Five or six years ago, with the hangover from the Great Recession still dominating the national conversation, macroeconomic policy was all the rage. Now, it’s an afterthought, with issues like health care, trade and energy taking center stage. But behind the scenes, macroeconomists have been rethinking the basics of how they approach their discipline.
The Peterson Institute for International Economics, a think tank, recently held a symposium on rethinking macroeconomic policy. The speakers included such luminaries as Ben Bernanke, who was chairman of the Federal Reserve during the crisis, as well as respected macroeconomic policy thinkers such as the Massachusetts Institute of Technology’s Olivier Blanchard and Harvard University’s Larry Summers.
A presentation by Blanchard and Summers provides a useful summary of how elite thinking has changed. They basically draw three lessons from the crisis: 1) the financial industry matters, 2) government should use a wider array of policies to fight recessions, and 3) recessions can last longer than expected.
The first two are relatively modest changes. The fact that finance matters became so blindingly apparent after the crisis that even macroeconomic grandee Robert Lucas, who had declared in 2003 that the problem of depression prevention had been solved, admitted after 2008 that shocks to the financial system could bring down the economy. In the past few years, macroeconomists have been scrambling to shoehorn the financial sector into their standard models. Of course, there’s always the danger that the Great Recession prompts macroeconomists to focus too much on finance, and ignore whatever leads to the next downturn — fighting the last war, as it were.
As for policy, a substantial minority of macroeconomists in the academy still turn up their noses at the idea of unconventional monetary policy or fiscal stimulus. But researchers and policy makers long ago tacitly agreed to maintain an amicable distance — it was understood that in a crisis, policy makers would take professors’ theories into consideration, but ultimately would do whatever seemed like it might work. This is why central banks were willing to try dramatic policies of quantitative easing after 2008, despite relatively little theoretical backing for the idea.
The real sea change is the third one — the reconsideration of what recessions really are. Most modern econ theories posit that recessions arrive randomly, instead of as the result of pressures that build up over time. And they assume that recessions are short-lived affairs that go away of their own accord. If these assumptions are wrong, then most of the theories written down in macroeconomics journals over the past several decades — and most of those being written as we speak — are of questionable usefulness.
Blanchard and Summers are hardly the first to raise this possibility — economists have known for decades that recessions might not be random, short-lived events, but the idea always remained on the fringes. One big reason was simple mathematical convenience — models where recessions are like rainstorms, arriving and departing on their own, are mathematically a lot easier to work with. A second was data availability — unlike in geology, where we can draw on Earth’s whole history, reliable macroeconomic data goes back less than a century. If economic fluctuations really do have long-lasting effects, it will be very hard to identify those patterns from just a few decades’ worth of history.
If macroeconomists heed Blanchard and Summers’ advice, they will have to do harder math, and they will find better data to test their models. But their challenges won’t end there. If the economy can linger in a good or bad state for a long time, it’s almost certainly a chaotic system. Researchers have known for decades that unstable economies are very hard to work with or predict. In the past, economists have simply ignored this unsettling possibility and chosen to focus on models with only one possible long-term outcome. But if Blanchard and Summers are any indication, the Great Recession might mean that’s no longer an option.
So macroeconomics is in the process of getting a lot harder. If the only tools available were the ones that prevailed in 2007, it might be best for economists to simply throw up their hands and declare that the problem of spotting, preventing and fighting recessions is best left to our distant descendants.
But fortunately, this isn’t the case. New tools are available that could help shed some light on the processes behind recessions. Now that almost all economic activity is electronically recorded, economists are able to observe much more about the behavior of businesses and consumers than they were even a decade ago.
Better microeconomic data will help researchers make better models of behavior. Those more realistic models — sometimes called “microfoundations” — will then be able to replace the old, simplistic assumptions that prevailed in previous generations of macroeconomic theories. Under the radar, more young macroeconomists are doingthis sortof work.
This is a long-term project, of course. The amount of micro data that will have to be sifted through is daunting, and the models of consumer and business behavior that eventually emerge will probably be complex and difficult. And in the meantime, policy makers should — and undoubtedly will — continue to rely on simple models, heuristics, past experience and judgment.
But unlike a decade ago, macroeconomists now realize that this long and difficult road is the only one open to them.
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