Noah Smith on heterodox models

As it is often the case when you've been blogging for a while, there is always a precedent, and one might have written about a particular topic. Noah Smith, which I think has been blogging for a shorter period of time than I've been, now comes up with another take down of heterodox economics (having difficulties of understanding the meaning of the mainstream, it's no wonder he gets heterodoxy wrong; on the definition of the latter go here).

He argues that "much of heterodox theory is non-quantitative." True, but so is the case with the mainstream. Not everything can be formalized. And there is qualitative knowledge. But, having said that, the point is that difference between the mainstream (marginalism, neoclassical economics) and heterodox approaches has nothing to do with the lack of formalization of the latter. His examples of heterodoxy are not the best, I would argue. He first deals with Hyman Minsky, which in my view accepted a good chunk of mainstream ideas in his interpretation of Keynes. And yes, he did not formalize his theory, but there are plenty of models (Lance Taylor, Alessandro Vercelli and Steve Keen have done it, to name a few).

The main critique of mainstream economics, or at least of its core theory of value and distribution, is presented in a very short, and formalized, little book called The Production of Commodities by Means of Commodities. The notion that supply and demand determine prices (long term equilibrium prices) and that the principle of substitution works is sketched there. And later Paul Samuelson (subscription required) admitted that neoclassical parables made little sense. I've dealt with this issues several times notably here. And the heterodoxy has formalized models of the determination of output, employment, inflation (see mine here), growth (in many varieties, but mainly demand-led) currency crises (see mine here), etc. So Noah is wrong when he suggests that "heterodox theory is non-quantitative."

Noah discusses essentially the so-called stock-flow models deriving from Wynne Godley's (my old mentor) work as examples of heterodox models that are formalized. His main critique is that there are problems with estimation of parameters. This is essentially one of the critiques raised against the Cowles Commission types of model that dominated the mainstream until the 1970s (before Lucas' critique). They are still around like Ray Fair's model at Cowles. Fair provides a response and comparison with modern methodology here, which is worth reading.  But the defense that Wynne would provide would be different in my view.

As I noted before, Wynne "was more concerned with what he referred to as 'model architecture' than with parameter estimation. The architecture, which was careful about stock-flow consistency, showing that everything came from somewhere and went somewhere so to speak, also imposed a clear causality structure, which determined most of the results. In fact, Wynne believed that significant variations of the parameters might not greatly influence the end result of the model, which was used for simulations and scenarios that helped to understand how the economy functioned, rather than for strictly forecasting purposes."

Simpler models, which do not provide the full accounting, as I suggested here, but that separate income and price determination, where output is demand determined, are in that sense also useful. Or just stated simply, of course there is a formal alternative to the mainstream. It's one that does not emphasize microfoundations and individual behavior as Noah would like, but that's another story.

Beyond Laissez-faire? Seriously?

As I noticed, posting will continue a bit slow for a while. So this is a bit old. Noah Smith suggests that the profession is leaning in a liberal, meaning moderately lefty, direction. He tells us, however, that:

"although there’s a growing consensus that something about U.S. economic policy needs to be changed in a more liberal direction, there isn't any consensus on what. Laissez-faire may have reached the end of its shelf life, but we don’t yet know what is going to replace it."

He praises Reagan-Thatcher's policies for their simplicity. I guess Occam's Razor is the criteria here. Not uncommon, as I noted before, that was Krugman's defense of free trade not long ago. He might be right on the lack of consensus on what to do, even though his minimal program from the discontented seems plausible enough, more fiscal expansion, less free trade agreements, higher wages (start with the minimum) and more regulation of finance.

Note, however, that this policy consensus, is open to a lot of dissensus, and not only on details of policy (e.g. more fiscal expansion where, infrastructure, health, defense? Do we increase the taxes on the wealthy too? And so on). The vast majority of those that now defend these policies do it from an essentially unreconstructed marginalist view (mostly New Keynesians). So the policy defense does not stem from different models (Mankiw, a New Keynesian as much as Krugman and DeLong would not endorse any of these 'left' policies), but from their policy preferences. I would suggest that left leaning economists using mainstream models have a harder time showing that their policy prescriptions are coherent with their theory (they need all kinds of imperfections, and ad hoc assumptions).

