Politicizing Macroeconomic Policy

A strong and sustainable global recovery needs to be built on balanced global demand. Significant weaknesses exist across G-20 economies. I am concerned by weak private sector demand and continued heavy reliance on exports…. Our ability to achieve a durable global recovery depends on our ability to achieve a pattern of global demand growth that avoids the imbalances of the past…. In some countries, strengthening social safety nets would help boost low levels of consumption. In others, product and labor market reforms could strengthen both consumption and investment. I also want to underscore that market-determined exchange rates are essential to global economic vitality.

This excerpt from President Obama’s letter to his G-20 colleagues ahead of the summit highlights many of the themes that global financial leaders discuss at such gatherings, but it is also notable for its tone of scientific certitude. There are readily identifiable characteristics of poorly functioning economies (“weak private sector demand”, “heavy reliance on exports”, “low levels of consumption”), and specific policy interventions that will cure these problems (“strengthening social safety nets”, “product and labor market reforms”, “market-determined exchange rates”). Fixing economies, in this view, is much like fixing a car. Take your car to the best mechanic you can find, and he or she will identify and correct the problem. Take your economy to the best economist you can find, and he or she will—in just the same way—identify and correct the problem. So how do we find the best economist for the job? It turns out that this isn’t so easy.

Macroeconomics is the branch of economics concerned with the economy as a whole. Mainstream macroeconomic policy is divided into two camps: Keynesians and monetarists.1 Obama’s letter is representative of the former viewpoint. It calls for active intervention in economies by government, direct “stimulus” spending, and a focus on consumer demand. Milton Friedman is often identified as the intellectual father of monetarism: the doctrine that the government’s only macroeconomic role should be controlling the supply of money in the economy.

Sociologists2 and philosophers of science3 concerned with expertise have proposed several possible criteria for deciding whom to believe in cases where we don’t have the necessary knowledge to make a decision on our own. Four popular criteria are credentials, experience, track record, and bias. Given two purported experts we often look to their professional status first for an idea of which to believe: Do they have a Ph. D. or are they a professor? Do they have peer-reviewed publications? Our next possible step in judging expertise is to ask whether our candidates have experience within the domain of the question. On issues of global warming we value the advice of climate scientists over geological engineers, for instance. Thirdly, we might ask whether those experts have gotten similar questions correct in the past. And finally, we might look to other, “external”, factors that might make us distrust an expert’s advice. If somebody would benefit personally from our taking a course of action, or has strong prior political views that could influence their answer, we tend to be more wary of their advice.

Neither of the first two criteria is especially helpful in evaluating advice from economists. There are many economists who have roughly equivalent credentials and experience who nonetheless disagree markedly regarding policy. What about track record? Keynesianism has been around since the Great Depression, and Friedman’s monetarism dates from the mid-1950s. While Keynesianism has certainly been the dominant doctrine for most of this period, both of these views (and many others) have guided the policies of many states at various times. Allan Greenspan, chairman of the U.S. Federal Reserve for almost twenty years, was, for instance, a strong monetarist (though he famously recanted after the 2008 crisis). Surely we can look at history to determine which of these doctrines work better?

The stock market crash of 1929 triggered the Great Depression. Herbert Hoover’s interventions were insufficient, but Franklin Delano Roosevelt’s New Deal and increased government spending eventually led to recovery by the beginning of World War II. Or was in not the stock market but bad monetary policy by the Federal Reserve that caused the depression? Or was it World War II that caused the recovery rather than Roosevelt’s policies? Or did World War II actually make things worse? Economists have been arguing these points for nearly a century now, with no clear resolution.

Diagrammatic representation of a macroeconomic model (Evans, p. 56).

But it’s not just the messiness of history at fault. Economic models are complex mathematical descriptions of the economy. The models take inputs such as current GDP, inflation, and worker productivity, and output predictions for those values in the future. Some models use monetarist theory while others are Keynesian. In theory we could look at the predictive success of these models and infer which underlying theory better describes the economy. However, in sociologist Robert Evans’s study of economic modeling in Britain during the 1990s, he found that none of the models under study performed uniformly better than any of the others: some models predicted some changes better than others, while other models predicted other changes better than those.4 Even incorporating all the best current data, all of them performed pretty poorly.

