Monday, December 8, 2014

Policy penance

The last few posts haven't worked out so well, that's for sure. After a too-grumpy reaction to Alan Blinder's review,  I wanted to say something nice and find common ground with the "what's wrong with macro" articles and even Krugman's posts. In doing so I was much too quick and superficial in characterizing what's going on at high levels of our policy institutions. The only result was that  I managed to annoy all my friends and colleagues at the Fed, IMF, and so on.

As penance, I'll try a blog post that more accurately characterizes the interaction of research and policy, "Keynesian" and modern economics, and so on, as I see it.

If we look one step below the political level, for example at the FOMC minutes and what research staff are up to at institutions like Fed and IMF, you see a very sophisticated interaction between the ideas of modern economic research and policy. The FOMC minutes and speeches by board members (all easy to find on the Fed's website) are a great source. The FOMC seems, to an outsider,  like the world's highest-level debating club on modern macroeconomics.

On many of the dividing lines between traditional Keynesian and modern economics, the policy discussion is decidedly modern.

Traditional Keynesian economics is above all, static. Consumption depends on income, today; investment depends on interest rates and animal spirits, today, and so on. This is in part its great success. At the time, people didn't have the tools to do dynamic intertemporal economics.

Now we do. Modern macroeconomics is, above all, intertemporal. People make consumption and investment decisions, thinking about today and the future. This intertemporal revolution started with the permanent income model, that consumption depends on expected future income, and continues to this day.

(Let me quickly stop a discussion that will spin out of control into quotations from Keynes and what he might have "really meant." What matters is what was in Keynesian models, used in policy for generations, and that's ISLM. Perhaps a deeper reading of Keynes -- or Marx, or Smith, or the Talmud -- might reveal some intertemporal poetry. But it really had little effect on how models are used or policy was done. So here "Keynesian" means ISLM-ASAD.)

Now, if you read FOMC minutes, Fed speeches, or talk to people at the Fed about policy, you will see that this intertemporal, expectation-focused approach resulting from the revolutions of the 1970s permiates the policy-making process. For example, "forward guidance" is the rage. It only takes one beer for the conversation to quickly acknowledge that QE likely worked as much by signaling low interest rates for a long time than it did by exploiting some sort of permanent price-pressure in Treasury markets.

More deeply, the Fed policy discussion recognizes that "expectations" are not the same things as "speeches by public officials." People have heard lots of promises before. Policy faces a deep "time consistency" and "commitment vs. discretion" problem, again part of the late 1970s revolution in macroeconomics. People don't believe promises made now, because they know the Fed may change its mind later.

This realization led modern macroeconomics to focus on policy rules, rather than policy actions, which we can chalk up as a second major break between traditional Keynesian analysis and modern macroeconomics. Rules can be written down, legal or constitutional constraints, or simply traditions long observed.  The best way to "manage expectations" is not to "manipulate" them with speeches, but instead to follow well-established rules -- even when you'd rather not.  Friedman's 4% rule from the 1960s had some of this flavor. Taylor's interest rate rule from the 1990s has it explicitly, and inflation target rules even more strongly.

Over the last 20 years, and especially under chairman Ben Bernanke, you could see the importance of transparent, predictable, rule-based thinking take hold. The early Fed was deliberately secretive and deliberately obscure. There was a time when they wouldn't even tell markets what the Federal Funds target was!  Since then, explanation of what the Fed is doing, why the Fed is doing it, what the Fed is likely to do in the future, and finally how the Fed will react to events in the future -- a "state-contingent" rule -- has become more and more important in Fed discussions.

This attitude took a little step back recently; the Fed tried to communicate that interest rates would rise when unemployment fell below 6.5%.  (Clarification below.) That promptly happened, unexpectedly, forcing the Fed to backtrack and say no, wait, we really want to look at broader labor market indicators.

Well, it's hard to follow rules ex-post. That's the whole point of rules! Adopting rules needs major changes in what we expect of policy too. If Janet Yellen had raised rates as "promised," then went to Congress to say "we proclaimed a rule, so we had to stick to it even though we and you both thought the economy way too weak to raise rates," you can imagine the howls.

I'm not here to criticize, or to opine on just how firm Fed rules should be. The point is that the Fed is conducting this debate at the highest levels, fully informed by modern academic research on the subject.

The discussion surrounding fiscal stimulus in 2008-2009 strikes me as having been a good deal less sophisticated and much more "old-Keynesian," involving static "multipliers," straight from a 1970s textbook. But that may be a poor example as it was done in a huge hurry, inside the Administration, and away from the kind of carefully constructed policy process that the Fed and other agencies maintain.

Fed speeches, even from chairs Bernanke and Yellen, are peppered with citations to academic work and staff work. More evidence of a tight connection between modern research and top level policy discussions.