But that's not the surprising thing in Noah's piece, at least to me. He's nonchalant about the assumption that the shelf life of laissez-faire policies has somehow expired. It is true that Keynes had suggested that laissez-faire was dead long ago, in 1926. But that proves exactly the policy resilience of laissez-faire. In fact, I would argue that the theoretical persistence of misguided (illogical and lacking evidence) mainstream positions often results from the advantage that these models provide for defending laissez-faire.

So laissez-faire is doing fine. And note that austerity is doing fine, in the US, in Europe, in Latin America, and is still being pushed by the IMF in their actual programs (forget the research department suggesting that sometimes it doesn't work; these views never apply to the real world). FTAs are also doing fine, and pushes for increasing the minimum wage or for more regulation of finance continue to be contested and fought back fiercely. We're far from the end of laissez-faire.

How Keynesianism became a dirty word: not Hayek, the New Deal is the real cause

Noah Smith, now writing regularly for Bloomberg, had a piece on this subject. There are a few good points on how New Keynesians are really followers of Friedman, something Mankiw admitted long ago, and how everybody including conservative economists (meaning GOP economists like John Taylor and Ben Bernanke) are New Keynesians (these would be the potty trained GOP economists, not your supply-side fringe economists like Arthur Laffer). Note that this is essentially correct as pointed out here before, since New Keynesians accept fully Friedman's notion of a natural rate of unemployment, while Keynes explicitly said he wanted to reject the twin concept of a natural rate of interest.

Noah also suggests that Keynes only wanted stabilization policies, and no redistributive policies, which is more open to debate. Keynes was certainly a moderate reformer trying to save capitalism from itself, and was no fan of the Soviet experiment. On the other hand, he was an Asquith liberal, meaning concerned with the expansion of the welfare system, and knew that laissez-faire, if it had advantages in the past, was essentially dead.

In the General Theory (GT) he famously starts chapter 24, on his social philosophy, with the idea that: "the outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes." That is, income distribution is squarely in the middle of his preoccupations, and the socialization of investment at the center of his solution (let alone the euthanasia of the rentier). Using public investment, and one would imagine taxes, to deal with employment and income distribution, plus compressing the remuneration of rentiers, and keeping low rates of interest to expand the safety net, are not simply stabilization policies.

On the main topic of his piece, however, Noah is simply wrong. He argues that the reason why: "people think Keynesianism is socialism-lite [is] the fault of Keynes’s main intellectual opponent, Friedrich Hayek." First, while it's true that Keynes and Hayek had a few debates in the 1930s (but the key Keynesian author in these debates was actually Sraffa, not Keynes), prompted by Lionel Robbins plan to make the London School of Economics (LSE) an alternative to Cambridge, it is preposterous to say that Hayek was the main intellectual opponent of Keynes. In the GT, it was his own teacher Pigou, and the Marshallian tradition in Cambridge that Keynes was battling. In his personal debates Robertson was certainly more relevant than almost any other conventional (Marshallian) economist. Hayek was irrelevant.

Second, Hayek basically vanished, literally, after the 1940s only to reaper in the 1970s as a result of his dubious "Nobel"/Bank of Sweden's prize (see Sissela Bok's, Myrdal's daughter, story on that topic). By that time Keynes and Keynesianism were already dirty words. Early on Keynesian ideas were associated, fairly or not, with Roosevelt and the New Deal in the US, and then to the war coalition government in the UK, the Beveridge Report and the post-war Labour reforms. Keynesian economists were in many cases persecuted, like Lauchlin Currie, the first economist to work inside the White House, and one of the early Keynesians. But by the 1950s and 1960s (particularly after the Kennedy administration) one kind of Keynesianism was dominant anyway (the Kennedy tax cut and the economists working for his administration are the symbol of the dominance of Keynesian ideas).

So you ask why indeed did Keynesianism become a dirty word? Simply because even if Keynes had differences with Roosevelt (FDR was actually a sound finance guy) and with Labour, his ideas did provide the intellectual basis for New Deal policies, particularly after the 1937-38 recession, and for the expansion of the Welfare State in general. The economists that where against these policies by the 1940s were in the minority. Mont Pelerin is, if anything, prove of their sheer irrelevance. Friedman years later would complain about how ostracized he was (but less than Hayek, since he accepted the ISLM/Phillips curve apparatus of the Neoclassical Synthesis Keynesians; and that's why New Keynesians, who are really followers of Friedman, can say they are Keynesian, by the way). Liberalism, in the US sense of the word, was at its height. But the rise of conservatism (Goldwater was a joke back then) eventually transformed liberalism into a dirty word (that's why we use progressive now rather than liberal).

