An Open Letter to my Fellow Macroeconomists--Talking to Germans


Basil Fawlty’s “Don’t mention the war!” has given way to something altogether nastier: non-German macroeconomists have all but lost it with their German (and BIS wingman) counterparts over the Euro and global reflation—with epithets like “ordoliberal” and worse flying. The feeling is entirely mutual. Not even Mr. Trump can distract from the bitterness.

I am no fan of the German-cum-BIS global policy line and, like many, fear that it is set to get even more entrenched by the ongoing coalition negotiations in Berlin.

But its critics should look to themselves first.

Because following the financial crisis that erupted post-2007, the critics have indulged in an orgy of “rethinking” macroeconomics. Everyone and his aunt is at it, from the Institute for New Economic Thinking to, even just this month, the fourth in the series of conferences “Rethinking Macroeconomics” with yet further episodes in this econo- rethink-o-saga promised.

But ask yourself: whatever your read of the overall genesis and evolution of the Great Financial Crisis, does any part of your account require you to apply notions of economics which post-date the crisis?

Of course, you might want to brush up on exactly how CDOs worked, or what the legal restraints on Fed liquidity support were, or exactly who in London blocked Barclays’ purchase of Lehmans and why, or on Hyun Song Shin’s latest, and you’re doubtless optimistic that the thousand PhD theses launched by all this will turn up something. And maybe some elements of the way you tell the story now were sotto voce or missing entirely from your favorite pre-crisis text book, or from your own.

But I’d bet a great deal that your desire for more detail does not even begin to amount to dumbfounded incomprehension at the big picture. And I’d suggest that if your favorite pre-crisis text book missed some of the story that the problem is with that textbook or your choice thereof, not with pre-crisis economics.

Contrast this state of affairs with two prior global crises. With the onset of the Great Depression, the profession had to invent a whole new discipline—Macroeconomics— to dispel its utter bafflement at what had just been observed. And it did so promptly: a decade after the Wall Street crash, the General Theory was already three years old. Likewise, with the onset of stagflation from the mid-60s, economics had to respecify its understanding of the process of expectations formation completely to get any kind of a handle on what on earth was going on. Adaptive expectations and the vertical long-run Phillips curve were proffered well before the decade was out.

Not so now. And that shows in how little substantial novelty this flurry of rethinking by the best and brightest has yielded—a flatter and more firmly anchored short-run Phillips curve; a return to a wider menu of monetary instruments; temporary price- level targeting and more active fiscal at the ~ZLB, maybe; bigger automatic stabilizers; more on finance and dark corner solutions; a tad higher bank capital requirements and wider regulatory perimeter. A full decade after the Bank Paribas default which kicked everything off, is this not, relatively speaking, somewhat much ado about .. ?

Of course, the discipline should always seek to improve (notably its self-presentation), econo-chums love a get together to swap old “war” stories and canapés, and research programs will always attach themselves to bandwagons for funding and exposure.

But a far more compelling explanation for this ostentatious and protracted rethinking is dissembling. Given public contempt for our profession post-crisis, the great and the economic-policymaking-powerful, at the apex of which sit and sat the “MIT bretheren”, would far rather appear to be earnestly rethinking everything from first principles than admit that they had everything they needed—including explicit, detailed, and real-time warnings from outside the MIT perimeter—to have seen the latent dangers well ahead of time. I’ve already taken Andy Haldane to task for this conduct and he has since somewhat changed his tune. But he is small fry in this matter (and no MIT alum) and he found himself in much grander company doing just the same at this month’s “rethinking macro IV and counting”.

So what has all this to do with talking to Germans?

Well, the preferred German take on the crisis and global policies now, whatever its shortcomings, at least has the merit that it implies no such rethinking of economics. Indeed, emphatically to the contrary, it says that the “three looses”—fiscal, monetary, and financial—spawned the crisis: “same ‘ole, same ‘ole, same ‘ole.” And the MIT gang and their pals, having blessed a little “symbolic Basle III regulatory jiggery-pokery”, now say we must double-down on the other looses: fiscal and monetary. i.e., the cure is, pretty much, a lot more of the same things that generated crisis in the first place.

Thus, Mr. Schäuble has just spent his valedictory appearance at the IMF annual meetings wishing everyone a hail and hearty farewell while prophesying doom.

At this point, à la Alan Beattie, you may incline to hurl your favorite Martin Wolf broadside or Krugman “sadomonetarists” blog at “those #### Germans”.

But hold your fire because if you’re also with the “rethinking” brigade, there’s a serious case of the pot calling the kettle black going on here.

