Is there an established field where professionals disagree more than they do in economics? Maybe politics? Maybe a few other places? I don’t know. As an economic outsider it always amazes me how much mainstream economists disagree. And they disagree violently. Take this recent post by John Cochrane of the Chicago School in which he blasts away at “Keynesian” economics, Alan Blinder and Paul Krugman.
In that post Cochrane is essentially making three points:
- Keynesian economics sucks.
- Keynesian economics sucks a lot.
- Chicago School economics rules.
I’ve read the real Keynes. I’ve read a lot of it. And I think Cochrane is right when he says that modern macro programs don’t teach Keynesian economics. As I’ve stated before, I don’t even think there’s a lot of evidence that JM Keynes would agree with how we’ve labeled current “Keynesians” like Paul Krugman. Yes, core principles in Krugman’s thinking are things that Keynes himself rejected (such as ISLM and the natural rate of interest). But what’s weird about the New Keynesian models is that they’re actually highly influenced by New Classicals and Monetarist economics – so much so that some New Keynesians like Greg Mankiw have stated that New Keynesian economics could actually be called “New Monetarist” economics.
Of course, I’ve been a critic of Paul Krugman’s use of the ISLM model at times because I don’t think it’s very “Keynesian” and I don’t think it’s been the right model to rely on to understand the current economic environment. But one thing is undeniable – his model has generated a lot of very good predictions. You can dislike Dr. Krugman’s politics, but when the rubber meets the road there are few economic models that can stand up to the predictions he’s made (aside from the Post-Keynesian models like the one I use). This validates the model to a large degree no matter how much me or anyone else wants to declare it flawed somehow.
But what’s most interesting about this attack is that Cochrane has used a framework for understanding the world that has produced some truly dreadful predictions since the crisis. For instance, in 2011 Cochrane wrote a detailed article about how the USA was on the verge of a serious disaster due to high debt levels, inflation, a run on the dollar and rising interest rates:
“As a result of the federal government’s enormous debt and deficits, substantial inflation could break out in America in the next few years.
Interest rates are very low, but they are likely to rise. An increase in interest rates could also bring on inflation today, compounding the inflationary effect of a potential debt crisis through a very similar mechanism.
Each of these commitments could suddenly dump massive new debts onto the federal Treasury, and could be the trigger for the kind of “run on the dollar” explained here.
We stand at the brink of disaster. Today, we face the possibility of a debt crisis, with the consequent financial chaos and inflation, that the Fed cannot control.”
That was all dreadfully wrong. Not a little bit wrong. We’re not talking about minor predictions after all – these calls for higher interest rates, higher inflation, collapsing dollar and debt crisis are some of the very worst predictions in macroeconomic history. They are grounded in misunderstandings that I have explained in excruciating detail for the last 5 years. So, this begs the question – if the Chicago School’s model is some apolitical and superior model for understanding the financial world then how can it possibly result in this sort of thinking which generates such dreadfully inaccurate conclusions from its leading economic thinkers? If Cochrane is right and his views are the ones most influencing policy and academic work then the state of macro is even worse than I think.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.