The anti-history boys, by J. Bradford DeLong, Commentary, Project Syndicate [earlier version]: If you asked a modern economic historian like me why the world is currently in the grips of a financial crisis and a deep economic downturn, I would tell you that this is the latest episode in a long history of similar bubbles, crashes, crises, and recessions that date back at least to the canal-building bubble of the early 1820s, the 1825-1826 failure of Pole, Thornton & Co, and the subsequent first industrial recession in Britain. We have seen this process at work in many other historical episodes as well – in 1870, 1890, 1929, and 2000.
For some reason, asset prices get way out of whack and rise to unsustainable levels. Sometimes the culprit is lousy internal controls in financial firms that over-reward subordinates for taking risk. Sometimes the cause is government guarantees. And sometimes it is simply a long run of good fortune, which leaves the market dominated by unrealistic optimists.
Then the crash comes. And when it does, risk tolerance collapses; everybody knows that there are immense unrealized losses in financial assets and nobody is sure that they know where they are. The crash is followed by a flight to safety, which is followed by a steep fall in the velocity of money as investors hoard cash. And that fall in monetary velocity brings on a recession.
I will not say that this is the pattern of all recessions; it isn’t. But I will say that this is the pattern of this recession, and that we have been here before.
But if you ask the same question of a modern macroeconomist – for example, the extremely bright Narayana Kocherlakota of the University of Minnesota – you will find that he says that he does not know, and that macroeconomic models attribute economic downturns to various causes. Most, he points out, “rely on some form of large quarterly movements in the technological frontier. Some have collective shocks to the marginal utility of leisure. Other models have large quarterly shocks to the depreciation rate in the capital stock (in order to generate high asset price volatilities)…”
That is, downturns are either the result of a great forgetting of technological and organizational knowledge, a great vacation as workers suddenly develop a taste for extra leisure, or a great rusting as the speed at which oxygen corrodes accelerates, reducing the value of large things made out of metal.
But modern macroeconomists will also say that all these models strike them as implausible stories that are not to be taken seriously. Indeed, according to Kocherlakota, nobody really believes them:
“Macroeconomists use them only as convenient short-cuts to generate the requisite levels of volatility” in their mathematical models.
This leads me to ask two questions:
First, is it really true that nobody believes these stories? Ed Prescott of Arizona State University really does believe that large-scale recessions are caused by economy-wide episodes of forgetting the technological and organizational knowledge that underpin total factor productivity. One exception is the Great Depression, which Prescott says was caused by real wages far exceeding equilibrium values, owing to President Herbert Hoover’s extraordinary pro-labour, pro-union policies.
Likewise, Casey Mulligan of the University of Chicago really does appear to believe that large falls in the employment-to-population ratio are best seen as “great vacations” – and as the side-effect of destructive government policies like those in place today, which lead workers to quit their jobs so they can get higher government subsidies to refinance their mortgages. (I know; I find it incredible, too.)
Second, regardless of whether modern macroeconomists attribute our current difficulties to causes that are “patently unrealistic” or simply confess ignorance, why do they have such a different view than we economic historians do? Regardless of whether they have rejected our interpretations and understandings or simply have built or failed to build their own in ignorance of what we have done, why have they not used our work?
The second question is particularly disturbing. After all, economic theory should be grappling with economic history. Theory is crystallized history – it can be nothing more. Someone observes some instructive case or some anecdotal or empirical regularity, and says, “This is interesting; let’s build a model of this.” After the initial crystallization, theory does, of course, develop according to its own intellectual imperatives and processes, but the seed of history is still there. What happened to the seed?
This is not to say that the macroeconomic model-building of the past generation has been pointless. But I do think that modern macroeconomists need to be rounded up, on pain of loss of tenure, and sent to a year-long boot camp with the assembled monetary historians of the world as their drill sergeants. They need to listen to and learn from Dick Sylla about Alexander Hamilton’s bank rescue of 1825; from Charlie Calomiris about the Overend, Gurney crisis; from Michael Bordo about the first bankruptcy of Baring brothers; and from Barry Eichengreen, Christy Romer, and Ben Bernanke about the Great Depression.
