Jonathan Portes, the director of Britain's National Institute of Economic and Social Research, recently pursued an online debate with the economist Diane Coyle over the state of economics; since my name comes up both in his piece and in Ms. Coyle's, I think I should weigh in and add some further points.
Mr. Portes was set off by Ms. Coyle's assertion that macroeconomists have no claim to authority in this crisis, because the public despises them. As Mr. Portes points out on his blog, the reality is that macroeconomics -- at least as he and I practice it -- has performed spectacularly in the crisis.
In a post published on June 25, Mr. Portes quoted a three-year-old piece from Harvard professor Niall Ferguson, ridiculing me as the "man from Econ 101" who believed, foolishly, that huge government deficits could fail to raise interest rates in a depressed economy. Indeed, that is what Econ 101 said -- and it has been completely right. Basic IS-LM macroeconomics (IS-LM stands for investment-savings, liquidity-money) also said that under these conditions printing lots of money would not be inflationary, and that cutting government spending sharply would cause the economy to shrink.
All of this has come true.
So Econ 101 has done just fine, and perhaps more to the point, it has made successful predictions "out of sample" -- that is, about what would happen under conditions very different from normal experience. This is the sort of thing that produces paradigm shifts in the hard sciences: Light bends! Einstein is right!
So why the sense that macroeconomics is a mess? I'd say that it's essentially political. The type of macroeconomics Mr. Portes and I do offends conservative notions of how things are supposed to work in a capitalist society, so they reject the theory no matter how well it performs, and throw their support behind other views and other people no matter how badly they get it wrong. As a result, all the public hears are arguments between dueling economists (some of them not knowing much about economics). That's a big problem -- but it's not a problem with the economics, which has, once again, been spectacularly successful.
The other thing I'd like to say is that the notion that microeconomics is in much better shape is questionable, to say the least. I mean, it's not as if the assumptions underlying standard microeconomics theory are, you know, true -- utility maximization? Really? Micro is consistent in a way macro is not, but for the most part it's best viewed as a metaphor that's helpful as long as you don't take it too seriously.
But isn't there a lot of solid empirical work in micro? Yes -- and in macro too.
The difference is that for the most part there isn't as much politically-based determination to deny the empirical results in micro.
Yet even there, when it comes to areas where there are strong political stakes, like health care economics, you see the persistence of politically convenient views no matter how strong the contrary evidence. I originally heard the term "zombie ideas" in the health care field, not macro.
So to return to the original point: the fact is that these have been glory days for standard macroeconomics, which has done amazingly well under crisis conditions. If you've heard anything different, blame politics, not the economics itself.
AN ACCORD ON BAILOUTS
Leaders from the 17 nations in the euro zone met in Brussels on June 29 and agreed that future bailout funds will be transferred directly to troubled banks, eliminating the need for governments to take on more debt. This was welcome news in Spain, which needs about 100 billion euros to recapitalize troubled banks.
The move was championed by Mario Monti and Mariano Rajoy, the prime ministers of Italy and Spain respectively, who argued that the euro could fail if their countries were shut out of bond markets due to their nations' increasing debts. So leaders agreed to give the European Stability Mechanism, an institution to be launched later this month to manage a $633 billion bailout fund, the flexibility to aid struggling banks directly. One condition was that a supervisory body for banks must be set up and managed by the European Central Bank, bringing the euro zone closer to a banking union.
The provision allowing direct capitalization of banks is politically risky for the leaders of pro-austerity northern European countries, particularly German Chancellor Angela Merkel, whose opponents criticized her for agreeing to cash injections. "Clearly, Ms. Merkel has invested heavily in making Germans believe she's made them immune to external grief," wrote the correspondent John Vinocur in an opinion article for The International Herald Tribune on July 1.
Other commentators suggested that while the agreement was a step in the right direction, it did not go nearly far enough. According to a New York Times editorial published on June 29: "What they did not address fully -- and what is crucial -- is how to let up on the crushing austerity, championed by Germany, that has been imposed on weaker economies in exchange for bailout aid."
