Ricardo Reis on Keynes, Macroeconomics, and Monetary Policy
Apr 27 2009

Ricardo Reis of Columbia University talks with EconTalk host Russ Roberts about Keynesian economics in the classroom and in research. Reis argues that Keynesian models are a useful framework for helping undergraduates understand macroeconomic ideas of general equilibrium. More generally, Reis argues, Keynesian ideas remain influential in macroeconomic research, particularly among Neo-Keynesians. Reis discusses the lessons the economics profession and the world have learned from the Great Depression and suggests that those lessons have helped us manage the current crisis. The conversation closes with a discussion of whether economics is a science.

Steve Fazzari on Keynesian Economics
Steve Fazzari, of Washington University in St. Louis, talks with EconTalk host Russ Roberts about Keynesian economics. Fazzari talks about the paradox of thrift, makes the case for a government stimulus plan, and weighs the empirical evidence for a Keynesian...
Noah Smith on Whether Economics is a Science
Noah Smith of Stony Brook University and writer at Bloomberg View talks with EconTalk host Russ Roberts about whether economics is a science in some sense of that word. How reliable are experiments in economics? What about the statistical analysis...
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Lee Kelly
Apr 27 2009 at 2:10pm

I took a course an undergraduate macro-economics course last year. It was very “Keynesian”. I consider it an appalling style of teaching economics; it was an uneducation in economics. I am interested enough in economics to unravel its nonsense, but most of my classmates were not. The “Keynesian” style divorces economics from everyday experience and common sense; it obscures simple economic relations behind unintutive and confusing diagrams. But perhaps that is the point, to make these ideas difficult to scrutinise, because when exposed they turn out to be bovine excrement.

I was disgusted with my “education” in macroeconomics. The incredible thing is that my professor agreed with me, but, at a two-year college, must teach what will transfer to economics courses at other colleges.

Lee Kelly
Apr 27 2009 at 3:05pm

Prices do neither adjust immediately nor correctly. The market is rarely in equilibrium, merely “seeking” equilibrium. And that’s okay, because the world is continually changing in ways that cannot be imagined, (at least within the limited time needed to make a decision).

But trying to compensate for such “stickiness” with monetary policy is just hubris. Money “injections” into the economy happen at a particular time and place. Whatever industries happen to receive the new money first will disproportionately benefit. In other words, using inflation to reduce real prices will not increase the use of resources uniformly throughout the economy. Instead, some industries will disproportionately draw resources toward them using their new buying power.

Spending might increase, but at the expense of re-allocating resources to less valued uses. One important function of prices is to prevent resource re-allocation where the prevailing allocation is more valued, but inflation subverts this function and allows industries which receive the money “injections” to draw resources from other uses toward themselves.

Worst of all is that recipients of the new money tend to be precisely those industries which are failing, that is, are among the least valued uses of resources in the first place. When the money injections stop, and the “sticky” prices eventually “un-stick”, we’ll be right back where we started, but in even more debt and with fewer resources.

Lee Kelly
Apr 27 2009 at 3:29pm

I apologise for the triple posting, but one more thing.

It seems to me that the government’s policy of continual price inflation is partly responsible for the “stickiness” of prices in the first place–particularly wages. If prices rose and fell like they should, then people would eventually learn to think about nominal wages differently.

It’s like an overbearing mother. If asked why she does everything for her some, she might answer that he doesn’t know how to look after himself. But perhaps he doesn’t know how to look after himself because his mother does everything for him. Learning can be painful, because it usually involves making mistakes. The notion that the government should compensate for economic ignorance by pandering to it, (i.e. creating the illusion that it is correct), will only help perpetuate that ignorance.

If we prevent cultural adaptation to avoid short-term pain, then we better be prepared to suffer the long-term costs of denying reality.

