Paul Krugman devotes multiple columns and blog entries to economists who got, and continue to get, things wrong. Those who preached austerity (“fiscal consolidation”), for example, predicted the return of “investor confidence” (on the assumption that capitalists can be voluntarily separated from their money if governments spend no more than they take in) and even economic expansion, on the supposition that the dollars governments lack are available to the private sector, which, as a matter of dogma rather than evidence, knows best. Other economists warned that monetary expansion would send prices soaring. Yet, even after the Federal Reserve has effectively tripled the money supply, inflation remains quite low.
To the legion of incorrect economists Krugman asks, if not demands, that they first admit that they were wrong and then revisit their models, which must surely be wrong. He, himself, confesses to a mistake, believing in the immediate post-recession months that deflation was a strong possibility. While prices dipped for a brief period, relatively modest inflation has been the new normal.
Krugman suggests that it’s his IS/LM model that allows him to make more accurate predictions than non-Keynesian economists, who rely on, say, dynamic stochastic general equilibrium models, with the underlying belief that macroeconomics is merely microeconomics writ large. Krugman questions whatever models or theories the non-Keynesians use to develop their predictions, since they’re obviously not working. (Milton Friedman opined that the strength of any model or theory was its ability to accurately predict future events.)
Yet, what about Professor Krugman? He predicted deflation. It didn’t happen. If he relied on one or more Keynesian-based models, should he not also question that foundation? He writes:
Notice how Keynesians responded to the partial failure of a prediction: by asking what they got wrong, and how their model of the world needed to be adjusted. This, of course, shows what fools we are: everyone on the other side of these debates knows that you respond to mistakes by never acknowledging them, and doubling down on whatever you originally claimed.
Let me pose a slightly different question: Is the failure to predict deflation cause to jettison the entire Keynesian edifice? Also, does this slip undermine everything else Krugman says or writes?
While reasonable minds may disagree, few of us would denounce Einstein’s relativity theories because he never got around to developing a grand unification model, something he suspected was implied by his other postulates. Nor should we condemn Newton’s laws of motion for their failure to anticipate a space-time continuum or relative frames of reference. Better that we say Sir Isaac was “incomplete.”
So, too, is Krugman “incomplete.” He got most of the big stuff right. The admitted error seems insufficient to warrant wholesale dismissal of his popular writings. Given recent evidence, especially the economic downturns of those nations practicing austerity, the onus would appear to be on those who asserted the world would be grossly different, including Fed-caused conditions of hyper-inflation or austerity-driven economic expansion.
That said, a good modeler constantly tweaks. Here’s to the tweakers.
UPDATE (May 29, 2013):
Noah Smith, a real economist, discusses the uses of models, in particular those of the DSGE variety. While he seems to dismiss their forecasting powers in his initial post, he then suggests that a variation of one does a pretty good job of predicting the Great Recession—after the fact. One has to add in “financial frictions” to get the desired result, an element missing from previous versions.