Macroeconomics hasn’t been a hot topic for a while. The years after the financial crisis of 2008 featured a lot of lively (and sometimes acrimonious) debates about fiscal stimulus and monetary policy. Obscure papers from the dusty halls of academia suddenly became points of public contention, with the fates of millions of unemployed Americans seemingly hanging in the balance. That was when I got my start as a blogger.
But it all died down when the economy recovered. Nor did the pandemic bring it back, because everyone realized that it was disease holding back the economy rather than some sort of liquidity preference shock or animal spirits or aggregate demand shortage.
Now, with the end of the pandemic in sight and the U.S. economy projected to recover strongly, you’d think macro would still be relegated to the dusty musty halls of obscurity (or perhaps just to Northwestern University). But no! Because the Biden administration is borrowing and spending a lot of money, a huge debate has erupted about whether that’s OK. And where the original Macro Wars were fought on the blogs, the current ones are more likely to play out on Econ Twitter. As Tyler Cowen points out, that has its upsides and downsides.
The most interesting thing about the new Macro Wars is that academic research is almost a total non-factor. In 2011 we were arguing about the Zero Lower Bound, DSGE models versus reduced-form models, etc. Now, though academics are involved in the debates, you rarely see an actual paper invoked. And when it is, it’s nearly always an empirical paper rather than a theory paper.
Why? If academics themselves weren’t involved in the debates, you could say that OK, maybe these people are just ignorant of the literature. But academics are involved, and they do know the literature; they’re just not invoking it much. Also, it’s not that Twitter econ debates are lightweight or short on references — the minimum wage debate, for example, cites papers constantly.
You can come up with various hypotheses for this, but it seems fairly clear to me that the reason is that everyone quietly stopped believing in the usefulness of academic macro theory. Macro profs are still out there doing their jobs, writing theory papers, and getting paid handsomely for it — in fact, I’d argue that with folks like Emi Nakamura, Jon Steinsson, Yuriy Gorodnichenko, and Ivan Werning on the job, the field of macro theory is chock full of top talent. And those are good people who take their jobs seriously and aren’t out to push political narratives.
But the problem is that macro theory is just really, really hard. The economy is a complex phenomenon, and the behavior of the consumers and companies and other actors in it are probably complicated. That offers macroeconomic theorists a difficult choice — assume rules so simple and goofy that the models are pretty much completely wrong, or unleash realism and watch your model degenerate into chaos.
Complicating this is the fact that macroeconomic data is really, really crappy. Milton Friedman said that we should only judge macro models with macro data, but if you do that, you’re dealing with a small handful of business cycles since good statistics started being gathered less than a century ago. That’s almost no data at all! That’s why economists often focus on microfoundations — trying to get behavioral rules that match micro data, since micro data is so much more plentiful and higher quality.
Crappy data means macro theories are very very hard to test (which somehow doesn’t stop a lot of them from being demonstrably wrong anyway). It also makes macro empirics hard to do — you can measure how stores change prices, or how workers find jobs in recessions, or other pieces of the macroeconomic elephant, but ultimately that doesn’t tell you the answer to the big questions like how much the government can borrow.
The financial crisis and the Great Recession really exposed the fact that macro theory wasn’t ready for prime time. When I gave a talk at the bank of England in 2013, the central bankers there lamented how little usable insight and advice their complex academia-derived models had offered in a crunch.
So I think macro theory is going to remain confined to the ivory tower for a while. In the meantime, people are using heuristics, rules of thumb, and simple calculations to make their arguments. For example, Olivier Blanchard, who thinks Biden’s relief bill was way too big, makes his argument using the very simple ideas of an output gap and fiscal multipliers. His argument is: The output gap is small, the fiscal multiplier is large, and therefore Biden’s bill will cause an excess of aggregate demand, leading to inflation.