Hayek was resuscitated very much like conservative ideas. By the big bucks of business leaders and their think tanks that were against the New Deal. The rise of Hayek or of his renewed respectability results from the same forces that explain why Keynesianism and the New Deal kind of welfare policies fell in disrepute, to the point that Niall Ferguson could say that Keynesianism was flawed because Keynes was childless and gay. Oh well.

PS: In fact, the title of this blog is related to the view that Keynesianism is a dirty word, and that some people (Galbraith) unashamedly teach naked Keynesianism to innocent college kids. For more see here.

ISLM: a further explanation and a defense

I noted before  the traditional representation of the ISLM is problematic. Yet as I also noted the ISLM model can accommodate changes that incorporate the criticisms of classical-Keynesian, post-Keynesian and other heterodox groups. There is no need for an investment function based on the marginal productivity of capital and the principle of substitution. The accelerator can be incorporated, and the inverse relation with the rate of interest would result from the effects of interest rates on other components of demand. Also, endogenous money can be incorporated easily, and for the most part this has been done in New Keynesian models (the ISMP).

In the post (linked by David here) that prompted this sort of defense of a changed ISLM, Lars Syll correctly notes that New Keynesians are often right on policy, but incorrect on theory. And I for the most part agree with Lars intentions. Yet, he suggests that the problem lies in that:

"If macroeconomic models – no matter of what ilk – assume representative actors, rational expectations, market clearing and equilibrium, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable."

As I noted in my debate with Noah Smith, the problem with marginalism (neoclassical economics) is NOT rationality, utility maximization or supply and demand (not quite the same list raised by Lars). Here I would add that although one can certainly add heterogenous agents, assumptions that simplify and assume representative agents maximizing profits, for example, are not really problematic at all. Classical political economists and Marx did assume something like that and still did not reach the conclusion that the system was efficient in the sense of providing full utilization of resources.

Also, the idea that agents use all information per se is not necessarily bad (Tom Palley favors some sort of rational expectations, which he refers to as model consistent; see his old manual here). The problem is that the model used, by New Classical and other mainstream authors, has logical problems. Last but not least equilibrium per se is not a bad concept (on this there is the whole thing that Post Keynesians have inherited from Joan Robinson that makes things confusing for many heterodox economists). Equilibrium is actually quite essential for long-term analysis. And I would actually argue that it is relevant since it DOES have real world applications. In other words, real economies do fluctuate around long-term equilibrium positions that are sub-optimal.

The problem with mainstream theory is the notion of a natural rate, which is based on the principle of substitution which allows for 'factors of production' to be fully utilized. These are the problems that Keynes, by negating the idea of a natural rate, and Sraffa, by showing the logical problems of the principle of substitution, undermined. An ISLM without the natural rate is not only possible, but actually reasonably good as a tool for analyzing real economies.

PS: Note that Keynes wrote to Hicks on the ISLM that: "I found it very interesting and really have next to nothing to say by way of criticism." Keynes did not criticize the investment function in Hicks model, but note that this problem also was integral to the General Theory (GT). And yes Keynes was being nice, but he was nice too about Harrod's review of the GT, but did tell him that he did not mention effective demand.

Neoliberalism, neoclassical economics and the return of vulgar economics

The term Neoliberalism has been used with increasing frequency over the last few decades. But is often a confusing term, also used interchangeably with neoclassical economics by some authors (in fact if you look at the graph below you can see that as the use of neoliberalism increased, the use of neoclassical went down). I'm not necessarily against the use of the term, but I do think that semantic clarity is needed if the term is to be used with any propriety. I discussed some of these issues in my review of Masters of the Universe: Hayek, Friedman, and the Birth of Neoliberal Politics, by Stedman Jones here.

As I noted before, in my exchange with Noah Smith, the term neoclassical is a bit of a misnomer. The term presupposes a continuity between the old classical political economy authors of the surplus approach -- the authors from Petty to Marx, including Quesnay, Smith and Ricardo, that assumed that real wages (distribution) were exogenously given -- and marginalists (the neoclassical ones), which assumed that real wages (equilibrium ones in the long run) are determined by supply and demand (endogenously) like any other price.

