Being more of an empirical bent, I do not generally indulge in the analysis of macroeconomic theory as thinking about it often causes me to recall what I think was a quote by John Kenneth Galbraith something to the effect that “Macroeconomics is like a religion, nobody truly knows what comes in the hereafter.” More to the point, I have to admit I find modern macroeconomic theory, policy and schools of thought rather confusing having been raised in an undergraduate world where it was simply Keynesian and Classical but I digress. Yet my curiosity has been piqued, first by Nick Rowe’s January 1st blog piece “My simple theory about why macroeconomists disagree” and then today’s piece by Paul Krugman on “Ideology and Economics”.
I suppose that when one looks at whether there is agreement or consensus amongst macroeconomists and views of the business cycle, it helps to factor in the role of ideology or economic philosophy. I recall the classic first year text by Parkin and Bade that helped me put this into perspective with the view that when it comes to the role of government and economic policy, economists could generally be classified as either “activists” or “passive”. Activist economists were generally comfortable with discretionary government intervention in the economy because markets were seen as often characterized by market failure and therefore government could have a positive role in setting the economy straight. Passive economists believed markets generally worked well, and therefore the role of government should be to provide frameworks and policy rules rather than discretionary interventions, which would either destabilize the economy or be ineffective at best.
Taking this basic continuum, one can then factor in the role of fiscal and monetary policy. If you are an “activist”, then both of these tools can be effective in addressing an economic downturn though there may be debate as to which might be more effective. If you are a “passive”, generally you would not advocate fiscal or monetary discretionary intervention but would stick with a more rules based approach and wait for the economy to recover. Let me put this all in a simple four-quadrant diagram with the continuum between “activist” and “passive” on the vertical axis and the continuum between “monetary” and “fiscal” policy on the horizontal axis. Despite my earlier reference to macroeconomics as a religion, the fact the diagram looks like a cross is purely coincidental. Let’s call it the macroeconomics policy cross or MPC.
So with this MPC diagram, can we classify the various approaches to macroeconomic theory and policy? Well, I’m not sure if I can but let me take a stab at it. I would place old-style Keynesians firmly in quadrant II – they are activist and firm supporters of the use and effectiveness of fiscal policy. I would place classical economists in quadrant IV – they are definitely passive as to the role of government policy and I think their approach to monetary policy would also be firmly passive. How about everyone else? A monetarist? I think quadrant IV. If you are a “saltwater” macro-economist, I think you would be in either quadrant I or II though the ultimate location would depend on views regarding the efficacy or importance of monetary and fiscal policy. I would place them in quadrant II but close to the border with quadrant I. “Freshwater”economists? In either of quadrants III and IV but I think more in IV. Real business cycle theorists? I think a IV.
Anyway, in studying disagreements amongst macroeconomists, I’m sure we will also disagree on how to classify them. However, my point is that while macro-economists strive to be scientific in how they analyze issues and their focus on evidence, they are also shaped by assumptions in how they approach empirical phenomenon that reflect their economic philosophy or ideology even if they choose to refer to it as theory. A macro-economist who is fundamentally activist in outlook will have views and policy prescriptions that differ from an economist who views the world from a passive perspective. The world and by extension the macro economy are of course complex, with issues that require both activist and passive responses. The real trick is to know when to be an activist and when to be passive in your policy response. That part is a real skill and requires the intuition of an artist.