In fact, one can quite plausibly complain that the Fed, IMF, and similar institutions are too close to academic research, or perhaps that academic research is too motivated by finding reasons for the latest policy idea. In no other area that I can think of, where important policy is made and there is a corresponding body of academic research, do people seriously propose to guide policy based on the latest, usually unpublished, and usually novel, research. We wait a while for ideas to settle.

As an instance, I've been a bit critical of the apparent distance between policy and research, and I've also been quite critical of the current generation of new-Keynesian models.  Well, John, make up your mind! On the latter view, I should certainly not advocate that the Fed tomorrow implement policy based on the latest large-scale estimated new-Keynesian model. But on the former, I have to admit that sort of thing has been standard academic research for 20 years now. Most bloggers mean "the Fed should pay more attention to my research," but I won't -- yes, research has to settle before being used for policy.

The hard fact is that economic models are quantitative parables, not explicit and complete descriptions of reality. The step of understanding the model's "intuition," "basic message," and so forth is devilishly hard. That's why we have such deep verbal discussions about economic models, where we imagine physicists just test them and are done.  (They don't, but that's another story.)

An example. In 2012, Mike Woodford gave a subsequently famous paper at the Jackson Hole conference, arguing that in new-Keynesian models, "forward guidance" that interest rates will be kept low for longer than usual can create stimulus at the zero bound. This paper generated lots of controversy, not least from me. Do people believe such promises? Yes, we can write a model in which the Fed announces a new new rule, and everyone believes it. But does the world work that way? More deeply, is the underlying model right? For example (of many) is my complaint that it assumes the Fed threatens to blow up the economy a big problem, or just an easily-fixed technical simplification?

Be it as it may, this was first-rate academic research, by a first-rate academic, and it evidently profoundly influenced the policy debate.

A similar story occurs daily on how the Fed should think about "secular stagnation," "macroprudential policy," "pricking asset price bubbles," long term labor force participation, inequality, and so on and so on.   As a concrete example, Jeremy Stein when on the board gave an excellent series of thoughtful speeches on the relation between monetary policy and financial stability. Here is a good one, bristling with citations to academic research.

The trouble with all this is not a lack of contact between Fed and academic research. The trouble is, if anything too much! The basic "trouble with macroeconomics," circa 2014, is about the same as the "trouble with physics," circa 1790. We know a lot. But there is so much we don't know.

All of this work, really, is about "frictions" in the economy. "sticky prices," "sticky wages," whatever they really mean, "financial frictions," leverage constraints, collateral constraints, temporarily segmented markets, "liquidity," as much in the eye of the beholder as smut, and so on and so forth. The "trouble" with macroeconomics is that we're really only beginning to figure out what all this really means and how it works.

To the similar complaint that there is "too much math" in economics: no, there is too little! We don't have the tools to model, understand, and control all these hazy ideas that seem to matter when we look at the world.

I think there are some unfortunate heirs of the old-Keynesian tradition still at work in policy-making, however.  It is natural that they are there, but I think it will be good when they vanish.

First, since models are quantitative parables, and it takes a long time to digest what they really mean for a given situation, it is natural that the top level of policy makers to continue to digest new work in an old model. "Oh yes, I see, this model really means 'aggregate demand' is low and stimulus will raise it.  Now I get it." That's a perfectly normal reaction.

Second, and deeper, the Keynesian policy tradition left a strong desire for activist, discretionary, "what do we do today?" sorts of answers.

I long ago sat at a hilarious academic advisory meeting at a Federal Reserve, at which the bank president asked, bottom line, whether we thought the Fed should raise, cut, or leave alone the funds rate. Academic after academic gave beautiful speeches about the right policy rule. (Me, an ode to price level targets rather than inflation rate targets.) The poor exasperated president said, "that's all very nice, but what should we do now?"

This call for action, for activist discretionary response, is at the core of Keynesian economics. It's very very hard to talk about rules and institutions rather than actions. And the core answer of modern intertemporal economics is to unask the question.  But people expecting a daily discretionary decision just don't want to hear about the rule.  In this regard, the policy mindset still is decidedly old-Keynesian.

As a counterexample, consider asking the question "what should monetary policy do about unemployment" in the 1800s. There was no Fed. "Monetary policy" consisted of the gold standard, implemented by the Treasury.  The answer would be, "the price of gold is $20 per ounce. What's your question?" I'm not (!) saying that's the right policy, but it is a pure example of a rule rather than activist discretion.  A serious discussion about a rules-based Fed would start by canceling the regular FOMC meetings and the economic review. That just presupposes that the whole process is to come to a discretionary decision.

Third, economic policy discussion seems to ignore the tremendous lack of knowledge we have over basic cause and effect mechanisms, even the signs and causal channels of effects let alone magnitudes. Policy discussions jump to exploiting the latest friction before the ink is dry.

But by and large policy decisions don't, and are quite conservative about implementing new ideas. Expectations, rules, discretion and commitment, are from the late 1970s!

When things are ambiguous, you stick with what you've got. Keneysian orthodoxy ruled for a long time. Even if it's shown to be wrong, replacement models are so different, still so untested and unrefined, continuing to use basic Keynesian intuition is a natural response to ambiguity.

