The new macro: "Give people money"
This time around, theory has taken a back seat
On Twitter, I recently joked about how macroeconomics has changed in the last decade:
Of course no one in academic macroeconomics is publishing theory papers that literally just shout “Give people money!”. But at the policy level, there has definitely been a change in tone between the Great Recession and the COVID-19 recession.
It’s hard to remember now, but when the Great Recession hit, people actually argued over economic theory. Prominent macroeconomists like Robert Lucas and John Cochrane invoked the concept of Ricardian Equivalence to argue that fiscal stimulus was ineffective by nature. They were wrong, and their arguments were debunked, but they were taken seriously at the time. Meanwhile, at central banks around the world, there were ferocious internal debates over whether to take dynamic stochastic general equilibrium models seriously when making policy. Because I criticized those models a lot, I was invited to give a talk at the Bank of England about the limitations of these models. Delegates from the Bank of Sweden pounded the table and demanded to know which part of DSGE I didn’t like — the dynamicness, the stochasticity, or the general equilibrium.
A decade later, all of this seems very quaint, like something out of another age. The COVID-19 recession is deeper than the Great Recession, and the government measures to deal with it have been bigger and bolder. Yet so far there’s been very little public talk about macroeconomic theory. The usual suspects are trying to claim that the $600/week Pandemic UI program raised unemployment (it didn’t), but even they aren’t using theory as a justification.
There are actually a few economists invoking theory, but only in broad-brush general terms. An example is Olivier Blanchard’s presentation at this PIIE/Brookings symposium on fiscal and monetary policy (begins at 1:14:30):
Blanchard mentions a number of theoretical reasons why governments might be able to safely take on a unprecedented amounts of debt in order to provide pandemic relief and stimulate the economy. These include secular stagnation theory, and a hint of loanable funds theory at the end. But there’s no real attempt to invoke any formal model — certainly nothing counterintuitive, that would serve as a restraint on the impulse to spend. Blanchard, recall, is the economist who declared in August 2008 that “the state of macro is good,” referring to the convergence of the field around a set of models that had no role for fiscal policy!
The rest of the symposium is similar. There’s no theoretical discussion of whether fiscal stimulus is effective; everyone seems to be in tacit agreement that it is, even Ken Rogoff (1:19:50), who was a well-known deficit hawk last time around. Nor is there much theoretical discussion around debt sustainability — overwhelmingly, the consensus is that interest rates are low, and have been trending down for a while, so it’s safe to borrow more for now. There’s some minor concern about the possibility that rates might rise in the future, but theory is not brought to bear on the question of when and why this might happen.
(Note: This is not to say that macroeconomists like the ones in the video aren’t using models to organize their thinking about fiscal sustainability. Blanchard’s 2019 AEA address, and a more recent paper about fiscal policy rules with Leandro and Zettelmeyer, are a good example of these models, and there are others as well. But these tend not to be fully specified DSGE-type models of the kind that were popular before 2008. And so far, any fiscal constraints that are derived in these models haven’t had done much to restrain the “paradigm shift” that Blanchard says is underway in policy thinking. If there’s any formal model involved in the shift, it’s the theory of secular stagnation; but while it’s sort of lurking in the background, this is not a very well-developed theory yet, and policy recommendations probably don’t hinge on its particulars.)
The “give people money” consensus will find a sympathetic ear in the Biden administration. Janet Yellen, who repeatedly worried in the past that the national debt was unsustainable in the past, now advocates for massive stimulus.
In other words, at least as far as policy debates go, arguments about optimal fiscal policy based in formal macroeconomic models seem to be out, replaced by a consensus that giving people money is necessary and good (at least, for the forseeable future).
Why did this change occur?
The simple answer is that economic policy thinkers learned important lessons from the last crisis. DSGE models proved frustratingly difficult to apply during the 2008-9 crisis, leading central bankers to fall back on a combination of simple heuristic models and intuition. Models that predicted rising real interest rates and/or rampant inflation were consistently proven wrong, as both quantities stayed low in advanced economies.
If your tools are broken, you stop using them, even if it means you have to go back to doing things by hand.
A related factor is the discrediting of austerity itself. Formal macroeconomic models don’t always recommend austerity — sometimes they recommend stimulus, and more recent models tend to have more of a role for fiscal policy. But by their nature, economic models are about finding an optimal middle ground between too much and too little (in econ jargon, modelers like to find interior solutions). That emphasis on tradeoffs means that nearly any macro model will come with a warning about how much stimulus is too much. So then if you use that model, you end up worrying about when to stop.
But such worries have proven disastrous in practice since 2008. Blanchard himself prominently recanted his support for austerity in the Eurozone crisis, and now says that we’re “on the verge of a shift in fiscal paradigm”. The IMF, once a bastion of deficit hawkishness, has evolved substantially on the issue. The repeated failure of austerity since 2008 may mean less appetite for models that focus on telling policymakers that too much is too much.
A third possibility is that macroeconomic thinkers are paying more attention to politics than before. Global unrest exploded in 2019, even before the pandemic. U.S. society seems to be coming apart at the seams, with massive unrest on the left and increasing authoritarianism and threats of violence on the right. Economists and policy advisors may conclude — probably correctly — that the need to mollify political tensions means that the government should err on the side of handing out cash. There’s no DSGE model that tells you how to balance public anger against the risk of a future rise in interest rates!
So for now at least, academic macro models have declining policy relevance in fiscal policy discussions. Partly this is a reprimand for getting things so wrong in the last crisis — a stern admonishment to go back to the drawing board. It’s also probably a recognition of the fact that sometimes politics supersedes the tradeoffs that economists study. Someday, if and when we have better macro models, and if and when the economic costs of government spending start becoming apparent, this situation may change. But for now, macro in the real world is “GIVE PEOPLE MONEY.”
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If only this sentiment could trickle down into academic macroeconomics as well. DSGE models need to be tossed in the trash.
Do you think there's anything to the argument I've heard that continually pumping money into the economy via low interest rates and deficit spending actually increases inequality in the long term because the usual suspects (wall street, big business) has a knack for soaking in up?