Bo Zimmerman
Apr 27 2009 at 5:39pm

Reflecting on Lee Kelly’s Austrian comments (while nodding wildly), and yet not knowing anything of his personal story, I’m forced to reflect if Ron Paul’s legacy will ever be fully measured — how many economics students have been so fully persuaded by methodological individualism, or even gone so far as to embrace praxeology. For a Thomist with libertarian leanings like myself, it was all a short journey (yet still profound for the passion it has stirred), but have all those who have made this journey travelled a longer or shorter intellectual route?

Just curious.

Greg Ransom
Apr 27 2009 at 6:54pm

Good discussion.

I must say that it is a real injustice to Bank of International Settlements chief economists William White to suggest that no one anticipated or understood what was happening with the building boom and coming bust — White personally confronted Alan Greenspan at Jackson Hole in 2003 about the matter and published a series of detailed reports for the BIS, including one in 2006 which used Hayekian macro to explain exactly what was going on and what the consequences would be.

See this news story:


and this BIS report from April, 2006:


arc of a diver
Apr 28 2009 at 12:28am

Sorry to interrupt, but Roberts is on NPR’s The Kojo Nnamdi Show (Monday) discussing mortgages and housing. He gets some good points in.


[Specific info at http://wamu.org/programs/kn/09/04/27.php#25674–Econlib Ed.]

Apr 28 2009 at 1:11am

Russ, you asked Ricardo why GDP would go down when demand for consumption goods goes down. He answered that consumption would go down today, while investment would go up next period, thus resulting in a measured decrease in GDP.

If GDP is measured using sales, then I can see how measured consumption will go down – people are buying less. But wouldn’t this be compensated for in the statistics by an increase in measured inventories (an increase in unsold goods)?

And if GDP is measured using income, then a cut in the production of future consumption goods will result in a lower income for consumption goods producers – hence lowering measured GDP. But again, wouldn’t this be compensated for by an increase in incomes for investment goods producers?

What frustrates me about these theories is that they explain why the millions of changes in preferences, technology, etc.., that occur all the time should result in a volatile, unstable, unworkable system – which is exactly what we don’t observe most of the time. In other words, the mechanisms described by these theories seem just as apt to cause booms and busts in normal times as they are in times like we are in now.

Stephen Monrad
Apr 28 2009 at 2:31pm

In the podcast, Reis talked about about how it takes time for people to absorb and respond to economic changes. He did say, however, that people eventually figure things out and get prices right.

I have two concerns. First, in an ever changing economy, the right price is a moving target. We may never get it right if we are always using old information. Second, if our ability to absorb and react to prices is very slow, the price mechanism may simply not be good enough to respond effectively to major shocks.

If I’ve lost my job, I don’t want to wait around for years for people to sort out the new economic order. Perhaps we need to find more direct mechanisms to help the economy respond to shocks.

Dr. Duru
Apr 28 2009 at 6:35pm

The paper on price and cost rigidity (Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets) can be downloaded with no subscription at:

I also found a related, more recent (2007) paper (Non-price Rigidity and Cost of Adjustment) at

Pietro Poggi-Corradini
Apr 28 2009 at 9:22pm

I found the segment about the costs of figuring out new prices quite interesting (35 min in). So many resources are devoted to this process of discovery that one is tempted to include prices in the “output” of an economy, further complicating perhaps the simple equations of macro-economics.

Apr 28 2009 at 10:35pm

Keynesianism always seemed a bit like alchemy to me and its adherents treat it as a religion. But the logical inconsistencies are the real problem.

Consider this: “But trying to compensate for such “stickiness” with monetary policy is just hubris. Money “injections” into the economy happen at a particular time and place.”

Well, “fiscal” policy isn’t the random diffusion of economic lubrication either and we’ve seen, it presents significant opportunities for political shenanigans, i.e. quid pro rewarding of conspicuous and cohesive constituencies, done in the name of the public good.

Incidentally, doesn’t anybody else see the irony in having a station with the call letters “WAMU” hosting a program on the mortgage crisis?

Lee Kelly
Apr 29 2009 at 12:07am

The forgone profit from mis-setting prices is the cost of accurate price signalling, that is, the price system cannot efficiently allocate resources without price trials. The shortages and surpluses created by such price experiments are how the price system adapts to reality. We often talk about prices “telling the truth” or “reflecting underlying economic realities”; well, how do prices do it? Trials are run to find the best price. Although shortages and surpluses occur, this is no “market failure”, but market learning.