So while history is not useless for judging macroeconomic theories, it does not leave us with a clear picture.

The final criterion for choosing an expert is bias. Paul Krugman (an avid Keynesian), for example, has strong egalitarian and liberal views. This no doubt predisposes him to prefer a style of economic management where the government takes an active role in the economy. So maybe we shouldn’t take his economic advice at face value: perhaps he’s just really good at making a convincing-sounding argument whether or not the facts support his position. But on the other side, monetarist economists like Allan Greenspan owe their philosophical allegiances to the likes of Ayn Rand and Robert Nozick, libertarians who argued that any kind of redistribution of wealth was morally equivalent to theft.5 Both sides of the argument about how the economy does work subscribe to competing views of how it ought to work.

Where does this leave us? Evans argues that the problem is not a lack of policy consensus among economists, but a lack of institutional mechanisms for mediating disputes. Diversity of opinion among policy makers forces their interests, values and assumptions into open debate, whereas consensus creates an illusion of objectivity. Economic models do tell us something about how the economy works, just not everything. What this ought to allow for is a public debate over the normative side of economics: what are, as a society, our economic values?

The problem with Obama’s letter is that it sweeps these issues under the carpet, making economics look like car repair. The scientific and objective language of the letter conceals the unavoidable reality that Obama and the G-20 leaders are doing politics, not simply implementing rational governance. There are plenty of mainstream economists who disagree with Obama’s economic policies. We need to raise the level of debate within society so we can have an informed discussion—a political discussion—not let a select few make these decisions behind closed doors while pretending that it is merely a matter of sound policy.

  1. Yes, I’m aware there are many other views.
  2. Collins, Harry & Evans, Robert. Rethinking Expertise. University Of Chicago Press (March 1, 2009).
  3. Goldman, Alvin. “Experts: Which Ones Should You Trust?” Philosophy and Phenomenological Research, Vol. 63, No. 1 (July 2001), pp. 85-110
  4. Evans, Robert. Macroeconomic Forecasting: A Sociological Appraisal. Routledge (1999).
  5. Though Nozick allowed for one-time reparations for past injustices.

9 Comments

  • W. Dean Reply

    Hello Mike,

    I have to take issue with the claim the criteria of expertise you mentioned don’t help us when it comes to macroeconomic policy, especially “bias,” which I would prefer to call “priorities” to avoid the pejorative connotation. We can see how salient priorities are when we consider that economists will reject even universally accepted microeconomic policies on political grounds. Left-leaning economists, for example, often support minimum wage and other labour laws, even though they’d have to admit that Economics 101 says that getting rid of them of would create more employment.

    I realize that things get more complicated at the macroeconomic level. But the unsettled state of macroeconomics is a point over which economists themselves agree, so the burden of proof must rest on the shoulders of the interventionist. Consider some settled stuff. All macroeconomists agree that you don’t really “create” 2000 jobs by hiring 1000 people to dig a ditch and 1000 more to fill it in. This ultimately destroys wealth through the inefficient allocation of resources. (I note that a “National Ditch Digging and Filling Program” is not a lot different in principle from spending billions on infrastructure projects to “prime the pump.”) Yet some economists would no doubt prefer to trade the short term gain of x-number of people employed for possible long term loss of real growth. Knowing their priorities, therefore, does help you know how an economist’s policy will play out.

    The harder case to judge, at least on the face if it, is an economist like Paul Krugman, who actually believes that Keynesian pump-priming works and that it’s a necessary response to “market failure.” For him, infrastructure spending is not a matter of choosing the short term trade-off, it’s just good policy. But this case is really the same as the first: it’s exactly the interventionist’s unsubstantiated certainty that should make us hesitant to accept his policy without more evidence. So, once again, priorities matter.

  • Mike Thicke
    Mike Thicke Reply

    Thanks, that’s a great comment. I have a couple thoughts.