For Europe's Leaders, the Solution Remains Elusive
The European Union summit in June was clearly an upside surprise: in effect, the Latin bloc forced German Chancellor Angela Merkel to bend, at least slightly. But was it good enough?
In an online article for Vox, the economist Charles Wyplosz argued, sensibly, that it was nowhere close. "At the end of the day, the summit was a little move in the right direction on bank supervision, but keep watching; we still don't know what will actually be put in place," he wrote on June 30. "There was nothing on collapsing Greece, nothing on unsustainable public debts in several countries, and no end in sight to recession in an increasing number of countries."
The main substantive thing was the agreement in principle to set up something more or less like a European version of the Troubled Asset Relief Program in the United States, in which funds for bank recapitalization will be supplied by a consortium rather than lent to governments already overburdened with debt. Good move, and Irish bond buyers are especially happy. But even this doesn't take effect right away. (Also some bond purchases, but not by the European Central Bank, so they're limited in size. So think of this as a very small version of
quantitative easing.)
What we know, even for the United States, is that T.A.R.P. and quantitative easing were perhaps enough to forestall disaster, but not to produce recovery -- and Europe has the additional problem of huge needed realignments in competitiveness, which would be much easier if the E.C.B. announced a dramatic loosening -- which it didn't.
Not nearly enough, then. Yet markets were buoyed.
I guess you can argue that this was sort of a down payment -- that it is the harbinger of bigger policy changes to come. I hope so. But like Mr. Wyplosz, I suspect that we're overreacting to the simple if admittedly surprising failure to achieve disaster.
The Hart of the Matter
And now for something completely different: I haven't seen anyone point this out, but a very interesting New York Times article published on June 24 on why Microsoft is building its own tablet computer was a perfect illustration of Oliver Hart's theory of the firm.
Just briefly: the Harvard economist's theory of the firm asks why we sometimes rely on contracts -- I sign an agreement with your company to make my widget -- and sometimes go for direct control: I employ people to make widgets. Mr. Hart (and others) argue that such things depend crucially on our inability to write complete contracts, specifying all details -- and that the incompleteness of contracts can pose problems for investment decisions. For example, if you contract with other people to build equipment, they may be unwilling to invest in quality in the belief that you will use your sole-buyer status to extract the benefits.
And that, apparently, is exactly what has been going on with Microsoft; its reliance on other people to build computers using its software worked very well for a long time, but lately Apple's control-freak approach has been winning out.
This article was great fodder for the kind of economic analysis that I would be doing more of if we weren't in such dire straits.
MACRO VS. MICRO
Economics is roughly divided into two general branches: microeconomics and macroeconomics. The aftermath of the global financial downturn has sparked an examination of policy prescriptions based on studies in these fields.
Microeconomics generally focuses on the behavior of individual households and businesses. It measures the economic impact of relatively small-scale phenomena such as immigration. Macroeconomics focuses on the performance of economies as a whole and on issues such as sovereign debt, gross domestic product and unemployment.
Macroeconomic models underpin many of today's fiscal and monetary policy decisions, such as the management of the euro by the European Central Bank. Consequently, some commentators and economists have suggested that the debt crisis has exposed serious flaws in macroeconomic theory.
"Although macroeconomists will insist that there are known scientific facts, they do not appear to agree on what these are," Diane Coyle, a British microeconomist and author, commented on her blog on June 20. Ms. Coyle argued, "it is hard to believe in the existence of a significant consensus about empirical truths in macro policy when the discussion among macroeconomists is so shouty."
The British economist Jonathan Portes countered on his own blog on June 25 that prominent macroeconomists actually do agree on mechanisms "by which fiscal policy affects demand" and asserted that "the legitimate discussion is about the magnitude of the impacts and the extent of the tradeoffs."
He continued: "Unfortunately, the fact that we agree on the theory and the evidence does not mean we can convince the public."
