Since I’m very interesting in economics, without being trained in it, I find the sociology of the field fascinating. There are, roughly speaking, two camps in economics: the “salt water” or roughly Keynesian side and the “fresh water” or roughly rational expectations side. Now I talk a lot around here about the conservative and liberal economists. Paul Krugman, for example, is a liberal economist, and Greg Mankiw is a conservative economist. But this is not the divide we are talking about today. Because as far as I can tell, both Krugman and Mankiw are more or less Keynesians.
Here we are talking about Robert Lucas and his followers. I always feel a bit worried when discussion people like Lucas, because he is by all accounts a brilliant thinker. And I’m just a blogger and a physicist. But I try. One of Lucas’ greatest contribution had to do with the Phillips curve. This is a relationship between inflation and unemployment. If unemployment went down, inflation tended to go up. If unemployment when up, inflation tended to go down. But in the 1970s, this broke down during the so called stagflation: high unemployment and high inflation. “Aha!” said the fresh water folks, “Keynes is dead! Long live Friedman!”
As for the details of what was really happening, it seems to be that stagflation was due to sharp oil price shocks. So it wasn’t that the Phillips curve was wrong. It was just a special case of a new model. You can think of it as the Hook’s Law of the Ideal Gas Law. But the fact of stagflation really shouldn’t have been seen as a revolution regardless. To begin with, the Phillips curve isn’t part of Keynesian economics. And it was only ever an empirical relationship. But like a lot of such things, it became something of a law among Keynesian economists.
As a result, this caused a great social rift that Paul Romer has been writing about (ad nauseam if you ask me). He is trying to understand why it is that the fresh water economists closed in on themselves and basically stopped listening to any economists outside their circle. And as a result, fresh water economics has turned into something more like a Euclidean cult than a modern scientific enterprise. And I mean that in a specific way, because the fresh water economists continue to innovate and come up with new insights. But they are always rather far removed from reality.
The whole thing reminds me of the skeptic movement (of which I’m part). At some point, they simply decided that based upon a single success and the perceived (but wrong) failure of Keynesian theory, that Keynes was in fact dead and that they never had to deal with it again. But there is a difference. I don’t pay attention to the constant background noise of Bigfoot spotting. But if tens of thousands of new people started making reports, I would have to reconsider. And I know that the skeptic community would head out into the forest and look into it. So why haven’t the fresh water folks done the same? Well a lot of economists are trying to figure this out.
Fundamentally, I think the problem is that economics doesn’t work very much like a science. I think it is that there is too much money in it that poisons the system. Based upon what I’ve seen, I think Keynes was about 80% right. And the likes of Milton Friedman and Robert Lucas have added some wrinkles onto that. But that seems to be what the New Keynesians have done. The fresh water economists seem to be lost in their own fantasy land. But they can live there quite happily, as long as they continue to get funding. And given that their policy ideas tend to be exactly what the power elite want to hear, I don’t see them changing any time soon.