What Good Are Economists Anyway?

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Ronald J. Cala II

The Rise, Fall, and Rise of Fiscal Policy
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new ideas to come in, much as they did in the 1930s and the 1970s," says Roger E.A. Farmer of the University of California at Los Angeles.

Besides, even if you're suspicious of economists' value, they are impossible to ignore. Here's why: Every idea you can think of for coping with this crisis is based on some supposition about the way the world works. Whether you realize it or not, all of those suppositions come out of one school of economics or another. As the British economist John Maynard Keynes wrote: "Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."

So we had all better hope that the profession can get its act together. It won't be easy, because this crisis is rubbing salt in old wounds. It is reopening debates about one of the most contentious questions in macro, namely, the ability of government deficit spending (i.e., fiscal policy) to stimulate demand and get people back to work.

In January the fight over fiscal policy broke out in public after then-President-elect Barack Obama made what probably seemed to him a safe claim, saying: "There is no disagreement that we need action by our government, a recovery plan that will help to jump-start the economy." Not long after, some 250 conservative economists, in an open letter published in major newspapers, wrote: "With all due respect Mr. President, that is not true." Middlebury College economist David C. Colander, who himself is suspicious of the stimulus package, says: "The debate is reasonable. What's unreasonable is that we're undertaking it at this time" rather than decades ago.

Economists' worst sin is hubris. In the 1960s, free-market economist Milton Friedman persuaded virtually the entire profession that the Great Depression was caused by the Federal Reserve. That seemed to imply that better policy by the Fed, guided by economists, would prevent a recurrence. Bernanke, then a governor of the Federal Reserve, said as much in a 2002 speech for Friedman's 90th birthday that acknowledged the Fed's role in the Depression. He told Friedman: "You're right, we did it. We're very sorry. But thanks to you, we won't do it again." Famous last words.

Believing in the power of the Fed, economists mostly stopped researching the use of fiscal policy to fight recessions or depressions. What's more, recessions had become rarer and milder—the so-called Great Moderation. So who needed stimulus? Says New York University economist Xavier Gabaix: "Up until a year ago, you would look very old-fashioned if you were talking about optimal fiscal policy."

Mainstream economists' adherence to orthodoxy was also apparent in their casual dismissal of worries about bubbles in housing and stocks. Former Fed Chairman Alan Greenspan denied that a national housing bubble was even possible, since housing was not a single national market. He also brushed off the dangers of Wall Street concoctions such as derivatives. Only last year did he concede he was wrong. In Senate testimony, he said he was shocked to have found a "flaw" in his ideology, adding: "I have been going for 40 years or more with very considerable evidence that it was working exceptionally well."

Politics compounded the trouble. As a rough first cut, you can divide macroeconomists based on how concerned they are about economic instability. One group, in the tradition of Keynes, worries about self-perpetuating economic declines that leave the economy in a deep trough it can't escape. Members of this group say government needs to break downward spirals with the kinds of aggressive policies the U.S. is following now—cutting interest rates and raising government spending. The group includes Paul R. Krugman, the Princeton University economist and Nobel laureate; NYU's Nouriel Roubini, who was early in predicting a severe recession; and Yale University's Robert J. Shiller, who predicted the housing bust and the tech-stock bust.

Other economists have more confidence that the economy is self-equilibrating. They believe low interest rates and heavy deficit spending will be ineffective while leaving the U.S. with a mountain of debt. Count Harvard's Robert Barro in this camp, along with Chicago's Robert E. Lucas Jr., Arizona State University's Edward C. Prescott, and the University of Minnesota's Patrick J. Kehoe and V. V. Chari. No surprise, the equilibrium school mainly leans Republican, and the interventionist school seems to be crawling with Democrats.

Before this crisis, it seemed that economists might resolve their differences. The oft-combative Krugman, in the first edition of his textbook Macroeconomics in 2006, wrote that "the clean little secret of modern macroeconomics is how much consensus economists have reached over the past 70 years."

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