In that sense, Smith (Ricardo was a radical and his classification is more complicated, and Marx was a critical revolutionary socialist) was a liberal in the sense of wanting Laissez-Faire, but his theoretical framework was very different from neoclassical authors like Friedman, a modern champion of free markets. In other words, the policy stance in favor of non-intervention and freedom of markets is a poor guide for the underlying theoretical framework or the political views of the author.

The liberalism of the classical authors was based on the notion that the rising bourgeoisie had a revolutionary role (something noted by Marx in his Communist Manifesto), and was a reaction against Mercantilism and the remnants of the Ancien Régime. Neoliberalism, in contrast, should be seen as the resurgence of a free market ideology, after the onsloghut on neoclassical economics by the Keynesian Revolution. It was the ideology of the anti-New Deal, anti-Keynesian conservatives, which was finally victorious in the 1970s, when the marginalist ideas had already proven to be either incoherent or/and irrelevant by the capital debates.

In other words, while the old liberalism was a progressive ideology at the service of the nascent capitalist system radical transformation of the structure of production and the social relations associated with it, the modern resurgence of neoliberalism is a conservative ideology at the service of the maintenance of the status quo. It is fundamentally what I referred before as the return of vulgar economics.

PS: Note that many neoclassical economists are not neoliberals in the sense of radical defenders of the free market ideology. In fact, the majority, the so-called New Keynesians, are willing to accept significant amounts of government intervention to deal with market failures, even if by the 1990s they had accepted much of the more radical stuff (think of Larry Summers, which last week quite correctly noted that more government spending is needed to get us out of the recession, but back in the 1990s believed in expansionary fiscal contractions and financial deregulation. On the latter no word).

What killed theory? What theory?

So Noah Smith and Paul Krugman are again trying their hand at the history of economic ideas to understand what happened with the profession in the last three decades. Noah calls the changes in theory "more evolution than revolution," and suggests that the dominant view is still compatible with neoclassical economics, which is I think correct, even if it is more involution than evolution.

His understanding of the changes in economics is colored by his views on neoclassical economics, which are fundamentally flawed (see more here). He then brings back the issue of lack of theoretical papers and now refers to it as the "death of theory." He suggests that what led to the demise of conventional theoretical developments within the mainstream is behavioral economics (he might as well have said information economics; sure enough that's what Stiglitz claimed with his post-Walrasian/post-Marxist notion; subscription required).

In his words:

"Why did this happen? I'm not sure, but my guess is that the meteor that hit the economics dinosaurs, and set the field's evolution off in a new direction, was named Daniel Kahneman."

Again, utterly incorrect, and proof of why PhD students should get some history of economic thought (particularly with so many coming from other disciplines). Behavioral economics, as much as information economics, and all the new theories of the 1970s onwards (New Classical, New Trade, New Growth, New Economic History) are a response to the crisis of the mainstream brought by the capital debates (and Samuelson's admission of the failure of the research program), and go hand in hand with the demise of the political Keynesian consensus that allowed for progressive policies.*
 

The mainstream abandoned the core model, for the most part, and research was dedicated to the analysis of a series of imperfections, from information, to alternative ideas of rationality and so on. Krugman is in fact wrong to argue that in New Trade and Business Cycle the reasons for change differed. Yes the Dixit-Stiglitz model allowed for the formalization of imperfect competition, but the point remains that New Trade theory corresponded in the trade field to the New Keynesian imperfectionist arguments in macro.

The fact that the death of neoclassical theory (and the post-mortem was written by Samuelson, even if Sraffa is the one that fired that fatal shot, not Kahneman) led to a period of confusion or fragmentation, as Roncaglia calls it (in his good book on the history of ideas that Noah and Paul should read), is not new. And as I noted before, lack of publications on theory are to be expected for a research program that has been shown to be so problematic by the capital debates.

An equivalent period in the history of ideas occurred after the demise of Ricardian economics in the 1830s, before the rise of marginalism, in which no coherent or dominant approach was left in place. Stuart Mill represented a hybrid, with too many inconsistencies, and the field was dominated by vulgar economics defending laissez faire policies. Some if this issues are discussed in this paper.

* Note that, in fact, up to the 1970s heterodox groups were no segregated from the profession, and published in the same journals as the mainstream authors (the Journal of Post Keynesian Economics and the Cambridge Journal of Economics are from the 1970s). Also, crazy right wing economists like Hayek, that had vanished and were part of secret societies like the Mont Pelerin were brought back from the dead, in his case winning the Sveriges Riksbank Prize.

