
At a recent blogger conference, I was asked to name the most important paper published in my field (which is macroeconomics) over the past ten years. I couldn’t think of any.
In one sense, that’s a reflection of the fact that the field has moved on from the 20th century macro research with which I am most familiar. My ignorance may say more about me than it does about the field of macro. In desperation, I suggested that Paul Krugman‘s 1998 Brookings paper (It’s Baaack . . . ) was the most recent one that I recall having a decisive impact on how we think about macroeconomics. A few years ago, I wrote a paper discussing how the important “Princeton School” of monetary economics was heavily influenced by this paper.
Many brilliant economists continue to do quite sophisticated research in money/macro. And yet I rarely see new papers that seem interesting to me, at least in the way that many papers from the last half of the 20th century seemed interesting when they were first published. And it’s not just macro. Casual art fans like me are familiar with hundreds of famous painting from the period from 1880 to 1924, but very few famous paintings from the period 1980 to 2024. Why is that?
Tyler Cowen recently linked to an NBER working paper by Joel P. Flynn and Karthik Sastry, which looks at how optimistic and pessimistic narratives could contribute to the business cycle. At a technical level, the 134-page paper is far above anything I ever did, featuring literally hundreds of mathematical equations, some fairly complex. Here’s an excerpt from the conclusion:
When we calibrate the model to match the data, we find that the business-cycle implications of narratives are quantitatively significant: measured declines in optimism account for approximately 32% of the peak-to-trough decline in output over the early 2000s recession and 18% over the Great Recession. Finally, we show that the interaction of many simultaneously evolving and highly contagious narratives, some of which are individually prone to hysteresis, can nevertheless underlie stable fluctuations in emergent optimism and output. Taken together, our analysis shows that narratives may be a significant cause of the business cycle.
Their work employs a “real business cycle” framework, of which I’m generally somewhat skeptical. It’s not that these RBC models don’t tell us important things about the economy, rather I believe that (at least in the US) real shocks are primarily important as a determinant of long run trends, not business cycles. (With Covid being the obvious exception.)
I only skimmed the paper, so I won’t offer an opinion on their empirical estimates, but this caught my eye:
Our analysis leaves open at least two important areas for future study. First, we have analyzed how firms’ narratives matter and abstracted away from studying households’ narratives. It seems reasonable that similar mechanisms could operate on the household side of the economy, where contagious narratives might influence spending and investing decisions. Moreover, co-evolving narratives on both the “supply side” and the “demand side” of the economy might have mutually reinforcing effects. From this perspective, narratives have the potential to explain even more of the business cycle than our analysis suggests.
I like this observation, as I’ve long believed that the most important impact of supply (real) shocks is the way they interact with demand (nominal) shocks. Thus a real shock in housing/banking during 2007 probably depressed the natural rate of interest. The Fed fell behind the curve and cut rates too slowly (especially in 2008.) This led to a fall in nominal GDP (less demand), making the recession much worse.
They conclude with the now almost mandatory call for further research:
Second, there remains much more to study about what “makes a narrative a narrative”—that is, in the language of our model, what microfounds the set of narratives and their contagiousness? A richer study of these issues would cast further light on policy issues, including both the interaction of standard macroeconomic policies with narratives and the potential effects of directly “managing narratives” via communication. Moreover, probing these deeper origins of narratives could further enrich the study of narrative constellations beyond our analysis, to account for the full economic, semantic, and psychological interactions between narratives in a complex world.
Will that follow up research answer those questions? I’m skeptical. I worry that the next brilliant pair of young macroeconomists will think to themselves, “Flynn and Sastry have already done that, let’s develop a different model.” There’s probably enough truth in almost any plausible macro model that you can find some empirical support for the theory (at least if you sufficiently “torture” the data set.)
It’s possible that my skepticism about modern macro merely reflects an old guy who is out of touch with recent developments. I plead guilty. But in the second half of the 20th century, one didn’t have to read 100 page research papers to understand that macro was generating lots of revolutionary ideas. I am not seeing interesting new ideas being explained in non-technical papers for the layman.
Here’s one way to think about my pessimistic mindset. I’ve done macro research for almost my entire life. Fairly early on, I came to the conclusion that US business cycles were pretty simple. In most cases (not Covid) it was simply a question of monetary policy mistakes driving fluctuations in NGDP, and real GDP being highly correlated in the short run due to sticky wages.
If you were going to explain why the paintings of 1880-1924 seem more memorable than the paintings of 1980-2024, you might point to the fact that painters in the earlier period discovered lots of interesting new styles, and that there simply weren’t as many interesting new styles to discover in the latter period. Another view is that I’m wrong, and that future generations will discover even more masterpieces in the art of painting from the 1980-2024 period than from 100 years earlier. Time will tell.