Some prices learn less enthusiastically than others, that is, some prices are “sticky”. But an adhesive is really the wrong metaphor for talking about prices, because reality has a way of dealing with those prices which refuse to learn. For example, the classic “sticky” price, wages, are not really “sticky” so much as resistent to small incremental changes. In the long-run, wages are just as variable as any other price, but simply move up and down in larger increments. Is not this what has just happened at the “Big Three”? The unions couldn’t stop wages from eventually falling, all they could prevent were small incremental changes. Ultimately, those costs are bringing these companies to bankruptcy, and reality is reasserting itself. Prices, including wages, are coming to reflect the prolonged and failed price experiment enforced by the unions.

At the onset of a recession (a drop in aggregate spending), the average price of an economy will tend to fall, but not all prices will fall proportionally. Some prices may fall significantly, others may not fall at all, and others still may even rise. There is not only a change in overall spending, but a change in the composition of spending. Against this backdrop, it is simply foolish to suppose that anyone could competently employ monetary or fiscal policy to alter prices favourably. Which prices should go up, and by how much? How will these price trials be tested? What if the “idle resources” or “unemployed factors” are allocated to uses for which there will be insufficient demand in the future? Isn’t such a solution to the problem merely setting up another crash?

Aside from all this, the “secondary deflation”, the “flight to liquidity” (a kind of inverted bubble), actually tells us something real about the world, namely, the corrupted condition of economic knowledge caused by the boom (i.e. last year’s expansionary fiscal and monetary policy). Others call it a drop in “confidence”, or “animal spirits”, but I call it a destruction of knowledge. A major, painful, and prolonged re-assessment of the economy must take place, but “Keynesian” policy recommendations seem to encourage people to carry on as before regardless of underlying realities. I am sure that investor confidence does need to return for an economic recovery, but what exactly should investors be confident in? Without answering that question right, we could just be setting up the next bubble, and it is a question that can only be competently answered by the discovery process of the market–a trial by prices.

But whatever, I have only taken one course in economics, perhaps I am talking bovine excrement myself.

student NZ
Apr 29 2009 at 12:25am

here are a couple of ideas that you might all disagree with quite strongly!

I think we all agree that trading increases welfare. Inflation encourages trading your endowment today, rather than in the future.

Right now factories, transporters have large excess capacity and combined with low energy prices, the cost of producing and moving goods is cheaper than it has been in recent times.

Yet, if aggregate demand for these goods is low now, with firms dependent on continuous cashflow to survive, this capacity to produce our current potential output could quickly decrease as capital depreciates, firms go bust and workers are unemployed.

This could decrease total factor productivity and the capital stock for future periods, which would make growth very difficult over the next few years.

If we can stimulate spending now and keep trading and keep capacity high, we might have a higher growth path coming out of this recession. Perhaps that is more important than the evil done by inflation.

I do agree with the austrians that we need to be careful where the capital and workers skills are accumulating, but i think there is potentially a role for the state in keeping capacity up in certain sectors of the economy.

Lee Kelly
Apr 29 2009 at 12:50am

Student NZ,

But trading does not necessarily increase welfare. That’s the problem with inflation. You trade some good for money, and later discover that the money isn’t worth anything–you would have been better off if you never traded in the first place. Even when you are on the other end of this transaction, you may only be selling money because you expect its purchasing power to be stolen by the government. For example, if someone were to begin stealing anything you own which is blue, then you might suddenly begin trading all your blue things for substitutes of another colour. But wouldn’t you just be better off if nobody was stealing from you in the first place? There are all kinds of situations in which trade would actually make you worse off. For example, would you rather dress yourself or pay your neighbour to do it? If the government passed some legislation that made it illegal to dress youself, and thereby forcing you to trade with someone else for the service, would you be better off than before?