    First, I don’t think “bias” and “priorities” are capturing the same idea. Economics 101 tells us that when choosing economic policies we face tradeoffs, a common one being between “efficiency” and “equity”. It would be a standard story to say that left-leaning policy-makers would prioritize equity over efficiency more than right-leaning policy makers. In this story the leftists and the rightists agree on the the positive side of economics, but come to different normative conclusions. The idea I’m trying to get at with bias is that the leftists and rightists also don’t agree on the positive conclusions of economics. To quote Krugman, “The Great Compression, far from destroying American prosperity, seems if anything to have invigorated the economy. If that tale runs counter to what textbook economics says should have happened, well, there’s something wrong with textbook economics” (The Conscience of a Liberal, 56). Because Krugman was part of the 60s student movement, and so on, we might think that his positive conclusion is at least partly due to bias.

    Regarding the minimum wage, there may be consensus about whether getting rid of the minimum wage would increase employment (it seems hard to argue against this), but there certainly isn’t consensus about whether minimum wage laws, on balance, hurt or help low-income people, or what would happen if minimum wage laws were abolished.

    Second, I don’t agree with you that in the face of uncertainty non-intervention is necessarily the best course of action. This is a political decision that needs to be argued for. It isn’t self-evident. Libertarians may point to rent seeking and political graft as good reasons for avoiding giving more power to politicians, while socialist-leaning people might point to the danger of corporate power unchecked by vigorous democratic oversight.

  • W. Dean Reply

    Hello again Mike,

    Perhaps I was being overly diplomatic, but my point was that the positive economics of Krugman and other (usually) left-leaning economists reflects their normative priorities. No one has shown that Keynesian pump-priming has ever actually ever worked; it’s simply been taken as an article of faith that FDR’s New Deal policies ended the Great Depression. Moreover, it was the failure of Keynesian policy in the face of “stagflation” in the 1970s that caused it to be abandoned in the 1980s. Keynesianism only reemerges whenever there’s a downturn, which tells me that even its advocates know it’s more of a social policy than an economic one (i.e., policy-makers want to be seen doing something about a crisis, and spending money is always easier for governments than cutting taxes). In short, there is not a “right-” and a “left-“ leaning macroeconomics; the choice is between (sometimes) several macroeconomic analyses of the cause and cure of a downturn and the political policies of some economists, who are speaking more as political advocates than economists.

    Second, and from a purely economic standpoint, the tradeoff is never between efficiency and equity, but between one person’s equity and another’s. Closed shops and minimum wages might grant a bigger share of the pie to some people in the short-term, but they deprive others (and usually all of us) in the long-term by limiting our choices, depriving some of employment, and by inflating prices. A classic illustration of the latter is marketing boards. Farmers might get more money and a stable price for milk and wheat by regulating the supply, for example, but poor mothers with children must pay more for milk and bread as a consequence. No doubt there are all kinds of rationalizations for this policy; but it’s a normative tradeoff between one person’s equity and another’s, not a choice between equity and efficiency. So again, it’s not a matter of left and right economics; it’s a matter of politics.

    Third, the short version of my defense of non-intervention is to point out that economic theory says markets are self-regulating. Stability will return on its own, all other things being equal. The reasons for intervention, therefore, are always political, so the burden of proof falls on the interventionist.

  • Mike Thicke
    Mike Thicke Reply

    On 1: As I said in my original post, there is a lot of disagreement over what ended the Great Depression. Even if it wasn’t FDR’s policies, Keynesians can retort that the reason for this is that FDR didn’t increase government spending enough, not that Keynesian economics is wrong.

    It seems massively uncharitable of you to imply that all explicit Keynesians know that they are wrong and are just making economic-sounding arguments for their political policies. There certainly appears to be a lot of genuine disagreement between honest economists about macroeconomics.

    Of course Keynesianism becomes more popular in periods of decline; it’s a theory primarily concerned with recovering from and preventing declines!

    As for “left” and “right” economists, this is obviously a simplification, but I would wager a lot of money that if you surveyed economists who are broadly Keynesian (Krugman, Joseph Stiglitz…) will have more left-wing tendencies than economists who are better described as monetarist (Friedman, Allan Meltzer…).

    On 2:

    I should have just said “equality” to avoid confusion, but I’m not sure what you mean by “equity” here. “Equity” is usually taken to mean “fairness”, or to be a near-synonym with “equality”. Eg. and eg. Whatever you mean by equity, it’s a community-level measure. You can’t say that the farmer’s equity was improved at the expense of my equity (unless you mean something like “stock”, “share”, or “wealth” by equity). Either society’s allocation of resources is equitable or it isn’t (or one distribution of resources is more equitable than another).

