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The messy methods of macroeconomics
December 2017 / January 2018

I have of course simplified Samuelson’s message, but I have not caricatured it. The first edition of his textbook was upbeat about fiscal policy and the therapeutic powers of government spending, while also remarking that “few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle”. Unfortunately, over the decades in which Samuelson dominated classroom instruction in macroeconomics, experience showed that money and banking had a profound bearing on the business cycle, and that the conduct of monetary policy mattered hugely. The 1985 edition of the textbook opined, “money is the most powerful and useful tool that macroeconomic policymakers have” and recognised the Fed’s centrality in decision-taking.

Moreover, in several key policy-making episodes it became clear that Samuelson’s interpretation of Keynes, focused on the multiplier theory of national income, was unsatisfactory. In Britain the intellectual watershed was the 1981 Budget, where a tightening of fiscal policy was followed by an improvement in demand, which ought to have been impossible if the textbook theory were correct: 364 economists — including a majority of Chief Economic Advisers to the government in the post-war period — signed a letter of protest to The Times, but are subsequently seen as having been wrong in their pessimism about the economic outlook. In the United States large cuts in government spending under President Clinton from 1992 were associated with healthy growth and strong employment, again an outcome that contradicted naïve Keynesianism. Even more damning was the sequel to the “fiscal cliff” of five years ago. Numerous forecasts appeared in late 2012 that looming big tax increases would plunge the US into a recession in 2013. In the event most of the tax increases went ahead, but the American economy saw higher demand growth in 2013 than in 2012.

My point is that the most familiar theory of national income determination among economists — the core of macroeconomics — is useless. Not only is there something wrong with it, but the problem is so deep-seated that it cannot be sorted out by minor addenda and corrigenda within the same paradigm. The last few years have seen statements from Robert Barro, a Harvard professor, that the multiplier has a value of zero and from Paul Krugman, a Princeton professor and the world’s most influential economic columnist, that it has a value of two. Both of them must be aware that Chapter Ten of The General Theory judged that in the 1930s it took a value of five. Other economists can be found who believe that a tightening of fiscal policy is often expansionary, opening up the possibility that reductions in government spending boost demand and that the multiplier is negative. So reputable sources can be found for estimates of the multiplier which vary between minus a half and plus five!

Economists should be proud of microeconomics, and of the important and valuable insights that price theory and welfare economics have generated in a range of public policy contexts. But macroeconomics is a mess. Contrary to a myth propagated by mostly left-leaning university economists in the English-speaking world in the late 1940s and 1950s, Keynes’s General Theory was not definitive. His theory of national income determination has not enabled policymakers to forecast how the economy will respond to their actions. As it is forecasts that non-economists really want from economists, this failure is all the more upsetting and tiresome.

While the debates in macroeconomics are raging with such intensity, it would be impudent for economists to claim that they form a profession. The muddles over the determination of aggregate demand and output are serious and unresolved. Economists are far from having a shared, objective body of expertise in exactly those areas of decision-taking where non-economists are most interested to hear what they have to say. If the Society of Business Economists decides to hold a vote on the proposed name change, I will be against it. And what is the best collective noun for our vocation? If pressed, I would say that a babble of macroeconomists is a good way to label believers in the multiplier approach to national income determination. 
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