Anyway, subsidising companies which should never have received capital in the first place, to continue employing that capital will not, in any way shape or form, put us on a stronger footing coming out of the recession. On the contrary, it will keep us in the recession for a lot longer, since it will prevent the capital reformation necessary to put the economy bak onto a sustainable development path.

Recessions don’t just come and go like the weather. It will not eventually pass of its own accord; we need to pull ourselves out of the recession by accepting the costs of past mistakes and fixing them moving into the future.

Lee Kelly
Apr 29 2009 at 1:02am

The “Keynesian” appeal is that we can somehow, by printing money, reshuffling assets, or going into debt, avoid paying for past errors. But this is nonsense, once the mistakes were made, someone, somewhere, was going to suffer for it. All the government can do with all its meddling is redistribute who pays, and perhaps increase the eventual cost along the way. As Superheater said, it’s like Alchemy, both in that it offers the promise of something extraordinary and doesn’t work. You can’t magic-away the real cost of squandering so many resources during the boom-phase. No amount of altering accountancy records, shuffling bank assets, or printing money can reach back through time and retrieve squandered resources.

The quicker this is accepted, and the sooner we get on with the business of economic restructuring, the faster we’ll be back on a road to recovery.

Lee Kelly
Apr 29 2009 at 1:35am

Again, I apologise for the triple posting, but one more thing.

Isn’t it strange that investors who predicted the real-estate bubble, and planned their investment strategies accordingly, have escaped the pernicious influence of the animal spirits? They are no less confident than before, and, in some cases, have even increased their investing. But then, perhaps, as I suggest, it is actually a knowledge problem. For most investors, their expectations have been shattered. Some part of the falling prices reflect this economic reality, that is, the corrupted condition of economic knowledge. Since government officials almost exclusively fall into this latter group, I have little confidence that they know what they’re now doing, and I trust the market to discover the solution much faster.

Toby DiPasquale
May 2 2009 at 11:10am

Russ, this was a fantastic session! No one speaks truth to power like that these days and I found it both refreshing and insightful. EconTalk is one of the best podcasts on the Internet. Keep up the great work!

May 4 2009 at 2:44am

Japan’s pre-WWII economy did not fail because of stimulus, it failed because of inflation as a result of an increase in money supply. Stimulus initially brought Japan’s economy out of the depression faster than most other countries, but because the stimulus was mostly military, when the government attempted to end funding from borrowing (in order to stave off inflation), the military threatened to overturn the government.

Using the Japanese economy as an example of stimulus failure is shallow. There are better examples, and much easier to put into context.

May 4 2009 at 2:57am

“Recessions don’t just come and go like the weather.”

They actually do, Mr. Kelly.

Economists are very much like meteorologists. They don’t often predict accurately, but they’re very much adept at letting you know precisely how much rain fell after the fact. Otherwise, we would have all known that this particular recession was coming and we could have all taken shelter from it.

A pocket-sized umbrella is recommended at all times.

Russ Roberts
May 4 2009 at 6:14am


The discussion of Japan (though it came right after the discussion of the Great Depression) was actually a reference to the last 10 or 15 years. Japan has spent a lot of money on infrastructure in an attempt to stimulate its economy. It does not appear to have been very successful.

May 5 2009 at 3:19am


I must have misunderstood, you and your guests are sometimes very quick in changing your timelines.

Japan’s recent efforts in stimulating its economy (in the last 10 or 15 years) are a lot different than the model used prior to WWII. Domestic policy market regulation have more than offset any effect that stimulus has had over the last two decades. Japan’s post-depression stimulus was pure, dumped right into the military, and there was no attempt to regulate markets at any level.

I really enjoy these podcasts, keep up the great work.