Fourth, I will complain a bit about how much academic research produces answers to support desired policy rather than the other way around. Stimulus came on the political landscape, and a hundred papers are written about how stimulus might work. The one thing I will gently chide some people (not all!) at the Fed for is how often staff reports come up with the number that the chair wants to hear. This is particularly true when introducing "frictions" to models. Yes, this or that friction might justify a policy. But if you really think sticky wages are the problem, why write articles justifying central bank intervention, and not one on how wages might be profitably unstuck?

But these minor complaints aside, as I look at the layer of policy process just below the headline political appointees, and just above the silly stuff in the opinion pages of the New York Times, really the interplay of academic ideas and policy is about as healthy as I could make it. (Obeying the rule that one has to be evenhanded about all research, not just my research!) A residual, fading, back of the envelope Keynesianism is pretty natural.  And the good ideas of modern, intertemporal, people-based, budget-constraint-disciplined, economics are being digested and slowly implemented.

Next, this whole new Keynesian vs. old-Keynesian thing.

Update: A correspondent points out that the actual FOMC statement is more nuanced,
[The committee] currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. 
But the perception of a rule and backtracking was real.

Update 2: I see from blogger's trackbacks that Paul Krugman covered this post. I'll keep to the usual don't-respond-to-Krugman policy, with one exception. Krugman writes:
Well, at least Cochrane now concedes that Woodford isn’t stupid. Progress!
I have never, ever, anywhere, in writing, in words, in thought, in insinuation, or veiled reference, said that Mike Woodford is "stupid.." I have never said or written that anyone is "stupid," "mendacious", "mendacious idiot," "evil," "corrupt," "hack," or any other ad-hominen attack or insult.  Google all you want, you will not find any such quote. Yes, I mercilessly skewer bad ideas, but never people. To me that is the most bedrock ethical principle of intellectual honesty.

Mike Woodford in particular has been a friend and a colleague for many years. I have learned a lot from him, I have benefited enormously from his comments on my work, and I've read his in detail.  I taught PhD classes from his book.

The charge that I don't know or haven't read or recently discovered Woordford is laughable. I spent about 5 years of my research life writing "Determinacy and Identification" which is nothing but a careful dissection of new-Keynesian economics as distilled in Mike's book. I may be wrong, but not out of ignorance.

Mike, if you're listening, I can't control the vitriol that the New York Times sees fit to print, so all I can do is post a correction to my humble blog -- Krugman is making this up out of thin air.

Update 3: Due to an avalanche of hateful comments from Krugman's choir, I've turned off comments on this post.


  1. > It's very very hard to talk about rules and institutions rather than actions.

    Very nice post and very well put. I suppose it's rather hard to get the policy maker (Fed Chair) to consider the equilibrium (and reputational) ramifications of a policy. The answer to

    "that's all very nice, but what should we do now?"

    should be "well, what do you think people are expecting you to do?" So John, what has your experience been with trying to convince policy makers of the existence of the larger equilibrium?

  2. Well, good post, but...

    If one reads not only the minutes but the transcripts of FOMC meetings, one concludes that in 2008 many FOMC members were monomaniacally obsessed with inflation.

    This peevish fixation, not any models or sophisticated intuition, seemed to "inform" the FOMC discussion. There were 2,664 mentions of "inflation" in 2008 FOMC meetings. That was 2008, remember, the year from which the economy has barely (if yet) recovered.

    The FOMC did hear staff reports in 2008 that unit labor costs should rise handily at 2% a year. They were essentially flat thereafter.

    I would say central bankers, globally and not just in the US, have become single-mandaters, and that is to seek lower rates of inflation until they get to zero, at which point the rhapsodizing about deflation begins. Does this reflect a model, or rule, or just a animistic impulse is hard to tell.

    Side note to John Cochrane:

    You recently wrote that Reagan's fiscal deficits were not primary (operating, or net of debt payments) and so his fiscal policies were coordinated with Volcker's tightening. When I went back and checked the figs, I found that Reagan's deficits were very large, even my a primary or operating basis.

    Does the early 1980 experience really fall within a Neo-Fisherite model? Seems to me, no.

    1. There was a large increase in primary deficits after the deep recession of the early 80's when unemployment reached double digits- no surprise there. However, it did decline sharply in the following years. By FY 1989, it was back into a small surplus. By the mid-90's there was a very large primary surplus. I don't really understand where you think the contradiction is here with the neo-Fisherian model.

