An Even More Dismal Science

"optimism is out of fashion."

BERKELEY – For the past 25 years, a debate has raged among some of the world’s leading economists. At issue has been whether the nature of the business cycle underwent a fundamental change after the end of the “30 glorious years” that followed World War II, when the economy was characterized by rapid growth, full employment, and a bias toward moderate inflation. Three positions have been staked out.

First out of the gate, in 1991, was Larry Summers, with his seminal paper, “How Should Long-Term Monetary Policy Be Determined?” Summers was unconvinced that the underlying economic reality had changed, so his focus was technical – an attempt to guard against a repetition of the inflationary disturbances of the 1970s that marked the end of the glory years. His prescription was to strengthen the technocratic independence of central banks. Politicians should set goals, but they should avoid micromanaging the economy or imposing strict rules that would inevitably fail in unexpected circumstances. Technocrats were far better placed to carry the policy forward, Summers argued, guided by a target of 2-3% annual inflation.

The debate continued with Paul Krugman’s 1998 paper, “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap” and his book The Return of Depression Economics, published the following year. Krugman made the case that central banks had already succeeded in anchoring inflation expectations to low levels, but had nonetheless failed to put the economy back on track. The economy in Europe and the United States, Krugman argued, had fallen from glory and returned to a pre-World War II pattern of “depression economics,” in which its dominant features were shortages of aggregate demand, risks of deflation, financial crises, and liquidity traps.

Then Ken Rogoff entered the fray with a comment on Krugman’s paper. In Rogoff’s view, what Krugman described as a long-term return to “depression economics” was a temporary condition, the consequence of failures to regulate properly and curb debt accumulation. This phenomenon, which he identified as the cause of the economic turbulence, inevitably ended in catastrophe, which could be resolved only through painful deleveraging and heterodox government-enforced debt write-downs.

Other prominent economists – including Joseph Stiglitz, Ben Bernanke, and Martin Feldstein – contributed to the debate as well. But, for the most part, they have not staked out their own positions as much as sat in Schroedingerian superposition, sometimes writing as if they believed that the post-war glory years had never ended, at other times making arguments that echo those of Krugman, Summers, or Rogoff.

Today, a degree of consensus has emerged. There is no longer much point in questioning whether the glory days are over. The models and approaches developed to understand the post-war business cycle and its bias toward moderate inflation are worse than useless today. Disagreement among economists nowadays reflects different positions not so much on the state of the economy, but on whether macroeconomic policy can provide an effective cure.

Summers has more or less abandoned his belief that central banks can, will, and perhaps even should attempt to prevent the return of depression economics. Central banks might have been able to attain the technocratic ideal of macroeconomic business-cycle management that Summers hoped for back in 1991, but they failed to do so. And few central bankers, if any, seem to have good ideas concerning institutional changes that could strengthen their ability to accomplish that mission.

In Summers’s view, with which I concur, governments need to assume greater responsibility for risk-bearing, long-term planning, and investment. Indeed, those governments lucky enough to issue the world’s reserve currencies are able to take on this role without overloading future taxpayers with inordinate debt burdens.

But, although Summers and Krugman now believe that more expansionary fiscal policies could accomplish a great deal of good, Rogoff continues to adhere to the Minskyite position that has underpinned his thinking since at least 1998: successful macroeconomic performance requires regulating finance and curbing debt accumulation during boom times. Attempting to cure an overhang of private debt by issuing mountains of “safe” government debt is too dangerous. After all, when the private debt was issued, it, too, was considered safe.

Whichever policies – macro or micro – turn out to work best for addressing today’s economic problems, one thing has become abundantly clear: optimism is out of fashion.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research.

Copyright: Project Syndicate, 2015.
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