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Podcast Episode Highlights
0:36Intro. [Recording date: Apr. 20, 2009] Keynesian economics, broadly defined. Classroom: Keynesian ideas pervasive, especially in macroeconomics; most undergraduate textbooks have some version of IS-LM model for aggregate demand and why policy has an effect on aggregate demand; price and wage rigidities; monetary and fiscal policy as sources of fluctuations in output and labor markets. Other views such as real business cycle model show up as a response to it, similar to Smith's invisible hand shows up without directly talking about it. Macroeconomics. Russ undergraduate in 1970s, N. Carolina; graduate school late 1970s at U. of Chicago. As undergraduate, learned IS-LM. What is IS-LM trying to capture? Three roles. IS-LM has disappeared out of research for 20 years, and gone from graduate classes, so why teach it to undergraduates? First, we now acknowledge that as interesting as simple partial equilibrium models may be, it is important for students to get an idea of general equilibrium. Change in one market affects another market, feedback. IS-LM is the only instance of general equilibrium in the undergraduate textbook. Talk about savings, money market--but they are partial equilibrium. Even Solow model--only one market in the economy. IS-LM shows money market and goods market, two independent markets that have feedback and have to find equilibrium in both. Second, macro more than micro is tied to policy. IS-LM is an intuitive apparatus that lets you think about policy, sometimes with right answers and sometimes wrong answers--but it's still an approach for students to see how fundamentals of monetary and fiscal policy have an effect on the economy. Students find that rewarding. Teaching monetary policy using Barro-Gordon model, inflation, central bank independence. Do fiscal policy, two-period choice problems, permanent income hypothesis; students can then link using IS-LM model and see the flaws and benefits of each model. Third, while traditional IS-LM is not part of graduate curriculum, teach new classical synthesis, new Keynesian model. Three equation model.
7:47IS curve--misty Internet blackboard. Talking about equilibrium in the goods market and equilibrium in the money market and how they interact. Summarize more advanced model without equations. In new, modern version, tradeoff is between consuming more today or more tomorrow, intertemporal tradeoff, interest rates is the relative price. In the old IS, the intertemporal dimension was ignored; link between output and interest rate that came through investment. Higher interest rate lowers investment and thus lowers output in the old model. New model, similar, real interest rate; higher interest rates means want to consume less today, and save more.
9:45Aggregate demand and paradox of thrift. Taught that aggregate demand is C+I+G (consumption plus investment plus government expenditure) in a closed economy (sometimes look at net exports in open economy). If one of those goes down, such as C, beginnings of Keynesian business cycle theory--we have a gap between actual demand and potential output/demand, which creates the possibility for fiscal or monetary policy to stimulate economy. In simple undergraduate classroom textbook story, is that shortfall in aggregate demand the creator of the opportunity for fiscal stimulus that we are talking about today? Only partly. In graduate level new Keynesian model, have to distinguish between two concepts: first, the flexible price level output--the potential level of output--what level of output would be achieved if all prices and wages were flexible, no rigidities. Then, the actual level of output given the shocks but also that some firms are adjusting their prices as quickly as they would. What happens if people want to consume less today, worried about future, etc.? By itself, even in the model without rigidities, that would lead to a fall in output today because people are going to start saving more, delaying consumption today for consumption in the future; putting money into investment, other things; leads to a fall in Y (output) today. But if it's C+I+G, if C goes down and I goes up, why is there a change in output? Tradeoff between C today and C next period. Think about I as being the difference between capital today, the increase in capital stock you are going to be generating. If today I want to consume less, by investing that will raise the capital stock for the next period, which will raise output in the next period. In old IS, thinking about C+I+G, if something goes up, something goes down; new IS, thinking about present versus future. Pandora's box: how does paradox of thrift enter into either the undergraduate or graduate version? With difficulty, especially in the graduate one. In the undergraduate, it follows from the more traditional story: if we all try to save more, it may end up being that by consuming less it pushes income lower today. In the graduate one, it doesn't show up. Should we be teaching just the new version? Main loss of not teaching the old one is the paradox of thrift only shows up in the old one. Is that a feature or a bug? If you are keen about the history of economic