    2. Get real, folks. What you forget is that economic arguments are considering the world as it was years ago while the life of Americans has changed drastically since the intense marketing of personal technology. The insanity of how we live now is that people can't "put down" as they say in "recovery" literature and meetings. "Families across America have cut back on food, clothes and entertainment ... as the draw of new technology competes with cellphone owners' more rudimentary needs and desires." ("Cellphones Are Eating the Family Budget." Wall Street Journal, Sept. 28, 2012.) So which companies are making money from the enormous growth in use of technology and which ones are losing money? The little guy loses while the corporations gain. And the corporations gain further by creating a huge number of techno-addicts or techno-zombies--people who would rather give up food and the pleasure of spending time together to have devices to look up when the next bus is coming or who won the last Knicks game. These people are losing their ability to make decisions without consulting electronic devices and are fast losing their human connections. Easy to see on the streets of any town where a man looks down at his cell phone while walking on a busy, uneven sidewalk. Or a group of teens hang out with each one looking at his/her cell phone. Or a mother crossing a main street intent on her cell phone while her three-year-old toddles behind him. "Oh, I thought my husband was watching him."

      Neither economic philosophy considers what would happen if a series or simultaneous "Sandys" hit the east coast. Is climate change considered or disregarded totally? A recent Pew Internet report said that 64% of Americans think that there will be a space colony in the next 50 years --they'll escape the end of the world calamity by flying off into space. 77% believe that people will control the weather. Isn't it sick and funny too? (Aaron Smith. "U.S. Views of Technology and the Future." April 17, 2014.)

  3. "But people expecting a daily discretionary decision just don't want to hear about the rule." - Is not the decision on a policy rule also an answer to the question what is to be done in the moment?

    And do we not still need economists debating at the FOMC meetings even if we have rule, since the rule won't be perfectly mechanical? E.g. methods of measurement and models would still have to be decided on, and discussed.

    Great post, I appreciated in particular the emphasis on verbal discussions about models in economics.

  4. "And the good ideas of modern, intertemporal, people-based, budget-constraint-disciplined, economics are being digested and slowly implemented."

    You may have convinced yourself that representative agent models are about real people living in real societies - but take that to a psychologist or sociologist and see how far you get. They may not use rational expectations models but they certainly use empirical evidence (which does not only include numbers in their observations of actual human and societal behaviour). Secondly,wrt current vs permanent income, firstly most of the world's population (there is a world outside the United States) has enough problems worrying about current income, the next meal, let alone their pension. We have not learned anything on what Keynes originally said on that - you simply cannot usefully generalise. Finally, there are things which cannot, and should not, be expressed mathematically; we have the humanities for those things, and for very good reasons we keep maths out of those areas. Economics, as it deals with real people and societies, or at least should do, is an area which overlaps into the humanities.

  5. I think you are wrong associating Keynesianism with the ISLMADAS model, or in fact any model. It is about philosophical ideals that are much bigger than that which can be reduced to a geometric gadget or a series of equations.

    Ideas like:

    (1) The economy is not a household
    (2) The labour market can stay in a permanent deflationary environment because people are irrational - ie subject to fear, exuberence, social influences etc (NOT because of sticky prices);
    (3) the key to recovery from a deflationary trap is raising effective demand.

    The silly thing "New Keynesians" did was to embrace rational expectations and the market efficiency hypothesis - even when they not only have no empirical evidence whatsoever, but also defy the most basic common sense. Markets are not efficient because agents are IRRATIONAL - how much clearer could he have made this point in 1936 and 1937? It is in plain English.

    It underlies the importance why disciplines such as economics, politics and philosophy have to be familiar with their classics. Knowledge is not linear in these areas as it is with physics or technological development. It is subject to all the irrationality and swings in groupthink that go with human behaviour itself. I would not be at all surprised if the New Keynesians had never read a page of the General Theory.

    1. I would not be at all surprised if 99% of physicists had never read a page of Newton's Principia, especially in the original Latin, so they'd know what he "really said." They seem to be doing ok without it.

    2. calling all toastersDecember 9, 2014 at 9:47 AM

      Robert Maynard Hutchins wept.

    3. Everything in the Principia can be expressed in equations. This is simply not true of the General Theory or ANY work of economics. Equations in economics MUST be accompanied with a story that makes sense or they will not convince. The stories that underlie the equations of "modern" macro I find unconvincing, as they rely on absurdly hyper-rational actors. The Keynesian stories rely on people who sound real. When you read the General Theory it's hard not to get the feeling that Keynes's understanding of the motivations behind the actions of masses of people was profound.
      The current Keynesian argument is that the government could create demand by spending money to create jobs. This demand would unlock the inactive money in the private sector as investors sought to make profits by supplying the demand. That sounds like real people. Those opposed to government spending seem to think that these potential investors will not invest because they fear inflation in the future or higher taxes to make up for the stimulus spending. This story doesn't sound real.
      You don't need to read the Principia to understand the equations involving gravity, and you can prove them by dropping a roc off the roof.

      Sasha Cooke

    4. According to your wikipedia page, your father was a historian. Surely he must have told you at some point that the history of humanity is not a story of continual linear progress? Or does he believe that all information from the past is factored and built on in agent's decisions and knowledge cumulative - just like the REH?

