Soul-searching? Or a whitewash?

I think everyone would now admit that the economics profession performed very poorly in late 2008.  There was an obvious and overwhelming need for more demand stimulus in the second half of 2008.  Interest rates didn’t even hit the zero bound until mid-December (by which time the monthly GDP numbers were nearing the trough) and yet it was hard to find a single prominent economist even talking about the need for much greater monetary stimulus.  I wasn’t blogging yet, but I was following the commentary with extreme interest, and all I can recall is one tirade by Jim Cramer in the fall of 2008, demanding easier money.  And I’m not even sure if he’s an economist.

For years I’ve been repeatedly emphasizing that we had all the tools we needed, all the theory.  There’s no need for new ideas, Frederic Mishkin’s textbook provides a template for everything that the profession forgot in late 2008.  Here’s the three key points for students to know about monetary policy, from the 9th edition (which I’m currently using in my classes):

1.  It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.

2.  Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

3.  Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero.

I knew that it was only a question of time before the profession was faced with a difficult issue; admit they made a horrible mistake in late 2008, or begin to repudiate everything that we’ve been teaching our students for the last 20 years.  For instance, in the 8th edition of the text, Mishkin had a question asking whether the imposition of a program of interest on reserves would be expansionary or contractionary.  Of course the correct answer was contractionary.  But then the Fed instituted an interest on reserve program in October 2008, right in the middle of the biggest NGDP collapse since 1938.  We can’t have a question like that!  It might give students the wrong idea.

I imagine some instructors complained, or maybe Mishkin really did come to believe the question was misleading (perhaps he supports IOR.)  No big deal.  But the next change was a big deal.  First a bit of background. In the 9th edition Mishkin must have felt he needed to say something about the crash of 2008.  (Usually textbooks are barely revised at all, the “new editions” are sort of a scam to prevent students from buying used copies, as the new copies cost over $200.)  But Mishkin did add some comments about the crisis, unfortunately they came right before the three principles listed above, and actually conflicted with those principles.  By now instructors from all over the country must have complained that these principles were “confusing their students” as I imagine they were teaching the standard Keynesian liquidity trap nonsense.

Last week I got the 10th edition in the mail, and naturally rushed to Chapter 25 to make sure that my treasured three principles were still there.  And what I saw made my heart sink.  Take a look:

1.  It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.

2.  Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

3.  Monetary policy can be effective in reviving a weak economy even if short term rates are already near zero.

See the difference?  The word ‘highly’ has been excised with all the ruthless precision that Stalin used to delete photos of non-persons.  Will the 11th edition remove “effective?”  I wish I could teach out of the 9th edition forever.  Or better yet, the 8th edition, which still had the “monetarist” AD, presented as a rectangular hyperbola, and that IOR question.

Slowly the dark night of ignorance is settling over the profession.  I feel that our job as market monetarists is sort of like those lonely Irish monks on windswept islands, who kept classical learning alive during the Dark Ages.

PS.  I’m not the only one who sees what’s happening.  Just in case anyone thinks I’m a paranoid lunatic, Arnold Kling recently noticed the amnesia settling over  the profession:

Also, nobody gave what I think of as the Scott Sumner answer, “We used to believe that employment depended entirely on the path of NGDP relative to trend. We used to believe that this path could be controlled by the monetary authorities, regardless of what is going on with individual banks. I have not changed my beliefs, even if everyone else has.” (Those are my words. Scott, feel free to correct me if I am misrepresenting your views. [update: Scott says that he would take out the word “entirely” but otherwise likes the post])

The fact that mainstream economists regard the question as settled is what leads me to expect a lot of research into how a financial crisis and de-leveraging cause macroeconomic distress. It’s not in the textbooks. Anyone can do handwaving. We’ve seen some papers come out in the the last few years. I expect to see many more.

So instead of admitting they were wrong, the profession apparently plans to dream up all sorts of fairy tales about how the Fed couldn’t have prevented NGDP from  falling in late 2008, even though (with a very few exceptions, Jim Hamilton had some sensible suggestions) when we most needed their advice those same elite professors were not even telling the Fed they should try.   I look forward to seeing all these clever new “finance view” models in futures AERs.

NGDP targeting in the AER?  It’s too simplistic.

PPS.  This earlier post discusses some of the changes in the 9th edition discussed above.

PPPS.   This isn’t personal; I actually like Mishkin and feel that Inside Job was somewhat unfair to him.  I happen to be using his textbook because it’s the best.  If I was using someone else’s book, I’d be hammering them.

PPPPS.  It just occurred to me that Arnold’s comments don’t prove that I’m not paranoid.  After all, he’s just summarizing my paranoia, not agreeing with it.  Or maybe I’m reading too much into everything . . .

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