On the Failure of Macroeconomists

For the past month or so, I’ve made it a habit to ask fellow economists how the response to the financial crisis has been improved by the past few decades of macroeconomic theorizing. Dozens of conversations later, I don’t have much to report.

Today’s big question is whether government spending can pull us out of this recession. We want to know what sort of oomph to expect from fiscal policy. In technical terms, this is a question about the multiplier: if the government starts spending more today, how much more spending will that stimulate tomorrow? And how worried should we be about government investment crowding out private investment?

If you took your first economics class 50 years ago, you’ll recognize all this talk about marginal propensities, multipliers, and crowding out. Fifty years later, it’s still the same debate, and it’s still unresolved. Why are we so reliant on mid-century macro for understanding our current predicament? And why haven’t we developed better answers?

Unfortunately, fiscal policy has largely disappeared from the research program of modern macro. Here are some facts, courtesy of my research assistant who searched Econlit (the guide to published economics). We searched for the number of papers published each year that mention monetary policy versus fiscal policy, in either the title or the abstract.


The rise in both lines reflects the increasing production of economic research, and the widening scope of the EconLit database. But the main point is evident throughout this period: there are about three papers written on monetary policy for each paper mentioning fiscal policy. And there are only a few dozen papers written on the multiplier each year.

The N.B.E.R. working-paper series has a similar flavor: you have to comb through a decade of yellow books to find 40 papers written on fiscal policy, while the past two years have generated an equal number of monetary policy papers.

I’m not sure why fiscal policy is the ugly stepsister. Perhaps the problem is ideology, and pro-market economists don’t like any discussion that gives government a greater role. Or perhaps there are just too many temptations for young economists — monetary policy research pays off because there’s a comfortable career path running from monetary research to the money markets.

Another possibility is research funding: there are 12 regional Federal Reserve banks subsidizing research on monetary policy, and almost no one provides similar subsidies for fiscal research.

Whatever the reason, the failure of macroeconomists to speak to this critical policy issue undermines our claim to relevance.


Or, perhaps Friedman's Theory of Consumption proved Keynes wrong.....

Jason B

I'd say it comes down to non-existant risk managment for the field of economics. As you said, the Federal Reserve naturally funds research on monetary policy. Who was systemically looking out for the overall development of the field? Who really considered that monetary policy would be at its limit, like it now is, with really only fiscal policy left to turn to?

No one.

Maybe in the future economics folks will be better at promoting both sides, even when things are comfortable and monetary policy is in vogue.


We don't have many fiscal "events" to study, thus we argue about what happened in the Depression or in Japan. Second, we argue about the facts of what happened because, again, we don't have enough events.

Third and certainly not least, economists were actually arguing recently that macro events such as great shocks were either things of the past or were naturally confined by the changes in the financial system. Of course, it turned out they were enabled by the changes but the entire idea was wrong.


i'll go with the cynical explanation: that economists have become mere apologists for corporate power- hence all the claptrap about 'free markets' and private enterprise/profit- the responsibility of any intellectual is to enlighten understanding of the way the world works, not obfuscate with propaganda- but there certainly are macroeconomists that have earned their integrity, e.g. Dean Baker has been a solid advocate for market regulation long before the houses hit the fan

jonathan feldman

I would think it is because monetary policy is checked and balanced with every other currency. Fiscal policy has no such limit. As such we can (and have) spent far more than we should have been allowed to before lenders stoped lending to the government. The point is that when studying monetary policy the outcome in knowable, with fiscal policy it is far more dificult to decipher and more importantly it is not knowable when the effects of a fiscal policy stop changing the fisca situation. For example the federal tax rates change long before any kind of stasticaly significant data can be drawn from it.

I also very much like the funding argument. All else being equal people will do their research where they get funding for it.

Bob C

Poor Keynes - he was essentially correct in all major respects but is only rememebered for exactly half of what he said.

It is certainly true that increased governmental spending to spur the economy comes with possible inflationary side effects. Hence the reason he recommended an expanded role for government during economic recessions and down turns.

What everyone forgets is the second part. You know, the part about government reducing deficits and cutting back spending during upward swings in the economic cycle.

Problem is now as it was in Keyne life: government leaders who lack the discipline to assist the markets when necessary and get out of the way the rest of the time. Wisdom to know which time is which would also be useful.