    The tradeoff between equality and efficiency is pretty mainstream. Mankiw talks about it in his first principle of economics.

    On 3:

    Economic theory says that markets will naturally approach equilibrium. Keynesains don’t dispute this. The dispute is mostly over how quickly this will occur, and how stable those equilibriums are. If there is considerable uncertainty over whether markets will or will not experience severe crashes when left on their own, I don’t see why non-regulation is the default choice. The choice of whether to regulate is both political and economic, no matter which way you choose. If we can’t come to any agreement on the economic aspects of the decision, then political considerations are going to dominate either way.

    • W. Dean Reply

      Hello Mike,

      “…there is a lot of disagreement over what ended the Great Depression…”

      Like most students, I was taught in intro to economics that “Keynes saved capitalism.” But I can remember that the demonstration at the time was not a historical, empirical argument, but an illustration of Keynes’ theory. I have been unable to find anything more substantive than this since then: no one shows how FDR’s policies worked; they either repeat it as fact that his policies did work or explain how Keynesian pump-priming is supposed to work. I have, however, heard persuasive empirical cases on the other side. But we’re not going to solve this here, so I’ll let it go as indeterminate.

      “…Keynesians can retort that the reason for this is that FDR didn’t increase government spending enough, not that Keynesian economics is wrong.”

      Not really. They cannot consistently claim a multiplier effect from injecting dollars into the economy, while also claiming that these particular dollars didn’t have any effect. If pump-priming works, then the amount of money injected must translate into growth. Arguing otherwise sounds like explaining away inconsistent results, trying to have it both ways.

      “It seems massively uncharitable of you….”

      You’re looking at it the wrong way. In the absence of knowledge (i.e., given the unsettled state of macroeconomics), it is not irrational or immoral to argue for the implementation one’s own preferred policies when one thinks they’ll help people in the near term. Krugman et al are just offering fiscal policies that are consistent with their political views. I do think it’s imprudent, but that’s a far cry from calling it immoral.

      “…Keynesianism becomes more popular in periods of decline; it’s a theory primarily concerned with recovering from and preventing declines!”

      All economic theories have explanations for declines. Only Keynesian theory supposes that declines are inherent in free markets and that the only solution is state intervention. That makes it a potent aphrodisiac for politicians of all stripes, because spending money allows them to buy votes while appearing to be “doing something” about the economy. Perhaps this is a happy coincidence. But I’m inclined to think that the frequent resurrections of Keynes have more to do with political expediency, which brings me around to:

      “As for “left” and “right” economists….”

      I don’t think left and right is as important as politicians and economists (or economists as politicos). Harper’s supposedly right-wing government engaged in pump-priming in last budget, even though Harper himself is an economist, and (so far as I’m aware) a monetarist to boot. I certainly don’t remember him advocating massive stimulus spending when he was head of the Tax Payers Federation.

      “… Whatever you mean by equity, it’s a community-level measure…”

      You claimed a tradeoff existed between equity and efficiency, so I assumed you meant that market valuations were not always fair ones. Marketing boards are a classic case of “fixing” the market by setting “fair prices” for goods. My point was that when we set the price of milk, we’re not trading the efficient outcome (market pricing) for the fair outcome (the legally set price); we’re trading fairness to one person (the farmer) for fairness to another person (the consumer). The same goes for labour. It seems like we’re giving people a “fair wage” by forcing the employer to pay more. But economics shows you’re really just pricing people out of jobs. When we introduce, say, a Floor Sweepers Fairness Act that forces employers to pay more than they would otherwise pay, we don’t end up with prosperous floor-sweepers, we end up with unemployed ones and unswept floors.

      “The tradeoff between equality and efficiency is pretty mainstream….”

      So it is. But I think it originates from economist playing at political philosophy, because it contradicts basic economic theory. Economics says that a rising tide will raise all boats. Redistributing wealth is an inefficient allocation of resources, and hence, an impediment to growth. For this reason, one never really trades efficiency for equality; one trades long term prosperity for short term equality. And the more wealth one trades off to achieve equal outcomes, the more the returns on redistribution will diminish over time. In other words, we’ll all be more equal, but we’ll also all be a lot poorer. This is why, in short, I don’t really accept that there’s a tradeoff between equality and efficiency.

