Two Big Lies

A Big Lie uses vigorous, confident repetition to promote a false argument. This post looks at two big lies, both originating with Robert Lucas, that damaged the development of stabilization-relevant macroeconomics:

• “Keynesian economics is dead.”
• “Involuntary unemployment is not a fact or a phenomenon which it is the task of theorists to explain.”

First lie. From Lucas (1980): “I intend to duck both questions put to the panel. I will not tell where the economy is headed or what the President ought to do about it. I’m sure that other panel members have wrapped these questions up for you. Instead I will try to tell you where I think economics is going – with emphasis on macro- or monetary economics. This a question of interest to me – I’m an economist and everyone is interested in developments in his own industry. But occasionally developments in economics matter for non-economists, and I hope the developments I will discuss will be of some interest to you.

“The main development I want to discuss has already occurred. Keynesian economics is dead. I don’t know exactly when this happened but it is true today and it wasn’t true two years ago. This is a sociological not an economic observation, so the evidence for it is sociological. For example, you cannot find a good, under 40 economist who identifies himself and his work as ‘Keynesian’. Indeed, people even take offense if referred to in this way. At research seminars, people don’t take Keynesian theorizing seriously anymore – the audience starts to whisper and giggle to one another. Leading journals aren’t getting Keynesian papers submitted anymore.”

Forty years later, Keynesian thinking is widely used to motivate the range of empirical and descriptive models. It is especially used by business economists who are paid to produce insights into real-world behavior of the global economy. Keynesianism is clearly not dead today nor was it in 1980. Its continued use is rooted in its much superior guidance in the tough job of providing useful advice than provided by Lucas’s general-market-equilibrium (GME) modeling. Is that why he ducked the question of where the economy is headed? He does not have anything to say on practical stabilization questions because the GME modeling, upon which he relies, has nothing useful to say. Useful answers to such real-world questions are instead almost always rooted in Keynesian analysis.

The bulk of Keynesian macroeconomics carefully models total spending, component by component. The behavior of aggregate nominal demand is made stabilization-policy critical by meaningful wage rigidity (MWR).  Lucas’s problem is that his GME theory cannot rationally accommodate MWR and he never figured out how to correct that problem. He chose to substitute a big lie for a solution. Keynesianism cannot be consistent with rational behavior and must be scrapped.. It is old-fashioned, embarrassing, and laughable. Keynesian economics is dead.

Readers of this blog know that GEM modeling has microfounded MWR, which then rationally motivates causation from total demand disturbances to same direction movement in employment and output. Proper policy is centered on the management of aggregate nominal demand. The more we know about its determinants, the more effective stabilization intervention will be. Keynesian economics is at the center of stabilization-relevant macroeconomics. Lucas’s confident, oft-repeated, badly thought-through pronouncement is a lie.

Second lie. From Lucas (1978): “Involuntary unemployment is not a fact or a phenomenon which it is the task of theorists to explain. It is, on the contrary, a theoretical construct which Keynes introduced in the hope it would be helpful in discovering a correct explanation for a genuine phenomenon: large-scale fluctuations in measured, total unemployment. Is it the task of modern theoretical economics to ‘explain’ the theoretical constructs of our predecessor, whether or not they have proved fruitful? I hope not, for a surer route to sterility could scarcely be imagined. In summary, it does not appear possible, even in principle, to classify individual unemployed people as either voluntarily or involuntarily unemployed depending on the characteristics of the decision problem they face. One cannot, even conceptually, arrive at a usable definition of full employment.”

If the real world were adequately described by neoclassical GME modeling, which Lucas assumes in almost all of his serious research, involuntary unemployment (IU) would not be a fact or a phenomenon which it is the task of theorists to explain. It would not exist. Market-centric analysis cannot accommodate IU. It therefore requires no explanation.

The problem is that IU does exist, as made clear by the table. Indeed, it is obviously one of the most crucial facts of periodic macro instability that stabilization authorities are tasked to damp down.

JOB-LOSS BEHAVIOR IN U.S. RECESSIONS

Lucas argues that involuntary job loss cannot exist in general market equilibrium and, as a result, macro theorists should stop obsessing over it. He is correct about the nonexistence. Market-centric general equilibrium cannot accommodate rational employer-employee behavior produced in information-challenged workplaces. It follows that it cannot produce MWR and involuntary unemployment.  But isn’t it damaging sleight of hand to gloss over the crucial policymaking fact that involuntary job loss has dominated rising unemployment in each and every recession for which we have the necessary data. Isn’t Lucas’s advice here another big lie? If he had continued his GME-nonexistence line of argument, Lucas would have had to eventually concede that the whole of his serious contributions to stabilization theory is hopelessly irrelevant.

Blog Type: Chicago School Chicago, Illinois