Joe Smith

The problem with all of the talk of the effects of stimulus is that it all assumes that 2006 was some sort of equilibrium.

2006 was a bubble in housing prices, stock markets, bond markets, credit, employment, income and consumption. It was fueled in part by massive ongoing stimulus from the Federal government deficit.

To debate over how best to get back to the height of the bubble is a foolish and childish exercise. Better to discuss how to get from where we are to where we can reasonably expect to be as quickly fairly and cheaply as possible.

Personally, I think that that all the government can reasonably do is: offer retraining assistance, force the derivatives markets (a major source of instability) to become transparent or to unwind and pump liquidity into the commercial paper market. The rest will have to be done by individuals seeking their own advantage.

Michael F. Martin

Who cares what the multiplier is? The government has got to make clear what it is going to do or not going to do so that private investors can fix that variable in their forecasts. It's more important for the government to make a public commitment to do something definite and then stick to that than it is what the government does in my opinion.

Eric M. Jones

I'll take the hard-boiled, profoundly cynical view:

Economists delight in believing they are some sort of "scientists", while in reality, they are simple pedants who worship supposed authorities and artfully mumble quasi-scientific cliches. If ever confronted with their wildly-buffoonish errors, they spout evasive answers--and blame reality for not "behaving as predicted". The "Dismal Science" is certainly not science.

What really scares me is that fundamental economic health is based on faith and trust. When enough "bad actors" scam the system, the faith and trust simply disappear. Now you can't trust the banks or the government (or even the Church). Wall Street crooks are rewarded handsomely. CPAs, after Enron, seem simply skilled at cheating the system.

I remember when announcing that "A government study says...," would settle any bar bet. Now finding someone to trust at all seems a naive and childish dream.


King Politics

I don't necessarily blame macroeconomic research for keeping up and predicting the current crisis or what to do about it. Academics, unfortunately, usually lags behind current events and we're best at developing post hoc explanations, not predicting future events. Besides, there is exact predecessor for these events. For instance, the economy before the Depression - caused by a bubble, yes - lacked the government entanglement in the market we see today.


Bobby G

I'm not sure if fiscal policy directly encapsulates things like taxes and subsidies or simply just "independent" government spending. In my mind, I'm aligned with what #6 said: it certainly would be ideal if the government always knew how (and how much) to interfere with free markets to improve efficiency in cases of market failures and then when to back down when they are not needed. However, those 3 criteria are, as evidenced by most actions taken by our government in its current state, rarely if ever met. A large reason for this is due to the way our government and political system has blossomed into one giant conflict of interest for politicians.

As such, I have very little confidence in the efficiency of our government and practically would prefer market failures than the government attempting to fix them. I consider myself a much more responsible spender than the US government and as such would want to trust them with as little of my money as possible. Fiscal policy almost always demands more taxes to be spent on likely hugely inefficient government programs that are virtually impossible to stop from a legislative standpoint. Not to mention the incentive destruction that comes with increases to taxes like income tax and capital gains.

Bottom line: please let me keep my money.



The JME exists, there is no corresponding Journal of Fiscal Policy.

Robert Waldmann

I think the explanation is simple. There is basically a consensus among macro-economists that, except maybe when the economys is in a liquidity trap, monetery policy is at least as good an approach to macroeconomic fine tuning than fiscal policy. The disagreement was whether it was better or whether they were equally worthless.

The case against fiscal policy is simple -- first economists since Keynes have argued that public spending arrives too late after the downturn is over. Second the effectiveness of temporary tax cuts can't be elegantly reconciled with the permanent income hypothesis which sure is nice and elegant. Third fiscal policy is set by congress and no one who eats sausage and believes in fiscal policy should watch either being made. Fourth (well third and a halfth) any excuse for deficit spending will be abused by politicians who enjoy it.

Now the rate on 3 month T-bills is essentially zero and the consensus gives us no guidance on fiscal policy.



Fiscal policy is inherently messy and political. What kind of stimulus and what does the money get spent on? Fiscal stimulus can be quite ineffective, think of 2001, or effective depending on what is done. Crowding out is only a concern in a strong economy, otherwise every expanding industry would induce the same crowding out and there would be no growth. In the absence of growth and inflation, crowding out is fantasy.