If modern macroeconomists do not reconnect with history – if they do not realize just what their theories are crystallized out of and what the point of the enterprise is – then their profession will wither and die.
I’m not sure this answers Brad’s question in general, but I think the general lack of interest in economic history may come, in part, from the rejection of Keynesian economics. The reason this group ignores economic history and the types of interpretations Brad is placing on it, certain parts of history anyway, may be, as David Laidler notes, that this group believes Keynes was a detour from the true path. Why learn this history when you think it is irrelevant?
People like Robert Lucas, for example, believe that modern models have little to offer when it comes to explaining the Great Depression or our recent experience:
Talking about “My Keynesian Education” at the 2003 HOPE conference on The IS-LM Model: Its Rise, Fall, and Strange Persistence (Michel De Vroey and Kevin Hoover 2004) Lucas pointed, almost as an aside, to
the problem that the new theories, the theories embedded in general equilibrium dynamics of the sort that we know how to use pretty well now – there’s a residue of things they don’t let us think about. They don’t let us think about the U.S. experience in the 1930s or about financial crises and their real consequences in Asian and Latin America, they don’t let us think very well about Japan in the 1990s (2004, p 23)
This remark dates from 2003, when the final “Greenspan boom” was in full swing, and the “residue” of problems to which Lucas referred did indeed seem rather remote from the immediate but apparently well-established economic environment in which it was made, and we should judge its offhand tone in this context. Viewed with hindsight, though, the remark was ominous, because those same models now, in 2009, do not help us to think about problems that are dominating the current evolution of the entire world economy – some residue!
But even though Lucas believes that modern models are not very useful, he is unwilling to learn from the past because he thinks it was an unproductive detour from the true path, i.e. there is nothing to learn:
As everyone knows, what was soon labeled new-classical economics emerged largely from Lucas’s own efforts… Initially, it was his replacement of adaptive by rational expectations that attracted most of the attention, but the closely related explicit application to traditionally macro questions of micro general equilibrium analysis marked a much more fundamental change in the then dominant approach to macro-economics, because it broke the area’s last remaining intellectual links to Keynes’ General Theory. Moreover, though Lucas’s contribution launched a radically new vision of how a market economy functions, he himself thought of it more modestly as involving the exploitation of newly available analytic techniques to deal with age-old problems that the macro-economic theory of the 1960s and the macro-econometrics that went with it had proved unable to address. Viewing the General Theory through the prism created by this macro-economics, he saw it as having created an unhelpful detour in the discipline’s otherwise orderly history, and interpreted its temporary success as a consequence of the historical situation that had prompted its writing.
In Lucas’ view, Keynes had not advanced economics but had merely offered an ad hoc political response to the circumstances of the Great Depression, a response which, seen in relation to what Lucas believed to have been the already long-established internal dynamic of economics, was of no lasting scientific value. In 2004, he made this point as follows:
“Keynes’s real contribution is . . .not Einstein-level theory, new paradigm, all this . . ..that’s just so much hot air. . . [I]n writing the General Theory, Keynes was viewing himself as a spokesman for a discredited profession. . . .in a situation where people are ready to throw in the towel on capitalism and liberal democracy and go with fascism or corporatism, protectionism, socialist planning. . . . What he hits on is that the government should take on new responsibilities . . . for stabilizing overall spending flows. . . . And . . . for everybody in the post-war period – I’m talking about Keynesians and monetarists both – that’s the agreed upon view.. . .
So I think this was a great political achievement. It gave us a lasting image of what we need economists for. I’ve been talking about the internal mainstream of economics, that’s what we researchers live on, but as a group we have to earn our living by helping people diagnose situations that arise and helping them understand what is going on and what we can do about it. That was Keynes’s whole life. He was a political activist from beginning to end. (2004, pp 23-24)
The history is not just forgotten, it’s intentionally ignored..
Originally published at Economist’s View and reproduced here with the author’s permission.