      Civilisations rise and fall. People have short memories. Knowledge expands and is forgotten and is subject to swings in conventional wisdom, fads, and power relations (none of these things modern macro-theory , ie. applied mathematics, handles well). The fact that people forgot the lessons of the Great Depression, the singular most important case study for macro-economic policy, especially in a deflationary trap, AND tried to incorporate rational expectations into Keynes when the whole argument was that markets do not equilibrate because agents are irrational is a very good case in point. It demolishes arguments that we do not need to refer back to the classics in a second.

    5. Let's just remind ourselves of what Keynes said and how New Keynesians lost the plot.

      Perhaps the reader feels that this general, philosophical disquisition on the behaviour of mankind is somewhat remote from the economic theory under discussion. But I think not. Tho this is how we behave in the market place, the theory we devise in the study of how we behave in the market place should not itself submit to market-place idols. I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future (Keynes 1937, 215).

      Could it be any clearer? If you are going to put micro-foundations into Keynes it must be on the basis of observed social behaviour. This is making the case for insights from philosophy and psychology into macro-economics, and most certainly nothing like the REH.

      How interesting you are defending New Keynesian Economics. Perhaps this is a new consensus in formation. Like the one we had just before 2008. Ironically it is precisely the group-think behaviour that Keynes observed!

    6. The parallel to Newton and the Principia is actively misleading here. No physicist has claimed Newton was wrong--even Relativity extends Newton's theories, doesn't invalidate them. But if you want to criticize Keynes, yes, I think it would be kind of important to know what you're challenging.

    7. I'm not criticizing Keynes, or some mysterious novel economics that might come from reading keynes again and coming up with something new. I'm criticizing "Keynesian economics," as practiced by his followers, and implemented in their explicit, objective, and written down models, and policy advice they have generated for decades. To this debate, it does not matter at all what Keynes wrote. It matters what Keynesians write. To a different debate, "did Keynesian economics really capture what Keynes was saying?" it might. But that's not our debate.

    8. "mysterious novel economics that might come from reading keynes again and coming up with something new."

      That is how innovation often happens. Unfortunately in economics it seems people get bad ideas from reading the classics - notably those applied mathematicians responsible for re-digging up trash like Ricardian Equivalence from the Victorian English School of Economics. (Although I am sure scholars would argue that Ricardo is not in the same league as say a Plato, Marx, Kant or Keynes in terms of philosophical depth.)


      Read Samuelson, especially where he was talking about the contributions of Lucas, Sargent etc. during Fed policy meetings. (Hint: none)

    10. "I'm criticizing "Keynesian economics," as practiced by his followers, and implemented in their explicit, objective, and written down models, and policy advice they have generated for decades."

      Absolutely, and I think many people would agree with you. Although New Keynesianism took this to new levels, the problems go back a long way, starting I would say with the Hicks model and Samuelson and their attraction to the precisely the "pretty and polite techniques" that Keynes warned about (Anon 11.30).

      The low point was reached in the 1990s with Patron Saint of New Keynesianism, Stan Fisher's, response to the Asian Financial Crisis:

      "Indeed, the reluctance to tighten interest rates in a determined way at the beginning has been one of the factors perpetuating the crisis. Higher interest rates should also encourage the corporate sector to restructure its financing away"

      Of course this was exactly the opposite of what they advised the US in 2007-8 and as a result the Asian countries felt a sense of betrayal. This idea that there are different rules for the powerful considerably undermined US soft power and therefore its authority as pointed out recently by Stiglitz (posted in Mark Thoma's blog).

      The word flim-flam has become associated with New Keynesian economics, and soon it will permanently stick. The classics are important because they are a bulwark against having to relearn old lessons the hard way. Although we cannot expect to know works like the General Theory from front to back, we must have an accurate understanding of it. New Keynesianism is an intellectual forgery at the highest level. It fails that test and the consistency in policy practice one.

  6. To the similar complaint that there is "too much math" in economics: no, there is too little!

    I'd say the problem is that it's too sloppy. Mathematicians go to the trouble of defining the terms they use, whereas even supposedly "rigorous" economists waffle about fiscal and monetary policy in a way that leaves plenty of room for doubt as to what they mean. The "poor exasperated president" you mention was probably trying to say: "If you've got a rule for me, how come you can't say what that rule requires me to do right now?"

    On this whole "Old Keynesian" thing, I'd say commenter Ragout had you dead to rights in an earlier thread: in effect you're just using "Keynesian" to mean obsolete. But even if we accept your definition (and we shouldn't), the conclusion you want doesn't follow. An obsolete model may well be more reliable than a shiny new one. Just because nobody writes programs in COBOL any more, it doesn't mean that their logic was faulty or even that they were unfit for purpose.

    1. Forget Keynes for a minute. His argument was against the idea that huge government spending by itself is a course correcting mechanism for big recessions. Since economists prefer models rather than subjective opinions, ISLM and others were offered up. This goes back to his original point - no graduate programs today teach simple ISLM models as THE policy answer to big recessions. And that's why we have these more advanced models. We can debate whether those advanced models are all garbage, but they were invented precisely because ISLM didn't do a good job at all.