thought then you are upset about that. Is it an important empirical fact, no evidence that that is the case. Summarize: undergraduate macro class relies on the IS-LM framework, which is a world where prices adjust either slowly or sometimes not at all, that failure of price adjustment leads to disruption and some elements of the business cycle. The graduate and research macro model tries to allow for a richer role for prices and wages, as a result of which the paradox of thrift is not so present, but still have some disruptions because of price or wage inflexibility. When you talk about the virtues, the IS-LM model is a way of organizing our thinking. It's not truth, it's not empirical science. Macro's a complicated place. Way to teach students general equilibrium; useful in seeing how policy is going to have an effect; a lot of intuition--interest rate, investment mechanisms still used in graduate, research macro.
16:54In the classical model, world pretty much lost, has adherents, poised for comeback; what frustrates about C+I+G is that it's an ex post story, true in an accounting sense but misleads. Someone said: With consumption down, somebody's got to make up the difference; where else can consumption come from. Brad Delong in a debate online said "Government spending is as good as someone else's." In this story, output comes from consumers wanting stuff, investors wanting resources as future consumers, and government wanting resources in collectively funded stuff. After the fact, you can apportion the output pile but it doesn't seem like the right way to think about it causally. Wealth creation and innovation come from the bottom up rather than the top down. Fair criticism? Yes, but why? Think about the economy again, general equilibrium. Thinking about people making some choices, consumption being one; combined by series of accounting identities, clearing conditions that say supply has to be equal to demand. Economy will be described by both. Too many unknowns for one equation; where it becomes powerful is when combined with models of C, I, and G. Confusion is by focusing on one equation and forgetting about the others, too many degrees of freedom, so easy to say that when C goes down, something else must go up. When Delong says that, he has a model of where the C and the G come from. Someone who disagrees has a different model of C and G. Have to think about the whole economy.
21:47Interesting: model of C, model of I, and model of G; but nobody really has a model of G other than what they think the model ought to be. George Mason U., one of homes of public choice theory, G. In most macro classes, G is not modeled but simply presumed. Start with models of why G matters; move on to how it could optimally be set; never get to the third stage which is how is G actually set. Partly running out of time; but flaw. It's a little too hard. Undergraduate economics: In discussing current crisis, the debate on G applies a lot to the policy discussion--government spending multipliers, can spend the money in so many different ways. Not just a flaw in teaching undergraduates, but one we don't have a very good model of. It's been proposed that G goes up $770 billion dollars, almost as if it doesn't matter what G is spent on. There is an argument for that: legitimate view in the policy world when Paul Krugman says it should be even bigger and he's pretty open that that's good enough. Economists are always taking partial derivatives even when there's a total derivative behind it. When Krugman says we should have higher G, implicitly saying there are all kinds of other effects but column today is not focusing on those.
25:31Sticky prices and wages. Keynesian model has sticky this or that; new Keynesian model not quite as sticky. What was that accomplishing in the intuitive side for the story of the business cycle? Why important, and why do we find that plausible. Important because you have to be able to tell a coherent story, say why output will sometimes be lower than it could have been; lower than what it could have been because prices are being set too high. Why set too high? Maybe stuck from previous period. Keynesian policy: A lot of Keynesian economics is about why the aggregate demand policies are powerful. Why when Fed changes interest rate or government changes spending will that have an effect? One channel is if there are sticky prices or wages. If Fed changes a nominal variable, why will it have an effect on some real variable? Fed pumps money into economy; if prices adjusted one-to-one nothing real would change, would just have money as a veil. If prices sticky, you boost aggregate demand. Nominal prices might be sticky, but real prices could fall even if nominal prices are fairly sticky. Two ideas: output can sometimes be inefficient, too low; and aggregate demand can have power over the economy, with sticky prices or wages are a powerful mechanism through which that can happen. Stay with theoretical world for a minute. Contrast that story with standard monetarist story, which sometimes has a Keynesian flavor to it. When Friedman and Schwartz wrote the Monetary History of the United States, counterrevolution against Keynesian model, but has Keynesian aspects. Changes in the money