they are stupid. I mean, they behave “as if” they are stupid. In the end if your research program is clueless and badly formed since the beginning but nobody was able to show this to you – maybe you were not so prone to hear, maybe nobody was so interested in plain science rather than propaganda – it could definetely be that you end with nothing but rubbish. Sophisticated modeled rubbish.
Monday ~ September 21st, 2009 at 11:24 am
Brad DeLong
Karl–
Cochrane’s tone is not an escalation. He–and others–have been at this pitch for quite a while.
For example: John Cochrane: “[That spending can spur the economy] is not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false…” Robert Lucas: “Christina Romer–here’s what I think happened. It’s her first day on the job and somebody says, you’ve got to come up with a solution to this–in defense of this fiscal stimulus, which no one told her what it was going to be…. [I]t’s a very naked rationalization for policies that were already, you know, decided on for other reasons…” Edward Prescott: “I don’t know why Obama said all economists agree on [the need for a stimulus bill]. They don’t. If you go down to the third-tier schools, yes, but they’re not the people advancing the science…” Eugene Fama of the University of Chicago: “Sorry, but I’m not familiar with [Hyman] Minsky’s work…” Luigi Zingales: “Keynesianism has conquered the hearts and minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behaviour…. They tell politicians, who are addicted to spending our money, that government expenditures are good…. In medicine, such behaviour would get you expelled from the medical profession; in economics, it gives you a job in Washington…” Michele Boldrin: “It is a fantasy that the economic profession at large finds the “stimulus” and the “bank bailout” plans sensible and adequate…. Outside the administration, the convinced supporters of the plans are a small minority among academic economists working in those fields. Both plans contradict four decades of research and are designed to please special interest groups…”
It’s the combination of extraordinary venom with… what by now I can only regard as extraordinary ignorance that truly frightens me.
And, yes, I think you do understand macro issues at a deeper level than Cochrane and Fama. It really does look like they think we are in an economy with a rigid cash-in-advance constraint and a technologically-determined velocity. That’s the only way I can find to make any sense at all of Fama’s manipulations of the savings-investment identity, and of Cochrane’s claim that it is logically inconsistent for a model to have people on aggregate trying to run down their real money balances.
And, yes, these issues were settled by the time of Irving Fisher.
Now venom I could understand–these are important issues that affect lots of people’s lives, and worth caring deeply about. Ignorance I could understand–the quantity theory of money is not an obvious and transparent beast. It’s the combination that is scary.
Tuesday ~ May 28th, 2013 at 2:13 am
djb
I mean savings = investment is a macro idea discovered by Keynes
Monday ~ September 21st, 2009 at 2:03 pm
Robert Waldmann
I think your understanding is defintely superior to that expressed by Fama and Cochrane. How can this be ? Well first Cochrane and especially Fama work in finance not macro. Second people often say things and post them on blogs without thinking them through. Third they both think that Keynes was obviously wrong and made elementary mistakes, and that this is well know. Fourth if people say something publicly without thinking, it is very unpleasant to take it back. Once a claim is public, people will stick to it out of pride even if they should be able to see that it is total nonsense.
So off the tops of their heads, they might make silly arguments about macro. They might not worry that the arguments are obvious and inconsistent with the views of Keynes and Keynesians, because they have the sense that it has been proven that Keynes etc were obviously wrong. Now their claims are obviously false as has been proven many times. Since there claims are about what must be, they are claims in mathematics and can be proven false.
Now you are suprised that Fama and Cochrane insist that they were right. I ask you, has either Fama or Cochrane ever admitted that they weren’t right ? Ever ? I ask for information. I can’t think of any occasion.
I also admit that, off the top of my head, I can’t think of any conclusion they have ever reached which didn’t seem to be obviously wrong to me or any case in which further thought and evidence has caused me to change my evaluation.
Monday ~ September 21st, 2009 at 2:40 pm
Karl Smith Is Somewhat Bewildered by the State of Modern Macro | Bailout and Financial Crisis News
[…] Krugman vs. Cochrane « Modeled Behavior: I posted Cochrane’s response to Krugman…. I tried to be as neutral in the posting as possible, but some may have interpreted as implicit support for Cochrane’s position. This is not the case. Indeed, at the time I wasn’t sure how I felt about either piece. Here are my thoughts as of now. […]
Monday ~ September 21st, 2009 at 2:53 pm
E
I dont know those predictions sound pretty general, especially since there was still ample opportunity for individuals and institutions to hedge risk after you made them. In early September forward volatility was priced in the low 20s for the S&P, if crude Keynesian theory predicted a crash you would think more people would protect themselves. Off the top of my head I also wonder about the Romer-Bernstein unemployment predictions. Im not an economist so im doing this quick and dirty but if the natural rate of unemployment is 5% and they predicted 8% (I think) and now we’re at about 10% then they underestimated the shock by about 40%. Obviously theres a lot of uncertainty in predicting unemployment but what strikes me is that the equity markets are up by 25-50% since then. Its hard for me to imagine a lot of precision in anyone’s models when such respected economists substantially underestimate the damage and the market rockets upwards. Maybe I’m missing something but it seems like a lot of economists sprayed out a bunch of predictions or vague magnitude and then give themselves credit for the ones that look best.
Tuesday ~ September 22nd, 2009 at 8:53 pm
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Tuesday ~ May 28th, 2013 at 2:09 am
djb
These guys have been bashing Krugman and Keynes for years….. then when you fight back they get all offended