Because, indeed, the German line misses entirely that the crash itself changes the nature of the problem. To adjust an analogy beloved of a certain genre of European, a cyclist may have crashed because she was going too fast. But to get going again, she has to accelerate. And the appropriate actions to that end cannot be as before; they have to reflect the damage to bike and rider from the crash itself. Acceleration post- crash may thus require much more effort from her—negative nominal policy rates, QE on steroids, and way bigger budget deficits—than she put in pre-crash.

But having said that—and this is where rethinkers overlook insight in the German line —there is still risk that she may, once again, find herself going too fast. And having sustained injuries and damage to the bike—elevated global public debt, monetary stimulus near its limits, the post-2010 Chinese credit boom, loud confirmation to banks from management of the crisis that they will collectively be bailed out again, much further concentration in finance, the productivity doldrums, and populism—what constitutes “too fast” post-crash may be a good deal slower than what constituted “too fast” pre-crash. And finally, infuriated as they now are with the Germans, lets face it, rethinkers got every judgement they made on global safe speed limits pre-crash wrong.

But—and here is the key point—so did the Germans.

Notwithstanding their celebrated Prussian orthodoxies, they blessed all the wild lending into Greece, the other Euro peripheries, and into US sub-prime by their own banks and others in the 2000s alongside “light touch” financial regulation, they arm- twisted their way around their own breach of the SGP back then, and they signed off on the long series of self-congratulatory IMFC and G7/8 communiqués celebrating, in terms Kim Jong-un would find familiar, the celestial wisdom of global policymakers in the decade-or-so run-up to crisis.

In all this, the Germans and the rethinkers are in very much the same boat.

So the question on global safe speed for them both now is, as every child in the back seat knows: “Are we there yet?”

To answer that, the key lesson from the crash is not that economics inherently fell short requiring endless rumination and rethinking now, or à la Prussians, that raising alarms will always be right eventually, but that those making global safe speed judgements cannot be one-and-the-same as those doing the cycling.

The global problem pre-crisis was not econo-groupthink: fully coherent technically based and non-cry-wolf warnings were given, going all the way back to Brooksley Born in the mid-1990s.

Instead, the problem in defining global safe speed limits pre- crisis was that cyclist, traffic cop, prosecutor, jury, judge, and prison warden were all, despite appearances, one and the same. Ministries of finance and central banks, each focussed on their parochial concerns, spearheaded in person or spirit by MIT’s brightest, were all bundled up together into one in the IMF, with no-one firmly outside of that orbit charged to maintain a routine and skeptical watch on the global goings on.

The need to separate such functions has been increasingly recognized in national level fiscal architecture—with the widespread adoption of Independent Fiscal Institutions, including the CBO in the US and the OBR in the UK. Fragile and fallible as they are, the power of that separation has just been vividly demonstrated in the CBO’s stellar work—still ongoing—on reform of US Health Care and in the OBR’s recent sobering forecasts in the face of fierce Brexiteer bullying; it works.

Accordingly, these are lessons to be learned.

If the shouting match with the Germans is not to deteriorate further, rethinkers need to switch gears. They can do so by doing a lot less rethinking of economics and a lot more acknowledging of failures in the application thereof.

And repetition of those failures can be addressed by extending the separation of fiscal functions at national level to global level, so as to separate those judging global safe speed limits from those driving the global economy. This would be accomplished by permanent and formal cooperation between Independent Fiscal Institutions at global level, as detailed here. This critical innovation to the global financial architecture can proceed with Mr. Trump in situ, and is needed more then ever with him there.

Evidently, the IMF cannot lead this watchdog function or the initiative to launch it. It is all-but-incapable of encountering an international, let alone a global issue like this, without conceiving itself as the solution or the arbiter thereof. And the IMF, by construction, is not just the handmaiden of but is inextricably subject to those driving the global economy, including Mr. Trump. Just as Ministries of Finance need Independent Fiscal Institutions as watchdogs over domestic safe speed limits, so the IMF needs its watchdog too—and for the same reasons—on global safe speed limits.

If rethinkers were to take up this cause in light of failures in the application of macroeconomics pre-crisis, then just maybe the Germans might also begin seeing their way to acknowledging some of their own past errors on these matters—and so possibly open their ears somewhat on issues of global reflation and the Euro now.

And who knows, perhaps it will then become easier for Basil Fawltys everywhere to talk about defeat in the global financial crisis “war”, given that both rethinkers and Germans—as well as the rest of us—lost it together. Acknowledging that the loss is shared and that the lesson to learn is that safe speed functions need to be separated at global level might greatly improve prospects of moving on from the unproductive shouting match to a more judiciously assessed set of global policies henceforth.

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