Robert Lucas and the intellectual collapse of freshwater economics

31 December, 2012 at 18:58 | Posted in Economics | 5 Comments

In a recent lecture on the US recession, Robert Lucas gave an outline of what the new classical school of macroeconomics today thinks on the latest downturns in the US economy and its future prospects.

lucasLucas starts by showing that real US GDP has grown at an average yearly rate of 3 per cent since 1870, with one big dip during the Depression of the 1930s and a big – but smaller – dip in the recent recession.

After stating his view that the US recession that started in 2008 was basically caused by a run for liquidity, Lucas then goes on to discuss the prospect of recovery from where the US economy is today, maintaining that past experience would suggest an “automatic” recovery, if the free market system is left to repair itself to equilibrium unimpeded by social welfare activities of the government.

As could be expected there is no room for any Keynesian type considerations on eventual shortages of aggregate demand discouraging the recovery of the economy. No, as usual in the new classical macroeconomic school’s explanations and prescriptions, the blame game points to the government and its lack of supply side policies.

Lucas is convinced that what might arrest the recovery are higher taxes on the rich, greater government involvement in the medical sector and tougher regulations of the financial sector. But – if left to run its course unimpeded by European type welfare state activities -the free market will fix it all.

In a rather cavalier manner – without a hint of argument or presentation of empirical facts – Lucas dismisses even the possibility of a shortfall of demand. For someone who already 30 years ago proclaimed Keynesianism dead – “people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another” – this is of course only what could be expected. Demand considerations are simply ruled out on whimsical theoretical-ideological grounds, much like we have seen other neo-liberal economists do over and over again in their attempts to explain away the fact that the latest economic crises shows how the markets have failed to deliver. If there is a problem with the economy, the true cause has to be government.

Trying to explain business cycles in terms of rational expectations has failed blatantly. Maybe it would be asking to much of freshwater economists like Lucas to concede that, but it’s still a fact that ought to be embarrassing. My rational expectation is that 30 years from now, no one will know who Robert Lucas was. John Maynard Keynes, on the other hand, will still be known as one of the masters of economics.

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5 Comments »

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  1. True to that. Strange, because in some ways Lucas has been at times a clever thinker. In my view, he has allowed his ideology to distort and undermine a rather creative mind.

    • That wouldn’t be the first instance of what seems to be a “clever thinker” suddenly going off the rails. As Krugman put it, “Again and again one sees people with seemingly sterling credentials — Federal Reserve presidents, economists with Ph.D.s from good schools — propounding views that I thought were obvious fallacies, at least to anyone who had studied the subject a bit. And the hits just keep coming.”

      I suspect that is because many “clever thinkers” are actually a sham. That is, they’ve mugged up text books and passed exams. But put them in a situation where they have to actually THINK, and they’re lost.

  2. Harsh! I can’t say that I disagree. I will give Lucas credit for his famous critique, though it was not original to him, and didn’t go far enough. Many of the “laws” he posits as operating have the same problem that Malthus’s law of population had: people can choose to behave differently than in the past. For the same reason people won’t always be fooled by inflation, people might not work less just because they’re taxed or regulated. Some might even work more!

  3. Yeah, supply-side…

    The government stocks the pond with it’s spending, and businesses fish for the dollars…don’t try to tell us that business drives the economy.

    Businesses pay their employees, subcontractors and vendors 2/3rds of the funds it requires to buy their products if they expect to make a profit….where do the free-marketeers think the other third of the funds comes from?

    It isn’t the private sector, it can’t manufacture money.

  4. Those who insist there is a demand shortfall, and go on and talk about output gaps and so on, almost never include any explanations, theoretical or empirically based, of why there was a sudden increase in the demand for money. It seems as though we’re all supposed to take such demand for money shocks as inexplicable recurring phenomena, and rather than address the issues that may have caused them, we are to treat the symptom (fall in spending) with a prescription that removes such symptoms.

    There are no serious explanations for why these recurring increases in the demand for money take place. There are attempts of course, but those coming from the Keynesian camp fail miserably, because Keynesian theory does not offer any serious explanation. There is “animal spirits”, and that’s that. There is nothing beyond this rather cryptic mysticism. It’s a given, and we have to deal with it somehow.

    Of course, there are economic explanations for why there are periodic episodes of increases in the demand for money and decline in spending, but Keynesians tend to hand wave and dismiss them, because they are explanations that implicate Keynesian theory itself. This explanation bears repeating: There are recurring episodes of sudden increases in the demand for money because of PRIOR non-market inflation. This non-market inflation has affected pricing and investment in such a way that the capital structure of the market economy becomes increasingly stressed and put onto a physically unsustainable configuration, which inevitably leads to large scale re-adjustments and corrections. It is these inevitable corrections that cause the sudden increase in the demand for money.

    The reason they are recurring is because central banks tend to do what Keynesians tell them to do: Inflate more and stop the fall in spending. This of course just brings about another round of capital structure distortions and inevitable correction, and another sudden increase in the demand for money.

    Keynesian theory is a theory of a dog chasing one’s own tail.


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