    2. "I'd say the problem is that it's too sloppy."

      I agree. Whether you choose a literary medium or a mathematical one, there is good and bad writing and good and bad maths.

  7. John,

    Another example of high policy debate was your "Unpleasant Fiscal Arithmetic" in the EER, no? It showed the importance of commitment and intertemporal decision making as it relates to fiscal policy. You cannot get any more modern macro than that and presumably it had some influence on policy debate.

    Along these lines, did you see this discussion of that article? Any thoughts?

  8. Much better. Here's a 'live one' to play with. Suppose a central bank adopts a Taylor-Henderson (Dale) rule. Under what unforeseen circumstances should it invoke an escape clause to confront for some previously unimagined state? (Peter Isard and I worked on that problem after our time at the Fed.)

    1. That's the great question, getting to the heart of the debate. The whole point of rules, of course, is to constrain yourself not to invoke the escape clause. My those sirens might really be great to listen to just this once. We'll tax away all the capital, just this once. We'll bail out the banks, just this once. So you want the rules to be just strong enough, but not infinitely strong. Post a link, sounds like an interesting paper.

  9. Link at the end. Isard and I published this stuff and then did not much with it for a while. Maury Obstfeld picked up on it and started the "Rules with and Escape Clause" Literature. Maury's point - for fixed rates anyway - was that the enhanced rule could have multiple equilibria. Fair enough - that's exactly what Garber and i found in our JPE paper on the gold standard (another rule with escape) Isard and I were at the IMF recounting our days at the Fed and trying to figure out how to put all the wild shit that hit the fan in the Volker years into a rule. We wrote the 88 paper because we knew we'd be at the Fed nights and weekends trying to figure out what to do when some shock hit that we'd never seen before.
    I do not think we ever really got it - but we took a shot. At the time, formalizing the appropriate response to a new element entering the state was beyond me. Link to the IMFSP paper

  10. Laymen members of your audience question some of your premises. For example, I would pose the question:

    "What is the empirical evidence that intertemporal models are a more accurate explanation of human behavior than static models"?

    As a layman passingly familiar with behavioral economics. I am well aware of how popular models developed in this manner have become. I won't dwell on the socioloigical reasons why complexity is in the professional interests of economists. I'll simply pose the question: what if human behavior is better approximated by static models? What evidence do we have that people consider the future at all?

    Or, if that's too marginal - what evidence do we have that consideration of the future doesn't boil down to an insensitive, static heuristic?

    Microfoundations based on false assumptions are literally worse than none at all. For all of the humility of the post, and all of its willingness to talk about what we don't know, it seems that the true lesson of all of that lack of knowledge is that the more complex a model is in areas of profound uncertainty, the worse it will perform.

  11. An awful lot of what you have written in this post is about your perception and is eminently subjective. A little ironic when you praise science in the same breath. To give but one example, you write "I think there are some unfortunate heirs of the old-Keynesian tradition still at work in policy-making, however. It is natural that they are there, but I think it will be good when they vanish." Well, I'm not sure what world you live in, but I'm guessing that your world doesn't have any 'old Keynesians' in it, but that you imagine them to be 'out there somewhere' like evil goblins or communists. But in my world the 'old Keynesians' are basically extinct and where they survive (Cambridge-England, The Journal of Post-Keynesian Economics, and maybe another place I haven't heard of) no-one pays attention, they are tolerated like lepers in a leper colony. You have it the wrong way around, imho, it's the old-RBC tradition that is still very much at work in policy-making and that we should wish to see replaced by something more scientific and less dogmatic. At our central bank, there has been about 4 RBC visitors for 1 NKE visitor since 2008. (I don't think either are particularly good, but that's besides the point)

  12. Best empirical evidence is in Milton Friedman's A Theory of the Consumption Function. Have a look. Friedman dismantled post-war Keynesian policy's three pillars: - 1.the fractional mpc leading to the govt spending multiplier - see above. 2. Govt fix of the Great Depression - have a look at his Monetary History with Anna - people are still fighting abt this. 3. In his AEA presidential address he laid out what would become the Phelps-Lucas rational expectations takedown of the accelerationist phillips curve. Above all - don't get hung up in the nonlinearities in modern DSGE work. You can linearize this stuff and get (roughly) the same story - there are some 2nd order risk thingys also. And do not go nuts over our inability to forecast - we have never really been good at forecasting. It's the nature of the beast - you always fight the last war then adapt.

  13. It seems Cochrane is firmly butting up against the dilemma between "what is?" vs "how ought we be, given what is?" The scientific method has allowed human debate to get so refined that we can no longer reliably separate the two.