Now, I think Blanchard is wrong. I think most of the Biden relief bill wasn’t fiscal stimulus at all, but a form of disaster relief — it wasn’t about priming the pump and stimulating economic activity, it was about making sure that as few Americans as possible emerged from the pandemic financially ruined. People may call it “stimmy”, but there’s evidence that Americans don’t spend much of their COVID relief checks. And some of what they do spend is probably spent on things like unpaid rent, which is really more like a debt. Thus, I don’t see Biden’s bill pumping up aggregate demand by very much, so I don’t think overheating is a danger.
But in any case, this is the state of public debate now. Theory has taken a back seat, simple heuristics (mostly Keynesian heuristics) are the order of the day.
In fact, I think that even heuristics derived from empirical macro research — fiscal multipliers, output gaps, etc. — are taking a back seat to simpler ideas, expressed in the form of memes. For example, MMT, despite having “theory” in the name, is not actually a theory of the macroeconomy at all — it’s a form of memetic warfare designed to support the policy conclusion that government deficits are good. One of the most powerful MMT memes is the idea that the government has no budget constraint, and that the only limit on government borrowing and spending is inflation.
In an episode of Brad DeLong and my podcast Hexapodia today, I argued to our guest, Claudia Sahm, that MMT has basically won this meme war, with a lot of help from the Fed. Essentially nobody is talking about interest rates being the constraint on government deficits and debt now; it’s simply assumed that the Fed will continue to do what it needs to do in order to keep rates from rising. If private companies and foreign countries stop buying bonds, the Fed will step in. The only danger then is inflation. And that, I argue, is why Summers and Blanchard are now talking about the danger of inflation as the reason to be afraid of deficits. (Anyway, check out the episode, it’s pretty fun.)
In fact, it’s worth asking whether this represents a paradigm shift in macroeconomic theory — not theory as academics do it, but theory as employed by central bankers, legislators, and public intellectuals. J.W. Mason says yes — according to him, the Biden bill is a recognition that fiscal stimulus is really, really important, that aggregate demand and employment matter a lot, and that public debt “doesn’t matter.” John Cochrane fires back, saying Mason’s theory is wrong, and that if we try to live by that theory, inflation will result.
I think Mason isn’t quite right, first of all because the Biden bill mostly isn’t fiscal stimulus, but more importantly because actions don’t constitute theory. Biden’s relief bill — and the even bigger infrastructure bill, if it passes — is actually an experiment. Like a minimum wage hike or a more permissive immigration policy, Biden’s massive spending is a bet that something economists traditionally thought would cause substantial negative consequences actually won’t be that bad.
If Biden’s bet fails, we’re in trouble. But if it succeeds, we’ll learn something valuable about the way the economy works. And that will hopefully lead to the development of better theories of government spending and debt. As with minimum wage, real progress in economic theory often relies on some bold leaders being willing to venture outside the bounds of what orthodoxy says is safe.
And it’s good for Blanchard, Cochrane, Larry Summers, etc. to put their predictions out there. Biden’s bill has already passed — if no significant inflation results, that will be a message to the skeptics go back and reevaluate their model of the economy.
In the meantime, the Macro Meme Wars are likely to continue. Stay tuned — it’s a space I plan to cover. Almost makes me feel like it’s 2011 again.
(Update: Paul Krugman argues that the reason we’re not talking about theory is that Keynesian theory won the day in the earlier Macro Wars, and now we’re all Keynesians. On one hand, he’s right — we are all Keynesians now, and everyone seems to agree that stimulus and multipliers are real things! On the other hand, regarding the new Big Question — “How much can the government safely borrow?” — nobody seems to be turning to theory, Keynesian or otherwise.)
(Update 2: Tyler Cowen likes this post, but argues that what’s basically happening is that Biden is being a populist, and that Democratic-leaning economists are rearranging their thinking accordingly. But that doesn’t stop independent- or Republican-leaning economists from using theory to put a check on populism, does it? If economic theory had useful and novel stuff to say about government borrowing constraints, wouldn’t we see Biden detractors citing it more?)
*Note: Northwestern University is great.