John Quiggin is loving the attention he’s getting for his series of posts labeled “refuted economic dogmas”. These refutations have left me unconvinced. Often, when I know a little about the “dogma” being refuted, I find myself suspecting Prof. Quiggin doesn’t really appreciate the nuances. For example, in his refutation of central bank independence, he conflated independence with inflation targeting and independence with the lack of cooperation between governments and central banks.
Another example: Quiggin argues New Keynesian Macroeconomics has been refuted by recent events. He defines New Keynesian Macroeconomics as the analysis of small deviations from Adam Smith’s ideal economy. This is not New Keynesian Macro. NK macro models a number of serious deviations from the ideal: imperfect goods markets, imperfect labor markets, sticky prices and sticky wages are standard features of these models. Its interesting that these serious deviations from Smithian ideal result, by construction, in a place being found for policy to improve macro outcomes but despite these deviations, the effect of policy is minor.
The problem of these models is that they can only analyze small deviations from these Keynesian economies. Shocks to the system are assumed to be small and “small” isn’t defined. It could be, in theory at least, the kinds of shocks experienced in the actual economy are bigger than the small shocks analyzed in the model. This would mean the results from the model don’t tell us much about the real economy.
In particular, it could be the shocks experienced to the economy in the current recession are too big to correspond to the implications of NK models. I agree, then, that this feature of these models is troubling. However, we can’t know if the shocks are too big. To use these models, we assume they’re not.
The standard rebuttal to this argument against using NK models, then, is that without an alternative framework of analysis — one that does at least as good a job of replicating key facts about the economy — we can’t do better than NK models. Yes, they’re not a perfect fit to reality, but they’re the best we’ve got. And until we have an alternative, this rebuttal seems persuasive to me.
BTW, Delong says that because NK models don’t tell us everything, they tell us nothing. This argument is just silly. Really very silly.