Lars Syll on the meaning of neoclassical economics

Lars Syll also replied to Noah Smith on the meaning of neoclassical economics here and here.

What is really neoclassical economics?

So Noah Smith thinks that I, Lars Syll and Steve Keen, and other heterodox bloggers (in which he adds Austrians; you see why they should teach History of Thought?* For a discussion of the meaning of heterodox economics, including why Austrians are not so, go here) use the term neoclassical economics as a pejorative term. In fact, in the post he links to, in which I do criticize his views on Graber's work, I do say this on neoclassical economics: "mainstream (neoclassical) notions about debt are really problematic." So nothing derogatory or abusive is suggested. What is said there is that certain views of that particular school of thought are not necessarily free of problems. So no, neoclassical is not a slur.

But before I get back to what I think Noah is trying to get to, we need to address the actual meaning of neoclassical economics. For starters neoclassical is a bit of a misnomer. Veblen invented the term to suggest continuity between the old classical school and the new marginalist school of his time, fundamentally based on Laissez Faire providing an intellectual link between both groups. But the continuity between classical authors and marginalists is not defensible, once one goes beyond certain policy stances and concentrates on the main theoretical propositions of both schools [in this respect the book by Krishna Bharadwaj is still worth reading]. But we are to some extent stuck with the name. So be it.

The core propositions in neoclassical economics are associated to what Garegnani referred to as the data of the system, that is, the variables that are taken as exogenous and allow explaining the functioning of the system, namely: the endowments of factors of production, the preferences of the economic agents, and technology. On the basis of these variables the supply and demand functions of all goods, including the so-called factors of production (capital, labor and land), can be determined, and as a result the relative prices of all goods and the efficient allocation of resources is established. Central to the approach is that supply and demand for labor and capital determine the remuneration of these factors of production, and as a result, and in contrast to classical political economy and Marx, income distribution is endogenously determined [there are insurmountable problems with this theory, as Paul Samuelson accepted, subscription required; for more go here]. And there are differences between the old version of neoclassical models based on the notion of a long term equilibrium (which is what is still taught in undergrad courses) and the intertemporal version, but for our purposes we can just omit the differences.

Note that Noah says that neoclassical economics is: "Assumption of individual rationality, utility maximization, and supply/demand." But this is at best incomplete, and at worst simply incorrect. Yes they assume individual rationality, but that was also true of classical authors like Smith, Ricardo and Marx, who wouldn't assume that capitalists did not rationally pursue profits. And a more relevant discussion would be about types of rationality, substantive or bounded (like in Simon, but I'll leave that for another post). And also, social utility, not personal individual subjective utility, was essential for classical authors, since nothing that didn't have use value (utility) would be produced. Finally, market prices, but not long term natural or production prices, were determined by supply and demand, and disequilibrium played a role in gravitation towards normal prices. So the three characteristics are not enough to distinguish Ricardo and Marx from Marshall or Noah Smith. The essential thing is that supply and demand determine the long term normal prices of everything including factors of production (endogenous distribution).

Noah then points out that papers that deal with the issues in the core are almost not published. He says that publication of papers that deal with the theoretical core fell "from over half of top-journal econ papers in 1963 to less than 28% in 2011." As it should be, in particular with a core that has been revealed to be so full of problems since the capital debates. And yes, most developments like the Acemoglu et al. paper (discusses here in various places by Cesaratto and I, also here) are orthogonal to the core. But these are developments outside the core, but still within the so-called protective belt of the neoclassical paradigm or research program (for protective belts and paradigms go here and here). The problem is that they still presume that the neoclassical theory in the core holds. Note that they suggest that a minimal government that protects private property rights is enough for development, something that goes hand in hand with the neoclassical core. So a lot of the time what seems to be the use of neoclassical economics as an insult is just frustration about the inconsistencies that appear between the empirical research in the protective belt and the incoherence in the core.

Mind you, as students and newly minted PhDs like Noah have never heard or read on the capital debates, and have not been exposed to the authors of the surplus approach and Marx (besides reading less in other disciplines in the social sciences) it is not surprising that the term neoclassical is seen as an insult hurled at them by crazy and older heterodox economists. But it's not. Don't get me wrong, the core of neoclassical economics is not good or bad in itself, but it is logically flawed.

