Robert Barro's famous polemic against New Keynesians

There has been some blog discussion lately (see Tyler Cowen and Scott Sumner) about Robert Barro, the famous Harvard economist who invented the controversial idea known as "Ricardian Equivalence", and who occasionally writes op-eds in the Wall Street Journal opposing fiscal stimulus. Cowen, Sumner, etc. are discussing whether Barro supports the idea of "aggregate demand" as a driver of business cycles. The paper most people know about is this one, but I thought it would be a good time to bring up Barro's epic polemic against New Keynesian models, from 1989. The title: "New Classicals and New Keynesians, or the Good Guys and the Bad Guys."

1989 was a time when the "macro wars" were much more intense than nowadays, and the "Freshwater/Saltwater" divide was much clearer. DSGE models were new, and two flavors of them had emerged: the RBC flavor, which assumed that the economy is driven by productivity ("technology") shocks, and the New Keynesian flavor, which assumed that "stickiness" in prices and wages is what moves the business cycle. The most prominent among the New Classicals were Edward Prescott, Robert Lucas, Charles Plosser, and Barro. The most prominent New Keynesians at that time were Greg Mankiw, Lawrence Ball, David Romer, Olivier Blanchard, and John Taylor. You can see that the divide wasn't a political one, since there were arch-conservatives on both sides.

In those days, blogs didn't exist, so when economists wanted to diss each other's ideas, they would write comments, short notes, or working papers (for another example, see Larry Summers' diss of RBC). Barro's polemic is actually a blog post in working-paper form. And like bloggers often do in the modern age, Barro makes it personal (and invents a taunting nickname). New Keynesians don't just have wrong ideas, he asserts, they are going about research totally backwards:

[T]he mission of the new Keynesian economics (which I like to describe by the acronym NUKE) is peculiar. Instead of providing new theoretical results and hypotheses for empirical testing, the objective often seems to be to provide respectability for the basic viewpoint and policy prescriptions that characterize the old Keynesian models.

In other words, Barro is accusing New Keynesians of reverse-engineering policy conclusions. He is saying that New Keynesians want to implement stabilization policies, and that their research consists of thinking of reasons why those policies might be warranted. This is an accusation that some bloggers still make against New Keynesian researchers - see here and here, for example - and that is still occasionally voiced behind closed doors by people who might reasonably be described as "Freshwater" macroeconomists.

In his polemic, Barro also makes a plug for the people he calls the "good guys": RBC theorists. Interestingly, he says this:

Overall, the real-business-cycle area has generated many new insights and techniques that assist in modeling the macroeconomy and in thinking about government policies. But it is not yet clear how much the models contribute toward understanding actual business cycles, or to the construction of policies that governments might wish to implement. [emphasis mine]

He says that the biggest contributions of the New Classicals has been their new modeling methodologies (which we now know as "microfounded Rational Expectations DSGE") and their interesting thought experiments:

[S]ome of the major successes of the new classical approach...include the application of equilibrium modeling to macroeconomic analysis, the use of rational expectations as part of this modeling, and the revolution in approaches to policy evaluation...

And he also takes the opportunity to plug his own work:

One specific application in which the equilibrium approach has achieved some success is in analyses of fiscal policy (see Barro, 1989b, for a survey). Some of this research revolves around the Ricardian equivalence theorem, which provides conditions under which substitutions of budget deficits for taxes are of no consequence. But further developments have brought out the real effects from government purchases and public services, the composition and timing of distorting taxes, and so on.

It's not clear what he means by "brought out"; he seems not to be talking about the relationship between theory and data, but about the intuitive appeal of his ideas themselves.

So what Barro is saying is that the New Classical/RBC people (himself included) were the "good guys" not because their models necessarily fit the facts better, but because A) their way of thinking about business cycles was more appealing, B) their motives for making their models were better, and C) they were personally responsible for more methodological advances than their New Keynesian counterparts.

This was a very interesting moment in the history of thought. An old paradigm, Old Keynesian models, had come into crisis, and a new paradigm, DSGE, was in the process of replacing it, but that new paradigm was split into two competing mini-paradigms, New Classical and New Keynesian (or "Freshwater and Saltwater", if you prefer), each jostling to carry the banner of DSGE.

Overall, the New Keynesians refrained from engaging in polemics like Barro's, and focused on the ways in which RBC models failed to fit the data (see the work of Jordi Gali here and here, and the work of Miles Kimball here and here). In 2006, Greg Mankiw came out with a blog-post-like working paper that was sort of a belated response to Barro, called the "The Macroeconomist as Scientist and Engineer," in which he expressed hope that the two competing sub-schools might learn to live in peace and divide up the kingdom of economics; Olivier Blanchard expressed a similar hope in 2008. The New Keynesians took the high road, and largely refrained from accusing the New Classicals of reverse-engineering a skeptical view of stabilization policy.

(But by the 2000s, the contest was largely over, and each side had gotten something that they wanted. The New Classicals had secured their place in history as the founders of modern macroeconomics, and everyone used their DSGE approach. But New Keynesians won the battle for the minds of policymakers; central banks often use DSGE models as part of their toolkit, and the models they use are New Keynesian models, not RBC models. But RBC survived too, spreading to other fields like asset pricing, international finance, and labor search, probably due to its ease of implementation compared to New Keynesian models. The happy synthesis hoped for by Olivier Blanchard didn't really exist, but the paradigm fight had settled down to a quiet, grumbling stalemate. Then the financial crisis came along and upset the whole apple cart, sending macroeconomists scurrying to find ways that the financial sector could be the cause of recessions.)

Anyway, I think it's interesting to see how this intellectual contest played out, because it's a window into how the field of economics works. Thomas Kuhn basically said that every field has its own standards for choosing between competing paradigms, and left it at that. Barro's polemic demonstrates how many macroeconomists are drawn to paradigms because of their aesthetic appeal, their methodological coolness, and (possibly) their policy implications. But the polite, data-driven, and ultimately successful fightback of the New Keynesians shows how other macroeconomists are more concerned with empirical validity. And the frequency of the paradigm crises in macroeconomics - one in the 1930s, another in the 1970s, and another in the 2010s - shows how few solid conclusions we can really draw from macroeconomic data (Note: On this point, see update below).


Updates:

A commenter points me toward this even angrier comment from Robert Lucas in 1994, in which he says this of Mankiw's 1994 New Keynesian manifesto:

Why do I have to read this? The paper contributes nothing - not even an opinion or belief - on any of the substantive questions of macroeconomics...One can speculate about the purposes for which this paper was written - a box in the Economist? - but obviously it is not an attempt to engage other macroeconomic researchers in debate over research strategies.

See? Economists' discussions were not that different before the age of the blogs.

And apparently, according to people who were there, the conference where Lucas delivered the comment was even more contentious.

Paul Krugman thinks my skepticism is a little more extreme than it actually is. Of course there is tons of evidence that monetary policy has real effects. And that means that there is tons of evidence that models that assume such effects away - like the original, Nobel-winning Kydland-Prescott (1982) RBC model - aren't really going to describe the business cycle (I mean, Volcker...1980s...duh). And there is also evidence of nominal stickiness, although it's not yet clear exactly how the stickiness works. But that is not the same thing as New Keynesian models themselves being validated. There's often good enough macro data to tell what doesn't work, but usually not enough to tell what does work, which is a much taller order.