Thomas Kuhn said that in science we often make progress by developing models, then discovering that there are certain “anomalies” not explained by these models, and then developing new and improved models to explain those anomalies. Perhaps our best late 20th century macro models do a pretty good job of explaining business cycles (and note that the “Fed mistake” theory I just gave could explain why explanation doesn’t imply prediction). Perhaps the remaining anomalies are simply very hard to explain.
But this doesn’t fully explain my skepticism about modern macro. You can argue that we invented too many good macro models in the second half of the 20th century. We have Keynesian models, monetarist models, real business cycle models, Austrian models, MMT models, and many variations within each category. Flynn and Sastry are employing a RBC framework in their paper. Because my own view is that this framework is not very useful for understanding business cycles, from the outside this whole line of analysis seems a bit off target. And that skepticism doesn’t just apply to RBC models, from my perspective any non-market monetarist model is somehow missing the point. They all appear to be trying to explain something that has already been adequately explained. They aren’t addressing anomalies in the model where Fed mistakes drive NGDP and create cycles due to sticky wages; they are usually working with an entirely different framework.
This is why to a grouchy old guy like me, macro no longer seems progressive. We are not filling in the gaps; we are continually trying to reinvent the wheel.
Again, it’s very possible that I’m out of touch. All I can say is that I no longer read papers and think, “I always wondered why certain macro variables (M,Y, P, i, U, etc.) showed this pattern, now it makes more sense.” I don’t see the progress.
But hey, people in 1890 didn’t yet see the brilliance of Van Gogh, so it’s quite possible that I’m missing something important.
PS. Here’s a Kandinsky painting from 1925. What was there left to say?
PPS. Here’s one of the 247 mathematical equations in the paper:
READER COMMENTS
Junio
Jun 28 2024 at 12:58am
That’s a scary looking equation. Interesting post though.
– Junio
Todd Ramsey
Jun 28 2024 at 9:32am
Not an academic paper, but nonetheless the most important writing on monetary policy in the last 10 years: themoneyillusion.com/wp-content/uploads/2023/03/Sumner_AlternateApproachesMonetaryPolicy_v1a.pdf
Thomas L Hutcheson
Jun 28 2024 at 2:11pm
I read it, annotated it, and learned a lot. But two things left me puzzled. First why we need to be able to characterize the vector of monetary policy instrument settings as “expansionary/contractionary” in order to criticize them?
Second was why the author thought targeting NGDP would be better than targeting inflation and indeed whether it would make any difference.
Well, three, but the third was not really within the scope of the book. Given that the “Princeton School” seemed to have pretty well nailed what to do when threatened with a ZBL, why Bernanke could not get the Fed to act on those insights in 2008 onward?
Scott Sumner
Jun 28 2024 at 8:56pm
Thanks, but how important can it be if few people have read it?
spencer
Jun 28 2024 at 10:37am
Love Kandinsky, “the creator of the first modern abstract paintings and a pioneer of Expressionism”
David Seltzer
Jun 28 2024 at 11:32am
Scott: I spent considerable time at The Art Institute of Chicago. Like you I was taken with Kandinsky’s abstract art. It was explained to me, by an artist, Kandinsky was greatly influenced by Monet’s Haystacks. The brilliant colors we see in his work seem independent of defined objects. If, for example, he was influenced by the impressionist Monet, I suspect a Kandinsky like macro-economist might well emerge if influenced by Hume or Fisher.
Scott Sumner
Jun 28 2024 at 8:55pm
Interesting observation. Kandinsky started out doing representational art.
Iskander
Jun 28 2024 at 1:16pm
That paper (and, in fairness, many papers) seems to think that “aggregate demand” is some sort of real (as opposed to nominal) variable. It’s model is one of monopolistic competition based on Blanchard and Kiyotaki (1987); “aggregate demand externalities” are present because one firm lowering its price (which is above marginal cost) raises aggregate income, resulting in greater demand for other firms’ output. This seems to me to actually be an aggregate supply issue – demand for other firms’ goods has gone up because real incomes have risen due to the decline in monopoly power. I suppose this is just opening up the Say’s law can of worms, but “aggregate demand” should really only be applied to monetary models and not RBC ones (B&K basically mention this and therefore include money in their model).
Perhaps I didn’t “ctrl+f” my way through the paper well enough, but I wonder what the effect of “optimism” is on pricing. A firm could be wrongly optimistic about demand increases or productivity increases, and hiring (the variable they focus on) would perhaps expand in both cases, yet the key pecuniary externality that seems to drive their results is from prices – which may go up or down depending on the causes of optimism.
Scott Sumner
Jun 28 2024 at 8:51pm
I probably shouldn’t even comment, but my impression is that AS/AD doesn’t map neatly into RBC models. AD is basically a nominal concept, and RBC models obviously focus on real variables.