    Lately, I find my fervor moderated not by any real change in my views, but rather in the recent difficulty we are all experiencing getting anyone on either side of our arguments to concede much of anything. What is driving this polarization? Ignorance? Laziness? I no longer think these describe the modern informed positions. I find it isn't too hard to use the is/ought template to generate the other sides' position. The more psychology, sociology, and political science you know, the easier it seems to be to predict the other side's response. This doesn't mean I'm more right - it seems to mean that much (maybe all) of our (informed) discourse is rooted in factual versions of reality that simply emphasize one or the other side of the "is" / "ought" divide. All too often commenters on both sides are unable or unwilling to address the fact that their staked positions are actually un-addressed facets of the same is/ought state.

    So we aren't disagreeing because we know "so little" - we are more and more disagreeing because we really do know a large fraction of what we need to know or ever *could* know, and both sides are accurate special cases (but not necessarily symetrical in their accuracy or applicability to the current discussion).

    So what is the resolution? First, accept that their is a necessary is/ought paradox at the bottom of any well-informed discussion. What is truly unifying is how this seems to be a mirror-image of Heisenberg Uncertainty and Wave-Particle Duality, and this relationship is instructive. I would assert that the apparent fact of the dimension and direction of time is what causes the similarity. And at it's core, economics is a description of flows that are remarkably similar in complexity to electromagnetic systems - only economics has more degrees of freedom - more dimensions - and the elasticity of those dimensions is always dynamically defined by ideas in people's heads - the distribution of those ideas, their varying rates of propagation in the population, and the characteristics of the population, itself (it's superficially humans, but ultimately the population could only ever be fully modeled by also accounting for the (economic impact of) all bacteria, viruses, and even particle states).

    Just as physics had to come to terms with the idea that it is no longer possible to *fully* model a system built on quantum uncertainty, economics must also come to terms with the idea that there will never be a complete economic model - because as soon as you accurately describe what "is" you necessarily modify the rules agents "ought" to employ. Furthermore, the idea that we will approach "the truth" or "reality" asymptotically is an illusion caused by focusing on small populations. Yes, you can get more and more accurate - to a very small error - if considering a small population. But as soon as you try to apply that to the reality-sized population, sync influences and the inherent error quickly grow too large to allow usefully accurate predictions beyond a mutually agreeable horizon.

    We probably need to fall back, like physics did (both the Schrodinger-Heisenberg unification, as well as the AdS/CFT Correspondence), and emphasize the pursuit of working out how saltwater macro describes the same thing, in different form, as freshwater macro. Keynes described an abbreviated special case (or sub-set of states) within both transformations, as did Hicks, as did Lucas, as does NK, as does Cochrane, as do modern liberals and conservo-libertarians. The only remaining erroneous position may well be a futile static encampment on one "side" of this unified socio-politico-econometric super-symmatry.

  14. This is actually a brave piece.

    At first I thought to myself "Someone who is a layman would misunderstand the disingenuousness of this. Like where he says the new Keynesians do not think about the intertemporal models. What a laymen would need to do is ask any of the thousands of people who have studied graduate level macro from Romers ubiquitous textbook ..."

    And the layman might turn to a friend who did a masters once 10 years ago and say "is that true?"

    And the friend would say "Well, look. When you read the piece, as much as it is written in a conciliatory tone, you can see that it is not cleanly neutral. It is obvious that there is like this undercurrent of passive aggression and barbs. I mean when he is throwing out that New Keynesians are reading Marx and the Talmud that is obviously not the case and kid of the style of the entire piece.

    "Have you ever seen the show Happy Days where The Fonz is unable to say he is wrong? Well in terms of prescriptive economics, those in the 'modern economic' school screamed loudly prescriptions those prescriptions turned out to be wrong. So John Cochrane here in this piece is like Arthur Fonzarelli . He is like: 'I was wro.. wro ... but the New Keynesians only look at the static picture, our model is more complex and looks at the intertemporal picture. But anyway, I was wro.. wro.. hey, did I mention the importance of mathematical rigor? ...'"

    On a personal level the cognitive dissonance must be powerful. I mean your standing in society as a professor at one of the world’s most prestigious schools, your prestige, your feeling of self-worth ... it’s all tied up in these models.

    One could argue that you have more invested in these models than those religious cult members from the textbooks on cognitive dissonance who go out into the middle of the dessert on apocalypse day to be rescued by aliens on the divine day, and the cognitive dissonance experienced when the prophecy does not come to pass.

    1. I have to agree with this, though this post is a big too negative for my tastes.

      You sound like you pissed off a lot of people by being a bit of a grumpy jerk and so instead you try to reconcile and prove how considerate you can be. Though instead you honestly come off a bit over-sensitive and insecure in an attempt to *look* nicer while still not conceding anything.

      As another comment author said you also seem to like to paint a picture of Keynesian = Obsolete. As if there's the modern new macroeconomics that is highly evolved and then some crusty old guys still kicking around that old Keynesian can.

      Quite honestly I think it's fairer to look at it like physics models... let's say newtonian physics vs special relativity.

