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.


Next to Ché people are now putting Keynes on their red banners.

History is repeating itself, it's not even funny. The worst thing is this is happening during my lifetime and I'll have to deal with it for my entire life.

Workers of the world, unite!


Also, nobody seems to wonder why it's mainly people with no concept of economics are the most adamant proponents of stimulus packages like this. I'm not saying here in this place but within "the public at large".

It's frightening.


#20 -

What you're saying is a major overgeneralization; much like macroeconomics in general. Comparing micro-economics to physics in the manner that you suggest is quite inaccurate; physics makes predictions that are falsifiable. Macro-economics doesn't really do that at all. It's more of a social science (at best); there are no sorts of covering laws or falsifiable predictions that the discipline makes.


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

With a Permanent income consumption function, things don't change so radically. Temporary fiscal stimuli still have impact.

Moreover, expenditures aimed at employed - who are typically credit constrained and where hence the PIH doesn't/can't work have full spending effects.


Correction to my previous posting:

Moreover, expenditures aimed at the UNemployed - who are typically credit constrained and where hence the PIH doesn't/can't work, do have full spending effects.

Nick Rowe

Robert Waldman #14 has already said what I was planning to say. Spot on, Robert!

j. Ringomon

Too many assumptions they make are wrong/ oversimplified.

For example: People don't act in their own self interest. They act in their own perceived self interest. That's a big distinction in my mind.

For example, many people in power roles make desicions to increase short term profitbabilty, but are in fact decisions that deteriorate their customer base in the long term. They might get out before everything collapses, but maybe not. Plus, even if they do, they've still ruined the market for future profits.

Outsourcing is an example of this. Outsourcing increases profits in the short term, but erodes the viable customer base in the long term. Credit helped prop up the base for a while, but now we're starting to see the true effects of such decisions, and their corrosive impact on the middle class that makes up a majority of the purchasing power of America.

Economists like to say things like the people just need to be retrained- but retrained to do what?
IT? Oitsourced
Engineering? Outsourced
Customer Service? Outsourced
High tech manufacturing? Outsourced
Scientific research? Outsourced?
Ecomonists ? Not yet, haha.
So maybe it's just a problem of the pain not hitting close enough to home for them to see what's really happening.


Jon Claerbout

The multiplier is irrelevant for a program that is politically neutral and can be scaled up or down rapidly. Give interest free loans to tax payers. Let them choose whether to spend, payoff, or invest.


The current plan to stimulate the economy is ridiculous. I voted for President Obama, but I think this stimulus bill is nothing more than earmarks that have been renamed "stimulus". They need to get money into the hands of people and small businesses. They seem remarkably stunned about how to do it.

Given that between the treasury and the federal reserve they have already spent about 3 trillion and there are reports that it will take 2 - 3 trillion more to buy up the bad bank debt, that is 6 trillion dollars. That 6 times what they told us it would cost in September. If we assume that the current 6-times factor will turn the total bill into 36 trillion before this is all over. If we assume there are 300 million Americans, that is $120,000 for every American -- young and old alike. Why don't we just give it out to every American. That would really stimulate the economy

Inflation would go wild, but give it out and implement wage and price controls for the next 5 years. Just to make sure everyone gets their fair share, Americans under 18 will have their checks put in trust until they become 18.

My plan to give $120,000 to every American would not only stimulate the economy, but it would also create a great social engineering experiment. Who would use that money for long term success and who would not. I would predict that we would have a burst of entrepreneurial efforts that would result in a vast expansion of the economy and it would be based on real goods and services instead of imaginary assets such as credit derivative swaps.



j. Ringomon #28,
Outsourcing, "...erodes the viable customer base in the long term"

It's a global marketplace my friend. It may erode a costumer base in one country, but it builds a customer base in another.

Look at the shift in pay and standard of living in countries like India in recent years. Wages continue to rise in these countries as job markets fill up and the people expect more and more for their time. Barring external forces, the pay differential will eventually even out with ours and outsourcing will be less prevalent (or more prevalent, depending on how you look at it...mutual outsourcing?).

j. Ringomon

Too simple of an assumption I think... one I hear often. Why do people assume that the two markets are equal?For example, What about makers of expensive goods, like cars or electronics?
An American customer base and an Indian customer base are not the same thing, because the Indians are getting paid less (the whole point of outsourcing), so they cant afford the same amount of goods. You will either need to reduce your prices, or face diminished sales. It's a race to the bottom, with short term gains for those in power. Money has been skimmed off the backs of the outsourced american workers, and unless the recipients of that new profit (Upper management, shareholders) reinvest it at 100% the market is now working with less money. The problem is, the more money people have, the less of it they tend to spend as a percentage. I think this is what is happening to the American economy, it just hasn't been clear until now because it was being propped up with credit.

People assume that the high paying jobs will be replaced, but with what? Once engineers and IS people are geting outsourced, what should these people do? It's a serious question.

What will millions of Americans be doing 25 years from now to maintain middle class lifestyles once these previously white collar jobs have been outsourced?
Not everyone can be a CEO or a stockbroker.



Isn't the main problem with dissecting fiscal policy that it arises from the assumption that taxes are the main fund base for governmental spending?
It's a much nicer theory to see governmental spending as entirely a product of international investment and government-endorsed inflation rather than as something that can increase only as taxes increase. The less the consumer sees the burden of their own government's actions on their own shoulders, the more change and policy shenanigan-ry the composite government can get away with!


Schoolyard silliness? The point is that the level of the debate is that one. You said, I said, she said, he said, with hardly some supporting evidence. Ideology and alter-ego are behind these debates. The worst is when they cite some academic literature or economists of the past (nothing better to do than backword-looking) and when you check it you may realize that either is not true, not existant or simply not applicable. These debates are sometimes "very depressing" and "not very stimulating". No good for economists or laymen.

John N. Winn

The bigger failure of macroeconomics has been its complete inability to recognize endogenously the formation of financial bubbles and panics.


I think there are three main reasons for the neglect of fiscal policy. The first is the belief, right or wrong, that fiscal policy is ineffective (via Friedman), and the ineffectiveness is argued to be both economic and political. Second, monetary policy under Taylor rules have dominated short-term stabilisation. (Asset prices are not mentioned in standard Taylor rules.) Third, the domain of fiscal policy now relates to medium-term and long-term issues, and the economics of short-term stabilisation has withered on the vine. Only recently is there talk of the three Ts and the three Ps, principles under which counter-cyclical fiscal policy should be conducted.