      “If there is considerable uncertainty over whether markets will or will not experience severe crashes when left on their own, I don’t see why non-regulation is the default choice….”

      To be clear, regulation and intervention are two different things. I don’t dispute that the state must enforce contracts, prosecute fraud and theft, charter banks, maintain the value and integrity of the currency and so forth. Intervention is a different bird altogether. It’s based on the notion that [1] market failures occur, and [2] that the state can and [3] should (i.e., has an obligation to) intervene in the market. Although [3] has been around since time immemorial, [1] and [2] are exclusively Keynesian. Outside of natural disasters and market corrections, most economists believe that all so-called “market failures” are really failed state interventions, i.e., the unintended consequences of our attempts to fix “capitalism.”

      The recent meltdown is a case in point. Low interest rates always create bubbles in real estate, which eventually deflate when the inevitable correction comes. No one is too seriously hurt when this happens. But the Clinton administration exacerbated the problem when it leaned on lenders to give mortgages to people who couldn’t afford them. It must have seemed like a nice thing to do at the time; but when combined with low interest rates, the subprime mortgages massively inflated the bubble. Making matters even worse, leaders sold off the bad mortgages as assets. So when the charade eventually collapsed, it had a cascading effect across the financial system.

      At that point, of course, it seemed like the only solution was to bail out the financial institutions that had been undermined by all the bad credit. So the burden of proof may seem to have shifted to the anti-interventionist, since not doing something seemed the worse course. But the intervention was ultimately a fix for an old, bad intervention, not an inherent flaw in the market needing a remedy.

      The lesson in all this, it seems to me, is that interventions should always be viewed with suspicion, because they have unintended consequences. After all, it’s not like the above outcome wasn’t predicted and predictable. But no doubt the predictable outcome was pooh-poohed by the usual suspects (like Krugman). It was thought (presumably) that increasing home ownership was a lofty goal and that capitalism leads to unfair outcomes that could be corrected by government.

  • Mike Thicke
    Mike Thicke Reply

    I’ve been holding off on replying to this because I don’t really want to get into a debate over which version of macroeconomics is right. One of the reasons I brought up Robert Evan’s study is to make the point that no macroeconomic theories do very well predictively.

    However, there are a few of thing that need to be addressed. First, you seem to be attacking a straw man Keynesianism that doesn’t reflect what modern Keynesians believe. There have been several empirical studies of the effects of government spending. As a result, Keynesians have generally reduced their claims for the magnitude of the effect, but maintain that there is some effect, and it is a wise use of government funds in a recession. Nobody is claiming that macroeconomics learns nothing from empirical observation, just that empirical observation is far from decisive given the complex nature of the economy.

    Regarding the Great Depression, who is to say that government spending had no effect on the economy? We can’t rewind the clock and see what would have happened with less (or more) spending. This is one of the fundamental problems with “natural experiments” in economics.

    Regarding left and right economists, I don’t want to bring politicians into the argument. Politicians clearly have a conflict of interest in the matter. My point is that there are (non politician) economists who are relatively left and right wing. Left wing economists are for instance going to be generally more concerned with equality in society, while right wing economists are more likely to consider taxation morally equivalent to theft. Those ideological, normative disagreements are, I’m arguing, likely to map on to descriptive or predictive disagreements.

    I never thought you were calling Krugman immoral. I thought you are claiming that Krugman is dishonest, because he knows that the theory he is advocating is false. If you are now granting that macroeconomics is unsettled and Krugman is merely overstating the case for his own view, then I agree.

  • Mike Thicke
    Mike Thicke Reply

    I forgot to say something about intervention. When I said regulation I didn’t have contract enforcement and the like in mind. I had capital requirements for banks, etc. An uncontroversial example of intervention is the bailout of Bear Stearns. When Bear Stearns was failing it is probably safe to say that nobody really knew (or knows) what would have happened if there was no intervention, and equally nobody really knew what would happen if there was intervention. Why in this case should the default be to not bailout Bearn Stearns?

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