      Just because special relativity indeed models situations that newtonian didn't model doesn't mean we throw out all of newtonian physics. Newtonian models are still very useful for certain situations.

      Find where the models are accurate and use them accordingly. From a physics perspective we can also throw in quantum mechanics. We still have yet to conclude on a universal physics theory/model to unify them all. Yet we still use the different models for the situations that fit.

    2. The physics analogy is remarkably appropriate and illuminating. Thanks!

  15. Professor Cochrane,

    You and Paul Krugman ought to read each other's writings a little more often. If you did, Krugman would know that you have been praising Woodford for a long time and you would know that Krugman and many other Keynesian economists objected very strongly to your blog post on Woodford's Jackson Hole speech in 2012. Here, for example, is David Beckworth explaining why he thinks you are guilty of major reading comprehension errors that result in claims you put in Woodford's mouth that are inconsistent with Woodford's stated positions. Your analysis that follows all but calls Woodford's policy recommendations stupid.

    You might also have noticed that Krugman has given you props for trying to understand New Keynesian models, but that he doesn't understand how you could fail to grasp some of the essential elements of the literature. More than a year ago, Krugman explained why he thought you were confused about the effects of fiscal policy on GDP vs consumption in standard NK models. Objectively, NK models say what they say whether they are right or wrong. If you assert they something different from what Woodford or Krugman do, isn't the onus on you to read their critiques and respond?

  16. As usual, I think just the opposite. I am invested in the models I created , but that is just the structure of the profession - and even on those models I fiddle around when there is new data. I learn and use the models others have created, but I use them mainly as another viewpoint. Trying a bunch of models on a problem is a good way to clear out the crap to see what needs to be done - a mental enema.

  17. "Well, it's hard to follow rules ex-post. That's the whole point of rules!"

    "I'll keep to the usual don't-respond-to-Krugman policy, with one exception."

    OK, I'm not a regular poster and don't mean to be snarky, but that's pretty rich. Particularly with the "just this once" response in the comments.

    In any event, since the audience here is probably better suited, can anyone direct me to a good response to one of Krugman's infamous Keynesians-get-everything right posts? This one is old, but seems relevant. A quick clip:

    "Anti-Keynesians assured us that budget deficits would send interest rates soaring; Keynesian analysis said they’d stay low as long as the economy remained far from full employment. Guess who was right?"

    "Keynesianism isn’t just about sticky prices, but it does generally assume sticky prices — and there is overwhelming evidence, from a variety of sources, that prices are indeed sticky."

    "Mainly I’d stress the first point. We have a model of the way the world works, and the world does indeed seem to work that way.
    "In fact, however, my preferred model has passed the test of events with flying colors, while the other guys’ models have been totally wrong."

    Sorry, not trying to be a Krugman fanboy, though I guess I qualify. I'm just a layman looking for a little counterpoint to follow. Maybe an example of somewhere freshwater folks got it "totally right"?

    1. About that Krugman piece: Notice that he never names or provides any links or quotes from any of these "other guys." Also, keep in mind this article was written by someone who, among other things:

      Repeatedly warned of a "deflationary spiral" a few years ago

      Called the sequester last year a "fiscal doomsday machine" and "one of the worst policy ideas in our nations history," adding that it could cost the economy "around 700,000 jobs" (see Cochrane's post from a couple weeks ago)

      Wrote last year that "we are in effect getting a test of the market monetarist view right now" and "the results aren't looking good for the monetarists"...then after the economy performed better than expected, claimed it was never a test of market monetarism after all.

      And I'm sure some of you remember this attack on Greg Mankiw regarding the White House's growth projections in 2009.

      Some of his posts are almost getting comical at this point.

  18. With regards to the line regarding the word "stupid", could it be that you're missing the transitive logic of Krugman's post? In the sentence before he writes "And it has been remarkable in the years since to see how determined anti-Keynsians are to keep believing that Keynsians are stupid." When one juxtaposes that sentence with the remark on how you now concede that "...Woodford isn't stupid" seems more a swipe at a mindset than remarks on a specific individual.

    I would have thought a stronger response would be a defense of your positions on Keynsians in general rather than on Woodford?

    1. Exactly. Krugman was drawing an inference, based on public statements by Cochrane, Fama, and Lucas. An entirely justified inference, in my opinion.

  19. As anonymous writes above, you've missed Krugman's point vis a vis 'stupid.'

    In addition to Anon's comment you should remember that it was just over a week ago, in his post Notes On the Floating Crap Game, he wrote:

    ...reading Fourcade et al, it occurs to me that the way everything outside macro works may explain one of the things that has puzzled me in the disputes over macro policy — namely, the seemingly unquenchable certainty among some of the freshwater guys that Keynesians are stupid.

    This has been a running theme for years with PK. Your defense that he has misquoted you badly misses the point. He believes your past statements have implied that Keynesians are stupid. He doesn't need a direct quote.

  20. OT –

    Thoughts on your paper…