Mr. Sargent and the Keynesians, A Suggested Interpretation

The title, of course, is borrowed from Hicks's seminal article, Mr. Keynes and the "classics", a suggested interpretation, which outlined what would become the canonical way that economists would not just understand Keynes, but that they would understand how the Keynesian system was meant to operate as a general theory, of which the classical system was a special case.

So, why "Mr. Sargent and the Keynesians"? Because Mark Thoma shared a wonderful interview with Tom Sargent - the great rational expectations economist - that I think really highlights a basic agreement with and understanding of the proper relationship between Rational Expectations and New Classicism and Keynesianism. The key quote that Thoma highlighted - which also stood out to me in reading it - was:

"The criticism of real business cycle models and their close cousins, the so-called New Keynesian models, is misdirected and reflects a misunderstanding of the purpose for which those models were devised. These models were designed to describe aggregate economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.

By the way, participants within both the real business cycle and new Keynesian traditions have been stern and constructive critics of their own works and have done valuable creative work pushing forward the ability of these models to match important properties of aggregate fluctuations. The authors of papers in this literature usually have made it clear what the models are designed to do and what they are not. Again, they are not designed to be theories of financial crises."

This, of course, is reminiscent of my post yesterday on Martin Feldman and the relationship between Reaganomics and Keynesianism. Feldman and Sargent don't sound like Keynesians, but that's largely because they made their names during eras when the demand-side wasn't really a problem, and they worked on questions and problems that didn't really feature weak demand cases or deflationary cases.

Hicks pointed out that Keynes's "depression economics" was simply the notable addition that he made (or, more accurately, the point that he synthesized, clarified, and expanded) - but the Keynesian/Hicksian system incorporated a quite classical world that was thoroughly developed by men like Sargent and Feldman. So - the "full employment by accident" is actually a special case of a more general (really Hickisian) system, and the "depression economics" we usually associate with Keynes is also a special condition of that system, with the system itself never guaranteeing employment and usually hovering in some sort of moderate underemployment that is proppd up (or not) by macroeconomic policymakers. To put a finer point on the relationship between Rational Expectations and the broader Hicksian paradigm (and the improvements that need to be made on that basic Hicksian approach that was introduced seventy years ago), Sargent says:

"To put it technically, the “new Keynesian IS [investment-savings] curve” is an asset pricing equation, one of a form very close to those exposed as empirically deficient by Hansen and Singleton. Efforts to repair the asset pricing theory are part and parcel of the important project of building an econometric model suitable for providing quantitative guidance to monetary and fiscal policymakers."

He also pushes back on some of the recent criticisms of macro:

"...aside from the foolish and intellectually lazy remark about mathematics [that macro is too highly mathematized], all of the criticisms that you have listed reflect either woeful ignorance or intentional disregard for what much of modern macroeconomics is about and what it has accomplished. That said, it is true that modern macroeconomics uses mathematics and statistics to understand behavior in situations where there is uncertainty about how the future will unfold from the past. But a rule of thumb is that the more dynamic, uncertain and ambiguous is the economic environment that you seek to model, the more you are going to have to roll up your sleeves, and learn and use some math. That’s life."

I couldn't agree more. I can barely supress my laughter when someone tells me about how highly mathematical economics is problematic and that logical precision is required in the same breath. And I'm sorry, but this comes from the Mises crowd and it needs to be said. I haven't read much Mises but I've read enough chapters of Human Action to know that Mises's thought processes are considerably more scattered and imprecise than anything that I ever read in David Romer's macro textbook. You may be able to say things precisely without math, but (1.) it's considerably harder, and (2.) it's much harder when you're talking about the relationship between quantitative variables. As Sargent says "that's life".

One final point that I liked was one he made about the relationship between the generous welfare state in Europe and labor market turbulence in locking in high levels of unemployment. Here, Sargent agrees with the Krugman critique of the old argument that generous welfare states cause high unemployment, because the welfare states were also generous in the 50s and 60s, when Europe had much lower unemployment than the U.S.. Sargent argues that the important point is the interaction of high labor market turbulence - lots of job switching - and a strong welfare state. In a microeconomic environment characterized by low turnover, generous welfare programs can actually foster lower unemployment by making stronger, more productive matches. In highly turbulent labor markets these same welfare programs prevent rapid reallocation of labor, deplete human capital, and lock in high unemployment.