In the 1970s the leading freshwater macroeconomist, the Nobel laureate Robert Lucas, argued that recessions were caused by temporary confusion: workers and companies had trouble distinguishing overall changes in the level of prices because of inflation from changes in their own particular business situation. And Lucas warned that any attempt to fight the business cycle would be counterproductive: activist policies, he held, would just add to the confusion.
The economists trying to provide macroeconomics with microfoundations soon got carried away, bringing to their project a sort of messianic zeal that would not take no for an answer. In particular, they triumphantly announced the death of Keynesian economics without having actually managed to provide a workable alternative. Robert Lucas, famously, declared in 1980—approvingly!—that participants in seminars would start to “whisper and giggle” whenever anyone presented Keynesian ideas. Keynes, and anyone who invoked Keynes, was banned from many classrooms and professional journals.
Yet even as the anti-Keynesians were declaring victory, their own project was failing. Their new models could not, it turned out, explain the basic facts of recessions. Yet they had in effect burned their bridges; after all the whispering and giggling, they couldn’t turn around and admit the plain fact that Keynesian economics was actually looking pretty reasonable, after all. So they plunged in deeper, moving further and further away from any realistic approach to recessions and how they happen. Much of the academic side of macroeconomics is now dominated by “real business cycle” theory, which says that recessions are the rational, indeed efficient, response to adverse technological shocks, which are themselves left unexplained—and that the reduction in employment that takes place during a recession is a voluntary decision by workers to take time off until conditions improve. If this sounds absurd, that’s because it is. But it’s a theory that lends itself to fancy mathematical modeling, which made real business cycle papers a good route to promotion and tenure. And the real business cycle theorists eventually had enough clout that to this day it’s very difficult for young economists propounding a different view to get jobs at many major universities. (I told you that we’re suffering from runaway academic sociology.) Now, the freshwater economists didn’t manage to have it all their way. Some economists responded to the evident failure of the Lucas project by giving Keynesian ideas a second look and a makeover. “New Keynesian” theory found a home in schools like MIT, Harvard, and Princeton—yes, near salt water—and also in policy-making institutions like the Fed and the International Monetary Fund. The New Keynesians were willing to deviate from the assumption of perfect markets or perfect rationality, or both, adding enough imperfections to accommodate a more or less Keynesian view of recessions. And in the saltwater view, active policy to fight recessions remained desirable.
The economists trying to provide macroeconomics with microfoundations soon got carried away, bringing to their project a sort of messianic zeal that would not take no for an answer. In particular, they triumphantly announced the death of Keynesian economics without having actually managed to provide a workable alternative. Robert Lucas, famously, declared in 1980—approvingly!—that participants in seminars would start to “whisper and giggle” whenever anyone presented Keynesian ideas. Keynes, and anyone who invoked Keynes, was banned from many classrooms and professional journals.
Yet even as the anti-Keynesians were declaring victory, their own project was failing. Their new models could not, it turned out, explain the basic facts of recessions. Yet they had in effect burned their bridges; after all the whispering and giggling, they couldn’t turn around and admit the plain fact that Keynesian economics was actually looking pretty reasonable, after all. So they plunged in deeper, moving further and further away from any realistic approach to recessions and how they happen. Much of the academic side of macroeconomics is now dominated by “real business cycle” theory, which says that recessions are the rational, indeed efficient, response to adverse technological shocks, which are themselves left unexplained—and that the reduction in employment that takes place during a recession is a voluntary decision by workers to take time off until conditions improve. If this sounds absurd, that’s because it is. But it’s a theory that lends itself to fancy mathematical modeling, which made real business cycle papers a good route to promotion and tenure. And the real business cycle theorists eventually had enough clout that to this day it’s very difficult for young economists propounding a different view to get jobs at many major universities. (I told you that we’re suffering from runaway academic sociology.) Now, the freshwater economists didn’t manage to have it all their way. Some economists responded to the evident failure of the Lucas project by giving Keynesian ideas a second look and a makeover. “New Keynesian” theory found a home in schools like MIT, Harvard, and Princeton—yes, near salt water—and also in policy-making institutions like the Fed and the International Monetary Fund. The New Keynesians were willing to deviate from the assumption of perfect markets or perfect rationality, or both, adding enough imperfections to accommodate a more or less Keynesian view of recessions. And in the saltwater view, active policy to fight recessions remained desirable.
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