supply could have real effects because people wouldn't be sure whether the increases in demand for their product which was economy-wide--inflation--or increase in demand for just their product alone, in which case you should go out and hire more workers. Attack on sticky price idea and on Phillips Curve, idea that inflation and unemployment should be negatively correlated. When that correlation didn't hold up, it was another challenge to the Keynesian view. Correct? Disagree somewhat. Accurate historically but not the one that describes well the current state of knowledge. Currently, opposition between classical model and new Keynesian model. Classical model: no information problems, no price stickiness; so monetary policy completely ineffective; no Phillips Curve at all; aggregate demand policies have no effect. New Keynesian model emphasizes the fact that policy can have an effect on output and that output can be too low or too high. Both shared, though wouldn't go so far as to call Milton Friedman new Keynesian. In terms of the current debate, new Keynesian and new monetarist economics are one and the same thing. New Keynesian model could be described as the new monetarist model. How do we get to the monetarist version from the 1960s to today? Today, frame both in terms of the new Keynesian model, but they differ in how effective those effects would be. Friedman view would have imperfect information stories to explain how prices behave and how monetary policy, while powerful, will not for the most part will not be able to control the cycle; Keynesian view opposite, sticky prices and how policy allows you to control the state of output. Reis's own work is on why prices don't move enough: new-monetarist economist.
33:02Irony for current research agenda: In old days, 1960s and 1970s, when people talked about sticky prices and wages, they invoked union contracts where wages were set for long periods of time, invoked things like you write your price on a sign and it's costly to repaint the sign. Office in Arlington looks out on gas station, price changes daily. In the 1960s those stories were kind of plausible, but in 21st century, unions are less than 10% of the labor force; prices are set with bar codes; and we're in the middle of a bad recession that was set off by enormous drops in housing prices and asset prices that could be bundled together. Where does that leave the sticky price story as an explanator of economic disruption? Reis's research: most plausible reason prices don't adjust is a Friedman-Lucas type story. When we set our prices, together with gathering information, is costly. Three different types of prices: must acquire the information, have to absorb all the different kinds of data, and process and translate them which can also involve costly bargaining within the company. Sticky prices is not changing the price according to current economic conditions. Sticky information; price not responding. Costs of gathering information down with internet, but cost of absorbing that information as high as ever. Parts manufacturer in the mid-West; menu cost view, costly to change the printed catalog. Sitting there every day, time spent in meetings, communicating costs to customers--found that it was very costly. Modern sticky price story is not about why the price is literally unchanged, but why it doesn't respond to current information. Why doesn't car dealer cut the price immediately? Reason has to do with the fact that he still hasn't figured out what's going on. But prices are falling--emails, ads. Recent podcast with Don Boudreaux, Austrian theories of business cycles: in those models, the business cycle results from distortions in the interest rate--capital gets misallocated; not just aggregate K (capital) but different kinds of machines. Similar story in sense that distortions are being caused because prices aren't quite right. Interest rates vs. goods prices.
40:04Policy debate: how strange is it that 70 years after the end of the Great Depression and 73 years since the publication of Keynes's General Theory, that the solutions for the mess we are in are the same: juice up the money supply and spend more money, which we borrow? In the classroom, teaching general equilibrium is hard to do, but the bottom line isn't just how cool it is, but how does it relate to the real world? Revisit what we know from the Great Depression? We learned about policy that it's very serious and bad to let banks collapse. Great loss of information and loss of the way funds are channeled through economy. Learned what is special about banks, what is the function that banks do. It's not about the banks themselves, but about keeping the flow from lenders to borrowers, keeping information about good and bad projects and that knowledge capital alive. We've learned fixed exchange rates are dangerous; gold standard may have been one of the reasons we had a worldwide Great Depression. 