Monday DeLong Smackdown: Macroeconomy Mean-Reversion Edition

Robert Waldmann saves me from having to read further in David Graeber's Debt: The First Five-Thousand Mistakes this Monday morning:

On unemployment-rate mean-reversion:

Robert Waldmann: "I will attempt a DeLong smackdown...

...Your analysis is notably different from Paul Krugman's analysis of private sector employment.

This is not odd--notoriousl,y unemployment has returned to normal partly through a decline in labor force participation. But wait, he says this recovery is a lot like the last recovery.

The difference is that you impose the assumption that everything before 2008 was the same. In contrast, Krugman argues (and argued in 2008) that financial crisis recessions are different from inflation fighting recessions. Spring 91 through (at least) Spring 93 saw the "jobless recovery". In 1993 you were attempting to understand why things were different pre- and post-1991. The 2001 mini-recession was followed by recovery with declining employment--the "job-loss recovery". At the time, you wrote something was going very wrong with the US labor market. Now there is a desperate need for jobs and you don't see a pattern in jobless, job loss, and job lust.

With a bit less reliance on vulgar empiricism, of course there was, from 1945 through 1984 at least, a strong force pushing the unemployment rate towards something someone thought was the NAIRU. That force is called the FOMC, or the target Federal Funds rate. It makes no sense to look at the univariate dynamics of unemployment. We have good reason to believe that what happened is that the FOMC decided to cause recessions to fight inflation and then, when it was satisfied, cut the target federal funds rate hundreds of basis points (or about a thousand in 1980 and 1982).

When Lehman collapsed the rate was around 2%. It couldn't be cut by 5%. Here part of the problem is that the standard definition of recessions convinced the business cycle timing committee to say the last one started December 2007. But there was a huge change in September 2008. Note the committee became super famous during the period of occasional inflation-fighting recessions. The idea that there is a clear peak and trough makes sense when they correspond (with a lag) to FOMC decisions to start then to stop a recession. This analysis doesn't even bring up financial crises, deleveraging or balance sheets. It's really just that the last 3 recessions started at times of low inflation (and therefore relatively low nominal interest rates) because the didn't start because of a perceived need to fight high inflation. So ZLB so liquidity trap.

Also, I note the qualifier "US" before economy. You have to include that because Europe shows no such strong reversion of unemployment. Nor does Japan (not that they have or ever had high unemployment--but it did shift from very low to low and stayed there). Now there are stories about why the USA is different.

Finally, in what sense are you a new Keynesian? On what issue where new and paleo Keynesians disagree do you side with the new Keynesians? NK models revert to the steady state. This is a methodological a priori--it does not follow from core assumptions which allow indeterminacy under conditions which are assumed not to hold, because we just can't allow indeterminacy.

The assumption that macro is stationary deviations around a smooth trend makes no sense for Europe or Japan. The only case that sortof worked was the USA. The Euler equation has a central role in NK models. You have argued in this blog (correctly) that it has no useful place in macro. In NK models future marginal costs are critical to price-setting to the considerable extent that they are predictable. Again and again you have asked New Keynesians if they really believe this. Never and never have you received an answer.

So I ask: in what ways are new Keynesian models better than or as good as old Keynesian models? Note I am not asking for an argument that, on balance, they are an improvement. I am asking for any advantages, of any sort, related to any aspect of macroeconomics.

Yes, I did worry in 1991-94 and 2001-05 that financial-crisis recessions saw slower labor market recoveries than did inflation-control recessions. But I did not worry enough.

Yes, I did understand that an inflation target of 2%/year was imprudent because it made it difficult to use standard monetary tools to stabilize aggregate demand, but I did not worry enough.

Why did I fall to worry enough? Because even when conventional monetary-policy tools and channels are tapped out, non-standard monetary policy, banking policy, housing policy,loan-guarantee policy, and fiscal policy remain powerful. Surely Bernanke, Geithner, and company understood that their task was to stabilize nominal GDP? Surely they understood the tools at their disposal?

Silly me...

In what way are new-Keynesian models better than paleo-Keynesian models? At fitting the time series, they aren't. At helping us understand the mechanisms behind macroeconomic fluctuations, they aren't. At disproving Robert Lucas's contention that economists could only reach Keynesian conclusions by fudging their microfoundational homework, they are excellent.