* By the way, it should be required at both the graduate and undergraduate level, since many graduate students come from other disciplines. A discipline that does not understand its own history is bound to move blindly rediscovering old truths, accepting already discarded myths, and forgetting useful ideas. And you might have, also, the paradoxical situation of a neoclassical economist that does not know what neoclassical economics is (like Dave Chappelle's black white supremacist).

PS: Note that Noah is not responsible for the definition of neoclassical economics he uses, which was lifted from Wikipedia. And yes Wikipedia is not the best source.

More on David Graeber’s Debt

Indebted? No problem we have a (minimum wage) job!

David (Fields) posted a link to Geoff Ingham’s review of Graeber’s book. Graeber is an anthropologist, recently hired by the London School of Economics, and that has often been associated with the Occupy Wall Street movement. Note that several mainstream economists have posted recently on the topic, and have been, as is often the case, barking at the wrong tree. Two mainstream takes on Graeber that are typical are from Noah Smith and Brad DeLong.

Noah wrote a post, a while ago, on David Graeber's views on debt. According to him Graeber is "a sort-of-leftish guy with a tendency to fight with other people on the left." Noah would be, by the same token, a sort of neoclassical-liberalish (in the American sense of progressive) economist fighting other people within neoclassical economics. And here lies the problem, because mainstream (neoclassical) notions about debt are really problematic, and there is quite a bit that could be learned by the profession from anthropologists like Graeber (or sociologists like Ingham; see for example this book).

Noah's complaint seems to be that David is confusing or confused or both. In his words: “his [Graber’s] pronouncements on the subject are vague or seemingly contradictory on all of the questions listed above.” In all fairness, Debt is a very long book, which deals both with one might call a Chartalist view of money, and (in my reading) a vaguely Marxist (certainly non-neoclassical) view of the functioning of the economy, but discussing the evolution of debt and economic development more or less since the beginning of Civilization.

But the basics are not difficult to get. Money does not appear as the efficient mechanism to reduce transaction costs (avoid the double coincidence of wants) in barter economies, but is the result of certain social groups ability in imposing a unit of account. As Keynes put it in his Treatise on Money: “money-of-account, namely that in which debts and price and general purchasing power are expressed is the primary concept of a theory of money.” And what is behind money of account is the power to determine what is the unit to be used, or as Keynes says, the power “to enforce the dictionary but also to write the dictionary.” Further, the classical political economy (and Marxist) approach, is not about market efficiency (not even for Adam Smith by the way, but that’s for another post) of individuals making uncoordinated decisions, but about capital accumulation in particular historical conditions, which involve class relations.

So debt is not bad per se, or good (Noah thinks that David’s point is that debt is bad, or something, as he says). Debt is an instrument that can be used by a social group to extract surplus from other social groups, from the elites in early civilizations that could command work from peasants and determine the means by which they were going to be compensated for their work, to countries that need to pay their debts in a foreign currency (normally dollars, which became the dominant currency after the victory in World War-II). Debt is then a way to force social groups and countries into situations of dependency (Noah himself is probably still paying student loans, with interests that he does not control, since he was told this is the respectable path to a happy life; yes he had a choice, but what are the choices for middle class kids with no money for college? Working for Taco Bell?).

Mind you, not all debt is bad. For example, the increase in debt to pay for unemployment insurance during this crisis is good, and in fact, too small to do any good (yes we need more spending and more debt). But not the kind of private, unsustainable debt that shackles workers to badly paid, unrewarding jobs, or that forces countries into economic arrangements that are contrary to their national interests (it was the debt crisis of the 1980s that forced most Latin American countries to accept the Washington Consensus policies).

Brad's complaint is more complicated to describe, and he is angrier it seems, but it appears to be associated to the fact that he believes David is not open to criticism, while his book contains too many factual mistakes. And yes there are some controversial points in David’s book, unavoidable in a book that is this ambitious and inter-disciplinary on top, including in chapter 12 (not sure why Brad was specially picky with that chapter). I do have also some disagreements on minor issues, but overall the framework of analysis seems to correctly point out the relevant social conflicts that arise from debtor/creditor relations, which have been absent in the mainstream analysis. At any rate, my two cents on the issue.

PS: The idea of Chartal or Cartal money is defended by 'serious' mainstream authors, and central bankers like Charles Goodhart, by the way (here). Not that it makes it more relevant. Authority has (or should have) little relevance when it comes to scientific evidence.

