In 1994, economists Greg Mankiw and Lawrence Ball wrote an essay for the National Bureau of Economic Research entitled “A Sticky-Price Manifesto.”...[T]he essay heralded the beginning of a macroeconomics mini-revolution. It was a direct threat to the line of research that had been dominant in the 1980s, which tried to explain recessions without sticky prices...
The economic establishment reacted harshly to the upstarts. “Why do I have to read this?" fumed Robert Lucas, the dean of macroeconomics. "This paper contributes nothing.” He went on to accuse the sticky-pricers of being opposed to science and progress.
But Lucas fumed in vain. During the following decade, the sticky-price models went from strength to strength. New math was developed to make them easier to use. Possible reasons for price stickiness were investigated -- for example, “menu costs,” in which the seemingly trivial costs of changing prices add up to a big problem across the broader economy.
Even more telling, sticky-price theorists proved that you didn’t need a lot of price stickiness to mess up the smooth working of the economy. Even the tiniest dash of stickiness would turn all kinds of theories on their heads. Economists Susanto Basu, John Fernald, and my doctoral adviser Miles Kimball, for example, showed that when prices are even a little sticky, bursts of technological progress actually hurt the economy for a short while, by causing a burst of deflation, before eventually boosting growth. Over time, the addition of various other economic mechanisms, like labor search, has further reduced the amount of price stickiness required to cause major recessions.
Sticky-price models have become the dominant models used at central banks. The smoothly adjusting, flexible-price models of the 1980s are basically not used anywhere, by anyone, for anything.
Even some of the biggest skeptics of sticky prices are coming around. In 2004, economists Mark Bils and Peter Klenow looked at how businesses changed prices, and found that the changes were too frequent to be consistent with the sticky-price story. But in 2014, they reversed their stance, looking at evidence on the adjustment of markets in recessions and concluding that “sticky prices...deserve a central place in business cycle research.” Meanwhile...Patrick Kehoe...long-time [opponent] of the mainstream sticky-price models, nevertheless wrote a paper in 2010 entitled “Prices are Sticky After All.”...
The moral of the story is that if you just keep pounding away with theory and evidence, even the toughest orthodoxy in a mean, confrontational field like macroeconomics will eventually have to give you some respect.Steve Williamson wrote a response to my post, and for the life of me I can't tell what he's trying to say. He calls me "confused". Well, after reading his post, I am confused.
Williamson takes some potshots at Ball and Mankiw:
The "Sticky Price Manifesto" is in part a survey of the menu cost literature, but it reads like a religious polemic...
Why should we care what Ball and Mankiw think is going on in the minds of their staw-men opponents, or in the classrooms of those straw-men? Why should we care what Ball and Mankiw "believe?"...
Noah seems to think that Lucas was being unduly harsh [in his response to Ball and Mankiw], and that he was somehow feeling threatened by these "upstarts." It's pretty clear, actually, that Lucas just thinks it's a bad paper - religion, not science - and that Ball and Mankiw could do a lot better...He then asserts that New Keynesian models don't have anything to do with the stuff Ball and Mankiw were writing about:
Noah is more than a little confused about the genesis of sticky-price New Keynesian (NK) models. In particular, he thinks that Ball and Mankiw's "Sticky Price Manifesto" was a watershed in the NK revolution. Far from it...
Where did NK come from? Which of the three threads in post-macro revolution Keynesian economics - coordination failures, sunspots, menu costs - morphs into Woodfordian NK models? To a first approximation, none of them. Perhaps NK owes a little to the menu cost approach, but it's really a direct offshoot of real business cycle theory. Take a Kydland and Prescott (1982) RBC model, eliminate some bells and whistles, add Dixit-Stiglitz monopolistic competition, and you have Rotemberg and Woodford's chapter from "Frontiers of Business Cycle Research." Add some price stickiness, and you have NK. So, NK basically leapfrogs most of the "Keynesian" literature from the 1980s. It's much more about RBC than about Ball and Mankiw.(For a brief intro to Mankiw's contribution to the New Keynesian research program, see the Wikipedia page for New Keynesian economics. See also the Wikipedia page for Steve Williamson.)
Williamson then tries to claim ownership of New Keynesian models for Chicago/Robert Lucas/RBC/His Majesty the King of Spain/I'm not sure:
[I]t's worth noting that Mike Woodford, the key player in NK macro, was at the University of Chicago from 1986 to 1992, the latter 3 years in the Department of Economics with - guess who - Bob Lucas. Indeed, they wrote a paper together. It's about - guess what - a kind of sticky price model with non-neutralities of money. Later on, Lucas wrote about sticky prices with Mike Golosov. So, I think we could make the case that the influence of Lucas on NK is huge, and that of Ball and Mankiw is tiny.He then goes off on a long tangent about how central bankers might use sticky-price models to think about financial stability (which, apparently, he thinks is now the main priority for central banks).
It's kind of funny to see Williamson trying to wrest historical credit for New Keynesian models from Mankiw & co., since just in his previous post he had this to say:
Mike Woodford can correct me on this, but my impression is that he came out of graduate school with a specific goal in mind, which was creating a version of Keynesian economics that would fit into modern macro. Ed Prescott's project left central bankers scratching their heads about what they were supposed to be doing, and Woodford and others stepped into the void. Interest and Prices is, I think, intended as a handbook for central bankers. There was a lot of effort put into marketing the whole NK project to the world's central banks. This is ongoing, and has been institutionalized[.]So NK was reverse-engineering of Keynesian ideas. But actually it was just RBC. But it succeeded because it was promoted via a slick marketing campaign. But actually Lucas was one of its founders.
Also, microfoundations are important. But Mankiw's efforts to microfound sticky prices with menu costs was totally unimportant to the creation of sticky-price macro models.
Damn, I guess I am confused.