A few weeks ago, Noah Smith expressed worry (maybe not too seriously) over the increasingly vicious public argument between Paul Krugman and John Cochrane. It’s been going on for years, mostly in classic left versus right terms, a liberal economist against a conservative one, each claiming that their understanding of economic science is obviously correct, and the other guy is mostly stupid or deluded:
Both of these guys are top-flight economists, though interestingly neither one did his main work in business-cycle theory — Krugman is a trade guy, Cochrane a finance guy, each undeniably at the top of his field. Each one has written a paper about the macro of “liquidity traps” in the years since the crisis — Krugman’s is here, Cochrane’s is here. Their debate has been running for five years now. It began with this Krugman op-ed and this Cochrane response, The argument is over two main issues: A) whether academic macro has run off the rails over the last 30–35 years, and B) whether fiscal stimulus a good idea.
Here are some of Krugman’s salvos, here are some of Cochrane’s salvos. There are a lot of salvos.
Since then things have gotten more heated.
Cochrane recently penned this attack on Krugman in the Wall Street Journal, proclaiming the need for “an autopsy” for the Keynesian ideas Krugman so likes. As many people have pointed out (here and here, for example), Cochrane played fast and loose with the facts, and often distorted Krugman’s arguments. This isn’t really an argument in any scientific sense, but a debate, at least for Cochrane, and the point is simply to win at any cost. To be honest, I’m not sure that Krugman’s arguments are all entirely sensible either; they seem to be based on his intuition (which generally seems to be pretty good) and also by reference to some crude models of macroeconomics.
And this is the problem: here we have two economists arguing viciously over things we just don’t know much about. And yet neither is willing to come right out and say “let’s admit it — this is mostly guesswork and intuition, because we really don’t have any solid knowledge of how economies work.”
A more helpful perspective on what economists really know comes from economist Richard Green, who takes an admirably honest position in an essay on the limits of knowledge in economics:
I rather like this paragraph from Ed Leamer’s Journal of Economic Perspectives piece on the utility and limits of econometrics:
“Our understanding of causal effects in macroeconomics is virtually nil, and will remain so. Don’t we know that? Though many members of our profession have jumped up to support the $787 billion stimulus program in 2009 as if they knew that was an appropriate response to the Panic of 2008, the intellectual basis for that opinion is very thin, especially if you take a close look at how that stimulus bill was written.
The economists who coined the DSGE acronym combined in three terms the things economists least understand: “dynamic,” standing for forward-looking decision making; “stochastic,” standing for decisions under uncertainty and ambiguity; and “general equilibrium,” standing for the social process that coordinates and influences the actions of all the players…that’s what we do. We seek patterns and tell stories…”
The point is correct: among other things, we have nothing like the necessary degrees of freedom (not exactly the same as observations, but to a lay person, close enough) necessary to identify causal relationships in the macroeconomy with anything like certainty. We are now in our 11th business cycle since World War II, and as much as we like using high frequency data (I, for one, am guilty as charged), that really means in an important sense we have 11 observations about the post-War macroeconomy.
All that said, I did support the stimulus, because I have a Bayesian prior that Keynes was basically right. In particular, the ideas that high unemployment can result from inadequate aggregate demand, and that in turn that high unemployment is an unrecoverable waste of resources, and, finally, that deficit spending can spur aggregate demand all make sense to me.
That seems about right — a statement of what he believes and why (it’s mostly intuition), and an admission that we really don’t know very much about macroeconomics at all. After all, most of the models still in use by macroeconomists envision the economy as one firm interacting with one household, making optimal decisions, often in the absence of any financial markets. I give Green an A+ for speaking the truth. In contrast, Cochrane gets an F and Krugman a C (at least Krugman has, on other occasions, been a little more honest about the limitations of current macroeconomic thinking).
Unfortunately, the Krugman-Cochrane battle is a perfect example of what is terribly wrong with economics, and why the debates never seem to progress much toward any conclusion. There’s very little real knowledge on which arguments can be settled, so they just go on. The deep issue is that very few macroeconomists are even trying to break away from the current modelling paradigm (the DSGE stuff to which Learner alluded above) to explore anything better. There are a few, but they don’t tend to take part in these public spats.
Rather than wasting time reading Krugman versus Cochrane, I suggest reading, for example, some of the great pioneering work of Yale economist Peter Howitt and colleagues. I’ve written a little on it here. This work makes a real effort to understand how economic coordination emerges in an economy, as people interact over time, and as firms come into existence to solve problems and create the kinds of goods and services that people need. This work doesn’t oversimplify the complexity of economic organization, but tries to understand that complexity directly — and for this reason it offers some important suggestions about what can go wrong after a crisis. For example, if many firms go out of business, then it takes time for new firms to re-emerge and get economic networks working again.
This kind of work, it must be said, doesn’t lead to any elegant mathematical theorems, and so isn’t prized by most economists. It doesn’t lend itself to easy and obvious truths that can be invoked to win left versus right Op-ed debates. It’s honest work that acknowledges how little we know, and takes aim at tackling some issues that might actually lead to a better understanding of real economies. Weirdly, it is all but ignored by the economic mainstream.