On the state of macroeconomics: fashion versus logic and evidence

Yes there is something rotten in the kingdom of Denmark, and it is macroeconomics; pretty much as in every other country. There has been an ongoing debate on the blogosphere on the topic (see Krugman, Smith, Thoma, Williamson and Wren-Lewis, not in chronological order, by the way). The New Classical versus New Keynesian debate tends to be on two issues the relevance of microfoundations on the theoretical level, and the importance of price rigidities on the empirical side.

Scientists, as Mankiw put it, are the New Classicals that emphasize the microfundations. They have intertemporal maximization models based on rational representative agents. The New Keynesians are the engineers, again using Mankiw's dichotomy, that strive for economic realism. Or so is what you are expected to believe if you read their posts. Of course all of these presumptions are bogus.

Noah Smith correctly points out that they all use the same DSGE models. But Krugman notes that on policy debates the whole difference is based on the assumption of sticky prices. So they use the same models, but reach very different conclusions. Of course the tools are not neutral though. Using DSGE models has hurt the positions that New Keynesian want to take. For example, Krugman has been forced to argue that the reason for the poor recovery is that the natural rate of interest is negative (and hence the current rate is too high to bring investment and savings into equilibrium).

This is a much weaker position than the one taken by heterodox authors that suggest that the crisis is due to lack of demand associated to worsening income distribution over the last three decades, and the consequent expansion of unsustainable private debt to allow for consumption. So the poor recovery is associated to lack of demand, since wages are stagnant and private debt cannot increase (and the GOP is bent in not allowing public demand to grow).

Note that the Godley type models, which follow the heterodox perspective, were much better for understanding and foreseeing the crisis (see here). There is no reason for intertemporal maximization models, and their kind of microeconomics (Sraffians have better stuff for that). New Classicals, Mankiw notwithstanding, are not scientists (or at least not good ones), since their models do have significant logical problems, and you cannot be a good engineer, somebody concerned with practical applications of scientific knowledge, if you share a model that is flawed.

On an interesting note, Krugman's main complain about Noah Smith's position is that he doesn't understand that the New Classicals have basically treated New Keynesians as outcasts. In his words:

"the freshwater [New Classical] types simply didn’t accept the legitimacy of what the New Keynesians were doing — in fact, didn’t even bother to read any of it, because anyone who actually worked with that kind of model would know that fiscal policy can indeed have an effect in that framework."

The problem is that they don't think he is legitimate. In fact, that is true. Williamson says:

"It doesn't surprise me that Paul Krugman isn't up on what is going on in macroeconomic research. Why should we expect him to go to macro conferences, spend time in seminars, and talk to his colleagues at Princeton? He has plenty on his plate, what with delivering two NYT columns per week, blogging, talking to pundits, and giving speeches. But if he's not up on the field, what purpose does it serve to make up outlandish stuff for people to read?"

Indeed Williamson's critique is that Krugman is not up to date, on the cutting edge, Colander would say. So he has missed the last fashion season in macroeconomics. And Wren-Lewis makes a point that he is a Karl Lagerfeld of macroeconomics (not sure if that is a correct fashion quote). Wren-Lewis points out that:

PK [yes, Paul Krugman] was very much at the forefront of analysing the Zero Lower Bound problem, before that problem hit most of the world. While many point to Mike Woodford’s Jackson Hole paper as being the intellectual inspiration behind recent changes at the Fed, the technical analysis can be found in Eggertsson and Woodford, 2003. That paper’s introduction first mentions Keynes, and then Krugman’s 1998 paper on Japan. Subsequently we have Eggertsson and Krugman (2010), which is part of a flourishing research programme that adds ‘financial frictions’ into the New Keynesian model. You would not think of suggesting that PK is out of touch unless you are in effect dismissing or marginalising this whole line of research.

So he is pretty much au courant, according to his New Keynesian friends (and that sounds right to me too, by the way). No fashion problem with Krugman and New Keynesians. They are trendy too. Good for them.

Yet, what it is expected of science is not fashion, but relevance following logic and evidence. And yes Krugman is right, there is evidence for price rigidity, and also no evidence for the sort of theory of distribution implicit in the mainstream neoclassical DSGE models (productivity equals remuneration of factors of production), or for a natural rate for that matter. And that is the problem with Krugman and his New Keynesian friends, too much preoccupation with fashion, not enough with logic and evidence. If the profession remains concerned with fashionable models it will continue to be irrelevant and impractical.