"The rest will have to be done by individuals seeking their own advantage."

Blah blah blah. When will economists learn that rational choice is dead--better yet, it was never alive.


More deeply, I think the situation that would call for fiscal stimulus has been consciously avoided because the implications and solutions are highly unpleasant to economists. Instead the belief that monetary policy would always be sufficient and superior held sway. Economists want to believe markets are always and everywhere superior to government, that they are always more efficient, that their distribution is optimal, and that the worst market failures are less than the least government imperfection. There have been circumstances where they have had to confront externalities and failures, but have done so only at the greatest reluctance. Something as deeply problematic as catastrophic economic failure is confronted with shock, denial, and all of grief.

Brian Shriver

It seems to me that modern macro has reached a dead end. If you start with a model which assumes equilibrium or slight departures from it, you can argue for years about multipliers without getting closer to an answer.

The problem is that your core assumptions are too far away from reality. Of course there is no such thing as economic equilibrium. The production function is a joke (except perhaps for Soviet managers). Etc.

More relevant to the current crisis, modern macro ignores a lot of important detail when it assumes saving equals investment. This naive formulation conflates three separate processes, each with their own behaviors. Moreover, the current crisis is a disease of the processes involved, not a deviation from equilibrium due to suboptimal fiscal or monetary policy.

Let's break this down.

1) Separate in your minds the payment flows for the real economy (C+I+G+NX, wages, taxes, transfers, gifts, etc) from financial flows. In the real economy, individual nodes may run surpluses or deficits, with the constraint that aggregate surplus is zero. In broad terms, the financial economy will mediate surpluses or deficits in the real economy.

2) Money accumulated by nodes in surplus are forwarded to other nodes via primary financial flows, creating financial instruments such as equity and debt. Of course, when financial markets are in a tizzy, these primary flows stop.

3) Borrowed money can be used to finance business investment, but also deficit spending, and even leveraged investment. Keep in mind also that some business investment is self-financed. The net result is that savings and investment has very little to do with each other.

The current crisis in a nutshell:
a) increasing imbalances in the real economy led to large primary flows (20+% of GDP??). The primary source of imbalances was household income polarization and the trade deficit.
b) excessive liquidity in financial markets led to declining standards, resulting in over-investment in residences and excessive leverage by intermediaries. The risks of excessive leverage were papered over by a network of CDS's and other risk management tools which were worthless in the aggregate.
c) troubles in subprime hit over-leveraged Wall Street like a bowling ball, forcing panicked deleveraging.

The problem as I see it with the debate surrounding the stimulus package is that people seem to be looking for traditional tools to bring output back up to equilibrium levels. Not only is this itself a fantasy, it also ignores the real problems - including the real economy imbalances which fed the credit market and real estate bubbles.

Neither fiscal nor monetary policy can fix the current problems. What's needed instead is an economic rebalancing.




Very insightful comments, and well-written. However, "markets are always and everywhere superior to government..." is, contrary to your opinion, very near absolute in the real world (however--by necessity--heavily assumption-laden in economic models). It's, as all things, the underlying incentive structure. Cost minimization and budgets just don't mesh. I pray that this Keynesian tact is successful and Mr. Obama recognizes when to take the back seat. I have faith that he will, so long as he anticipates the lag before it's too late (seemingly oxymoronic).

An aside: do macroeconomists control for lagged media sentiment in their forecasts (i.e. frequency of the utterance of "recession" in spoken and print media during the quarter or half prior)?


I am not a macroeconomist, I am full, micro. But one thought is compare this to the other sciences; physics esp, but also chemistry,

In those we rely on mid milenium discoveries and it hasn't moved on much. The only difference is that the science of physics is more accurate and predictable. perhaps the existing Macro is pretty good in terms of the accuracies of economics, and it hasn't developed further simply because its hard to get a more accurate model. similarly in physics we haven't been able to find a more accurate model for E=mc2, and f=ma, since they were first discovered.


At least that is the charitable view. Others see in this greedy self-interest and propaganda to protect and advance their interests and ideology at the expense of the others and the public. I do not doubt many know what they are paid to offer and that they were selected for that. They know what their customers want to hear. Deluded or opportunistic?