Prof. Delong has a nice summary of the pre-RBC (aka “purist”) macro literature of the 70′s:
The underlying argument went something like this: (i) There is no sense talking about anything like “involuntary unemployment”: markets clear, and at all times people work as much as they want to work and firms produce as much as they want to produce. (ii) Workers work more relative to trend when they think their real wages are high, and firms produce more relative to trend when they think real prices for their products are high. (iii) Workers work less relative to trend when they think their real wages are low, and firms produce less relative to trend when they think real prices for their products are low. (iv) Workers and firms have rational expectations, so if they expect government fiscal or monetary policies to expand (or contract) nominal demand they will expect nominal wages or prices to rise (or fall) accordingly. (v) Thus if a predicted government-driven expansion (or contraction) raises (or lowers) nominal demand and thus their nominal wages or prices, they will understand that their real wages or prices have remained unchanged–and hence will not work more or less, and will not produce more or less. (vi) Only if nominal wages or prices rise (or fall) in an unexpected fashion will workers or firms get confused, and work and produce more (or less) than the trend. (vii) But with rational expectations the only cases in which government policy produces unexpected rises or falls in wages and prices is if the government policy is random. (viii) In which case its effects are random. (ix) And so government policies–not just fiscal but monetary policies too–cannot be stabilizing but only destabilizing. (x) Hence the best of all policies sets a predictable and constant rule for monetary and fiscal policy and does not deviate from it no matter what.
Regarding (i), (ii) and (ii), there’s a growing literature in macro on unemployment. Robert Hall has done a lot of work on this (e.g. note that he uses some psychologist-pleasing behavioral assumptions in wage bargaining). This macro research has done a very healthy thing; it inspired research questions for micro folks (e.g.). The back and forth between macro and micro people on this issue (and the state-based vs. time-based pricing stuff) suggests, at least to me, that macro is far from insular. In fact, I’d say the field is learning real things about the real world. We’re learning practical things that pragmatist might find interesting if they paid attention.
Also, these employment search models — ones where employment doesn’t hinge solely on the labor/leasure trade-off (i.e. doesn’t require unemployment to be equivalent to vacation time) — have recently found themselves studied in the DSGE framework (e.g.) where they’ll quickly find applications in policy making.
All modern macro papers have sticky prices and wages. Recently maligned Nobel prize laureate Robert Lucas has found evidence consistent with sticky prices. In other words, (iv) and (v) may have been the purist view in the 70′s but they don’t reflect the current state of macro.
As to the consequent points (vii to x), modern macro doesn’t deny discretionary policy can have short-term effects, but once the public learns policy makers are using their discretion, they will expect it, policy becomes incredible and it becomes inefficient or ineffective. Policy makers will say one thing but the public will suspect they’re lying. Policy makers will promise to be good and do what’s right in the long run, but the public will suspect they’ll do what’s most expedient. There’s a good discussion of this in the introduction of Micheal Woodford’s textbook.
And have you ever noticed how deficits aren’t counter-cyclical ((Changes in the deficit and GDP growth have had opposite signs only 27% of the time since Eisenhower, if I have my sums right.))? Fiscal policy looks awfully discretionary.
You might interpret the actions of the Fed last year as discretionary, but that entirely depends on what rule (or which rule-making framework) the public thinks the Fed was using. If the public thought the Fed was targeting inflation, then the Fed’s actions may not have looked discretionary at all. If it thought the Fed was doing something because something had to be done, then, yeah, the Fed’s actions looked discretionary. It may be too that last Fall was so unprecidented any action on the part of the Fed would look like it was acting with discretion. On the other hand, if the Fed was seen as acting in its prescribed role as lender of last resort and so it wasn’t acting expediently, its policy credibility may sill be intact. Its hard to tell, but a spontaneous dirty fight between economists — and their political slaves ((Yes, my tongue is firmly planted in cheek)) — about the relative merits of fiscal and monetary policy during that time didn’t do much for the credibility of policy making.
In any case, Professor Delong says, “So when the financial crisis began in the summer of 2007, we Pragmatists largely ignored the Purists, for they seemed to have nothing to say.” There’s been a lot of progress in macro since the Puritan 70′s. The professor has seemed eager to attack finance people and he debated a theorist here in Davis, but as is evidenced by this post he has had limited engagement with modern policy oriented macroeconomics.
And this is all an attempt to change the subject. For standard counter-cyclical policy when given a choice between effective monetary policy and effective fiscal policy, monetary policy wins hands down (and I’ll go out on a limb and say Prof. Delong’s hand would be down too). Monetary policy is faster and, when you consider policy expectations, more efficient. The current debate is over whether or not monetary policy can be effective right now. Are we in a liquidity trap? Is the Fed pushing on strings? Theory says no; monetary policy can be effective when short-term nominal interest rates are zero. What does the evidence say? Well, there hasn’t been very many instances where those interest rates were zero, but monetary forces got us out of the Depression. And so far we’ve managed to stay out of deflationary spiral, so chalk one up for monetary policy at the zero lower bound.