Lizard Man
Jun 28 2024 at 4:12pm
Are questions pertaining to the impact of government policies on aggregate supply part of macro? Another way of asking my question is, beyond studying business cycles, what do macro economists study? It seems that Sumner believes that most of what anyone needs to know about business cycles has already been discovered. So what other questions are there in macro, and is progress being made on those questions?
Scott Sumner
Jun 28 2024 at 8:54pm
Long run economic growth is also viewed as part of macro. But in my view that should be viewed as a separate field. To me, money, prices and output/employment is the core of macro, what makes the field distinctive.
I am skeptical that we’ll ever have a general theory of economic growth. Rather it seems to me that growth is impacted by millions of distinct supply side factors.
Todd Ramsey
Jun 29 2024 at 10:58am
In support of your point, my oversimplified catchphrase: “In the long run, it’s all Micro”.
Scott Sumner
Jun 29 2024 at 12:25pm
Or think of it this way: Macro can be views as the implication of shocks to the medium of account, in a world where most contracts are nominal. One implication is inflation/deflation. Another is business cycles.
spencer
Jun 28 2024 at 5:44pm
Ha. Economists can’t even define the variables in the equations.
Philippe Bélanger
Jun 29 2024 at 11:59am
Have you looked at John Cochrane’s book on the fiscal theory of the price level? I think it is intended to be simple yet revolutionary, much like the 20th-century papers you mention. I disagree with most of it but I thought it was very thought-provoking.
Kurt Schuler
Jun 29 2024 at 8:13pm
Cochrane’s book is pushing 600 pages. Simplicity would be 100 pages.
Philippe Bélanger
Jun 29 2024 at 9:53pm
I agree but most of the book is extensions of the fiscal theory and discussions of classic issues in monetary economics from the point of view of the FTPL. The theory itself is quite simple.
Scott Sumner
Jun 30 2024 at 1:34am
I am extremely skeptical of the FTPL. I favor a monetary theory.
SK
Jun 30 2024 at 5:44pm
I do too, but find that are a bit attached at the hip with more emphasis on Money, but no exclusion of FTPL
David Seltzer
Jun 30 2024 at 10:32am
Kurt: I see your point. Having plowed through it several times in a year it seems John’s proofs, theorems and lemmas are pillars intended to support his FTPL hypothesis.
Travis Allison
Jun 30 2024 at 3:40pm
Scott, would you agree with the following statement?
“A moderate amount of demand side inflation (~2%) is necessary to reduce real hourly wages for people who lose their jobs so that those who are unemployed can get hired again more easily.”
Is this the crux of the problem of sticky wages and how monetary policy deals with it? It seems that we could have NGDP level targeting without any inflation included in the target otherwise.
Why do you think that an NGDP level target needs to be greater than RGDP?
Scott Sumner
Jun 30 2024 at 4:17pm
I understand the argument, but I don’t think it makes sense to talk in terms of inflation. I do think we need a moderate amount of NGDP growth to insure full employment, although I cannot say for certain how much. Japan gets by with relatively little.
Hawk T.
Jun 30 2024 at 3:43pm
This is how I feel about most sociology research and a lot of psychology research. We already have very simple explanations for most phenomena that are well supported by tons of evidence, but those explanations are forbidden, and so people spend entire research careers coming up with Rube-Goldberg machines to explain things that are already explained.
Scott Sumner
Jul 1 2024 at 1:24am
“but those explanations are forbidden”
I’ve noticed that it’s considered acceptable to say ethnic group X makes more than white Americans due to cultural factors, but it’s not considered acceptable to say ethnic group Y make less than white Americans due to cultural factors.
Knut P. Heen
Jul 2 2024 at 7:43am
Did anyone provide any evidence that business cycles actually exist? The reason I ask is that in finance there is clear evidence that stock market returns follow a random walk. Therefore there are no bubbles or cycles in the stock market data even though it may look like it is. A random walk may produce something that looks like a bubble in hindsight. A simple way to check this is to plot today’s return vs. yesterday’s return for a long time period. The picture you get always looks like a shotgun shot (no correlation). It does not matter whether you do it on a daily, weekly, monthly or yearly basis, no correlation.
Now, with macro data, I suspect there is a long-run growth trend with a random walk element to it much like the stock market. Equation (169) looks like it comes from such a process (a stochastic differential equation with upwards drift?). But is there any evidence of any cyclic behavior?
In the stock market, random walk is consistent with the efficient market hypothesis. If business cycles do exist, the stock market must anticipate these perfectly because there are no cycles in the stock market data. This leads to the following conundrum. If the stock market anticipate the business cycles perfectly, why cannot macro economists do that?
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