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War Among the

[T]he ideas of economists and political philosophers, both when they are right
and when they are wrong, are more powerful than is commonly understood.
Indeed the world is ruled by little else. Practical men, who believe themselves to
be quite exempt from any intellectual influences, are usually the slaves of some
defunct economist. Madmen in authority, who hear voices in the air, are
distilling their frenzy from some academic scribbler of a few years back. I am
sure that the power of vested interests is vastly exaggerated compared with the
gradual encroachment of ideas. Not, indeed, immediately, but after a certain
interval; for in the field of economic and political philosophy there are not many
who are influenced by new theories after they are twenty-five or thirty years of
age, so that the ideas which civil servants and politicians and even agitators
apply to current events are not likely to be the newest. But, soon or late, it is
ideas, not vested interests, which are dangerous for good or evil.
Who cares what economists think? Keynes, conclusion of
The General Theory of Employment, Interest, and Money:
When the Great Recession struck, and Obama proposed a
fiscal stimulus as a response, many economists were in
favor but there was also substantial pushback
This controversy had its roots in an economic debate that
began in the 1960s
Until the late 1960s, there was broad consensus that recessions
reflected a fall in aggregate demand.
There was dispute over why demand fell and what should be
done about it. Traditional Keynesians blamed unstable private
investment (animal spirits) and called for fiscal policy;
monetarists, led by Milton Friedman, blamed destabilizing
monetary policy and called for a money growth rule
But why did money have real effects? The search for
The Phelps volume view:
sticky prices due to imperfect
Also Friedman on natural rate
Big prediction: any attempt to
trade off higher inflation for
lower unemployment will
cause apparent tradeoff to
Unemployment versus inflation, 1959-68
The same, 1959-1980
But if its imperfect information, doesnt this mean that
policy only works by fooling people? And in that case can
activist policy ever be useful? Rise of rational expectations
Lucas, 1980:
One cannot find good, under-forty economists who identify
themselves or their work asKeynesian. Indeed, people even
take offense if referred to as Keynesians. At research
seminars, people dont take Keynesian theorizing seriously
anymore; the audience starts to whisper and giggle to one another.
Keynesian revival in the 1980s
Costly disinflation
in the 1980s seemed
at odds with rational
Saltwater versus freshwater
Saltwater dominates policy positions:
Ben Bernanke, Ph.D. MIT 1979
Janet Yellen, previously at Berkeley
Mario Draghi (ECB), Ph.D. MIT 1976
Olivier Blanchard (chief economist of IMF), Ph.D. MIT 1977
Lawrence Summers, Ph.D. Harvard
But freshwater has a strong role in academics
Ken Rogoff, 2001:
The Chicago-Minnesota School maintained that sticky prices
were nonsense and continued to advance this view for at least
another fifteen years. It was the dominant view in academic
macroeconomics. Certainly, there was a long period in which
the assumption of sticky prices was a recipe for instant
rejection at many leading journals. Despite the religious
conviction among macroeconomic theorists that prices
cannot be sticky, the Dornbusch model remained compelling
to most practical international macroeconomists. This
divergence of views led to a long rift between
macroeconomics and much of mainstream international
There are more than a few of us in my generation of
international economists who still bear the scars of not being
able to publish sticky-price papers during the years of new
neoclassical repression.
The phony peace
And then came the crisis and the stimulus
Robert Lucas: Christina Romer heres what I think happened. Its
her first day on the job and somebody says, youve got to come up
with a solution to this in defense of this fiscal stimulus, which no
one told her what it was going to be, and have it by Monday
So she scrambled and came up with these multipliers and now
theyre kind of I dont know. So I dont think anyone really
believes. These models have never been discussed or debated in a
way that that say Ellen McGrattan was talking about the way
economists use models this morning. These are kind of schlock
The Booth School survey
The big issue: crowding out
Traditional crowding out: interest rates
Immaculate crowding out: John Cochrane
First, if money is not going to be printed, it has to come from somewhere. If
the government borrows a dollar from you, that is a dollar that you do not
spend, or that you do not lend to a company to spend on new investment.
Every dollar of increased government spending must correspond to one less
dollar of private spending. Jobs created by stimulus spending are offset by
jobs lost from the decline in private spending. We can build roads instead of
factories, but fiscal stimulus cant help us to build more of both. This is just
accounting, and does not need a complex argument about crowding out.
Market confidence arguments