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Jul 27
2010

Time to reread Keynes

Posted by Ron F in recoveryrecessionObama Administrationjobsjoblessnessinvestmentfinancial crisisenvironmental policyenergyemploymenteconomydemandCongressCareers/Management

Ron F

I've avoided rehearsing the on-going debate over the bleak macroeconomic picture, because it quickly descends into endless political back and forth along with the usual name-calling, as my colleague Steve Taub and I have been discussing internally today.  But it's time to make an exception:

Is the private sector not hiring because it fears more aggressive action from the public sector, and so the public sector (read Obama administration) should leave the economy to itself, as those on the right claim? Or is the lack of private sector hiring a reflection of a lack of private sector hiring, and thus a vicious circle and market failure that requires the public sector (read Obama administration) to step in with a serious jobs program involving infrastructure, alternative energy and schools, as those on the left insist?

Not to speak for Steve, but my sense is he tends to agree with the first perspective, at least for the most part, and I can safely report that I agree with the second, and would recommend James Surowiecki's recent column to help make my case if I could find it. Since I can't, suffice it to say Surowiecki made the useful observation that the two sectors where hiring is picking up, banking and health care, are those where the government has taken the most aggressive regulatory action.

Still, rather than engage in the particulars of that debate, I'll let Robert Solow cut to the chase by attacking the root of the problem. The MIT economist, and a self-described mainstream one to boot, told Congress last week (not that anyone would know of it based on the dearth of coverage) that the reason we can't seem to make any progress on the economy is that mainstream economics has itself embraced right-wing market fundamentalism, and is taken as gospel by the powers that be. So debates about public policy never really move in any direction except toward a knee-jerk, anti-government dead end.

Yet as fellow MIT economist Simon Johnson put it in his own blog post last week, the fact that Solow was testifying about this problem at a hearing on Capitol Hill may be cause for hope that things may be starting to change. After all, the hearing was entitled "Building a Science of Economics for the Real World."

In any case, Solow thinks the essence of the problem is that the reigning "rational expectations" school of thought that mainstream economists embrace and employ in their so-called "dynamic stochastic general equilibrium," or DSGE, model does not comport with reality, or in his words, "pass the smell test."

As he put it in his prepared statement to a subcommittee of the House Committee on Science and Technology, "The DSGE model has nothing useful to say about anti-recession policy because it has built into its essentially implausible assumptions the ‘conclusion' that there is nothing for macroeconomic policy to do."

Solow went on to say that we have just seen how untrue this is for an economy attached to "a highly-leveraged, weakly-regulated financial system" but that "it was just as visibly false" in earlier recessions and in episodes of inflationary overheating.

"There are other traditions with better ways to do macroeconomics," Solow testified. And while he didn't specific which ones he had in mind, it's pretty obvious he was referring to those in the same vein of John Maynard Keynes.

From Solow's mouth to everyone's ears.

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