Thursday, November 17, 2011

New Monetarists, scientists or engineers?

Back in 1994, when the New Keynesian (NK) label, if not the models, were relatively new, Ball and Mankiw argued that Milton Friedman was closer to the NK approach than the New Classical (NC)/Real Business Cycle (RBC) one. For them (see here, 1994, p. 9):
"although traditionalist are often called 'new Keynesians,' this label is a misnomer. They could just as easily be called 'new monetarists.'"
The whole point was that monetarists believed in the non-neutrality of money in the short run and in sticky prices, like NKs. Now there is an explicit New Monetarist model with sticky prices here, and a growing literature surveyed by Stephen Williamson and Randall Wright here. Williamson has a blog here.

New Monetarists seem to build on ideas developed by Thomas Sargent and Neil Wallace in the early 1980s (here, for example). A simple introductory presentation is given by Champ and Freeman (here). The theoretical framework is in general based on overlapping generations models, in which monetary policy can affect relative prices and, as a result, change the intertemporal consumption, labor supply, and investment decisions of rational maximizing agents.

As Williamson says:
"Monetary policy matters due to distortions in intertemporal prices, for example the anticipation of higher money growth and higher inflation acts as a tax on labor supply and reduces output."
Not sure if he thinks that the current slow growth is to be blamed on the expansion of the money supply after the recession, and higher inflationary expectations, leading to an increase in the demand for leisure time (a reduction on labor supply, that will be taxed by the higher inflation). That would explain why he thinks that the Fed should sell bonds, and raise the interest rate (not a joke!). At any rate, the whole New Monetarist approach is fundamentally, like New Classical authors in general, concerned with microfoundations. In this case, microfoundations in the money market.

This kind of approach reminds me of another Mankiw paper on the nature of macroeconomic research. For him macro, from the Keynesian Revolution until the rise of Lucas and the New Classical school, was dominated by what he calls engineers, that is problem solvers. From Lucas on it has been dominated by scientists, meaning those that search first principles.

So the first group was concerned with empirical regularities, like Okun's Law, while the latter emphasized rational intertemporal maximizing economic agent models, like in the Ramsey model. New Monetarists are clearly in the latter camp. So are we better off with the rise of the "scientific" macroeconomists? Here is why Mankiw's paper is so important. He candidly tells us (p. 19):
"The sad truth is that the macroeconomic research of the past three decades [the 'scientific' micro-founded stuff] has had only minor impact on the practical analysis of monetary or fiscal policy. The explanation is not that economists in the policy arena are ignorant of recent developments. Quite the contrary: The staff of the Federal Reserve includes some of the best young Ph.D.’s, and the Council of Economic Advisers under both Democratic and Republican administrations draws talent from the nation’s top research universities. The fact that modern macroeconomic research is not widely used in practical policymaking is prima facie evidence that it is of little use for this purpose. The research may have been successful as a matter of science, but it has not contributed significantly to macroeconomic engineering."
No kidding, great science that has nothing to say about the reality of how to solve actual economic problems. The rise of sci-fi macroeconomists. Welcome to the Twilight Zone!

1 comment:

  1. 'Monetary policy matters due to distortions in intertemporal prices, for example the anticipation of higher money growth and higher inflation acts as a tax on labor supply and reduces output.'

    Williamson is better than a characture of mainstream economics and he shows it here. The idea that average workers anticipate high inflation due to M0 expansion is laughable in itself, but to think they would then have the inclination - and in fact, the ability - to reduce their working hours in response is simply beyond the pale.


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