July 25, 2023
A week or so ago, the economist Paul Krugman put out a subscribers-only opinion piece entitled “Camps of economists fought grand theoretical battles, and all lost.”
To his credit, he numbers himself among those who “lost” in these battles, which were over the likelihood of serious inflation resulting from the massive government spending in response to COVID-19. He quotes one of my favorite passages from John Maynard Keynes, one that appears in my forthcoming book, Fatal Certainty:
Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.
Krugman portrays a debate between “Team Transitory – which argued that we were mostly seeing temporary disruptions from the Covid-19 pandemic, which would fade away over time — and Team Permanent, which placed the main blame for inflation on the combination of large government spending and low interest rates.”
As a member of “Team Transitory,” Krugman admits that he and his “team” initially erred. “[A]s inflation went far higher and far longer than I had imagined possible, I admitted that I got it wrong.”
After this initial “victory” for “Team Permanent,” however, a new dispute arose between “Team Soft Landing,” which argued that inflation could be conquered without wrenching unemployment, and “Team Stagflation,” which argued that the nation would have to endure “years of high unemployment, just as it had in the 1980s,” in order to tame the inflation monster.
What Krugman finds to be interesting, however (and the reason he quotes Keynes above), is that the members of Team Transitory tended almost universally to be also members of Team Soft Landing, while Team Permanent and Team Stagflation were also nearly the exact same people.
As it happens, at this moment, Team Soft Landing appears to have been right about the ability of the economy to tame inflation without severe unemployment. Indeed, unemployment in the United States, despite two years of predicted recession, has plummeted to near all-time lows, while most measures of inflation show that the United States, compared to other major countries, is experiencing a greater lowering of inflation. “[I]t’s still running above the Fed’s target, but it has come down a lot, with no cost at all in higher unemployment. Team Stagflation was wrong.”
Krugman’s ultimate point here, however, is not that he personally turned out to be correct, nor that his “team” ultimately came out “on top.” His larger point is that both “teams” appeared to engage in “motivated reasoning” (my phrase, not Krugman’s) of a kind that fit with pre-existing political or ideological preferences.
Krugman believes that the real source of error here is that each side “lost” the “battle” it lost” because it abandoned standard economic theory. “Team Transitory” ignored the standard economic theory that “big fiscal stimulus like the American Rescue Plan, applied to an economy where unemployment was already falling, would lead to overheating and inflation,” and “lost” Round One. “Team Stagflation,” however, ignored standard economic theory that “High inflation can persist despite high unemployment [only] if continuing inflation has become embedded in expectations….[which] very much wasn’t the case in 2022.”
Krugman, therefore, believes that the answer is for economists to believe in standard economic theory. But I would submit that there is no standard economic theory these days; there are merely competing, mutually contradictory theories. As I write in Fatal Certainty:
…[O]ne only has to look at the vast philosophical differences between someone like, say, Paul Krugman, and the Chicago School economists, to understand that technology and massively increased data collection and analysis has not led intersubjective realities such as economics, for one example, toward consensus as to the basic assumptions of their field. …It is as though evolution through natural selection was simply one school of biology in 2021, with Lamarckism and creationism holding roughly equivalent sway, and each of them publishing numbers-packed papers to support their point of view. …In astronomy, when one scientist predicts that a certain asteroid will reappear at a certain spot after going behind the sun, and another predicts a different spot, it will be fairly clear which scientist was more correct, and her or his method of prediction will quickly be adopted by the entire field, and that of the other scientist abandoned. …But in economics, as in the other social sciences, there can be few “natural experiments,” and there are nothing like pristine laboratory conditions.
The obvious solution is for economists, not to completely abandon their “standard theory,” which seems to vary by the economist, but rather to use rigorous imagination to imagine the full range of plausible outcomes, including some different from those they expect. But even economists who freely and honorably admit when they get things wrong don’t seem to have quite yet embraced the obvious solution: to replace the cult of prediction, which simply guarantees mistake after mistake, with a rigorous form of imagination that constantly asks “What if the outcome is different? What is the broadest practicable range of plausible outcomes we can imagine here? What should we do in each case?”
Rather than “Team Transitory” and “Team Permanent,” how about broadening the “teams” to include other outcomes as well, and planning for each potential outcome? I hate two-by-two matrices, but “Transitory/Stagflation,” “Transitory/Soft Landing,” “Permanent/Stagflation,” and “Permanent/Soft Landing” were all plausible outcomes. Each could have been examined, and plausible reasons for each fleshed out, before they took place. None of them, almost certainly, would take place exactly as its “team” might have expected; but each added “team” could have achieved insights that might have been helpful in anticipating the future that actually occurred.The lesson is, “Abandon certainty and even probabilities, all ye who would enter an uncertain future.”