1970s went from fixed to flexible exchange rates, transmission of shocks. Learned from the Great Depression how in a frenzy to do lots of things, while Roosevelt got us out of the depression, he also made some mistakes that may have stalled the growth in the economy--NRA, unions, etc. Fourth, learned that reacting to a big shock through protectionist measures can push a recession into a deep Depression; realized importance of free trade, especially after the 1970s. Be careful about protecting too much the capitalists when trying to save capitalism; be careful about unions, etc. Every economist--virtually, enormous consensus--agrees that cartels that increase one sector of the economy at the expense of another are not good. Pigs; destroy cars to save the auto industry. Shifts in the money supply are not good for the economy, gold standard, not good. But easy to misapply the lessons. Bank point: don't want massive banking collapses, don't want to destroy the intermediary. But you also don't want to let no banks fail. Keeping in place decision makers who made really bad decisions. Too far the other way. Didn't say: deficit spending is the way to stave off a depression; people argue that in the Great Depression we never really tried the Keynesian remedy of deficit spending, Roosevelt too worried, balanced budget, and we know now that that was a mistake, which is why we know better now. But what do we really know about that?
47:42Empirical evidence. Let's start with the banks. Nobel Laureates on both sides calling names; not science, demeaning. Real actions can be hard to apply, particularly when it comes to the banking sector. Can understand, but reality is harder. Scientist's job is to clarify. Models can tell us, but when it comes to applying the models, policy decisions made subject to constraints. Paper: at end of Bush administration, decisions about TARP, etc. were made for political reasons, not with understanding that these were bad policies, bad economics. Legal constraints, orderly bankruptcy of banks not easy. Sticky laws. Allen Meltzer podcast, argued that Federal Deposit Insurance Corporation Improvement Act (FDICIA) is an orderly method for letting banks fail. Problem is that FDIC doesn't have power over modern banks like bank holding companies, shadow banks. On fiscal policy: In the Great Depression, we learned that fiscal stimulus can be useful to boost output. Keynes argued that persuasively; others argue it persuasively. But great uncertainty on the quantitative magnitude of these things. Disappointing that when we needed to say something useful we had very little empirical evidence to support us. On monetary policy, hit a liquidity trap, lower bound on interest rates; lot of theory on what to do about it, work in Japan, buying up other assets. When it came to fiscal policy, empirical evidence in the end is very small. Christy and David Romer, others; but a lot of the work is very rudimentary. In debate, people talk about their pet theory or ideology because they have no data. Problem is not inherent flaw of profession, but this was something where we were caught with our pants down.
54:30More pessimistic view: Embarrassing that the tiny subfield of economics called macroeconomics has limited empirical evidence. In classroom, IS-LM is really good for exam questions: balanced budget multiplier, etc. To say that we don't have a lot of evidence on the magnitudes is kind of like saying there isn't much science. Multiplier estimates range from 0 to 1.57. Proponents like Christy Romer say it's the upper bound; opponents even argue it's negative. Crummy level says: we know fiscal stimulus works, WWII ended the Great Depression but the rest of us weren't stimulated. Japan spent trillions on infrastructure, but it didn't work very well; other side argues that they just didn't spend enough. Are we doing any better than that, or is it what Taleb would call, the narrative fallacy, ex post story telling; or what Leamer would call faith-based econometrics, just confirming their biases? Can we make real progress? is it so disappointing that we are doing social science but don't have an answer? Macroeconomics went through a real revolution in the 1970s and 1980s, comparable to relativity in physics. Back in the mid-1980s we couldn't give answers but now we are able to give very precise answers on monetary shocks. Fiscal policy is not one we've devoted time to. We've only been doing this for 20 or 30 years; fiscal policy has just not been exciting. Is it possible to use econometrics? Christy Romer's work: looks in history of U.S., infer causal effect, smart use of econometrics. Study just scratched the surface, need more. Can always criticize econometrics. Failure of focus. Monetary policy: No one, neither monetary economist of the first rank like Ben Bernanke anticipated what happened. Some claimed there would be something catastrophic but no one really foresaw it. Second, Bernanke has done extraordinary things to base money, but nothing has happened. What evidence is there that our understanding of monetary policy is so healthy? First: economists have been doing a good job at stories, but not doing good prediction. Second: monetary policy consensus is about what happens when you change monetary policy during normal times. And have some evidence on extreme times, changing monetary base. Maybe they have worked; let's see what happens in the next couple of years. Given our models, monetary policy has been very adequate; but it can't do everything. We only learn ex post whether our models are wrong.