You can’t but agree with Mark Thoma’s observation concerning the debate within the dismal science about the Second Great Depression: “There is no single class of macroeconomic models that is best for all questions.”
Sure. Absolutely. There are different models for different questions and problems.
But then Thoma unnecessarily limits the debate to a single choice—between IS/LM and New Keynesian models, between the older type macroeconomic model with non-dynamic money and product markets and the newer models with individual agents guided by rational expectations, various kinds of imperfect markets, and dynamic reactions to external shocks. And he asks for tolerance among the advocates of each type of model for those who use the other type.
The New Keynesian model was built to explain a world of moderate fluctuations in GDP. It features temporary price rigidities, and the macroeconomic aggregates in the model are consistent with the optimizing behavior of individual consumers and producers. For certain types of questions – how should policymakers behave to stabilize an economy with mild fluctuations induced by price rigidities – it is the best model to use. Hence it’s popularity during the “Great Moderation” from 1984-2007 when there were no large shocks to the economy.
The IS-LM model, on the other hand, was built in the aftermath of the Great Depression to examine precisely the kinds of questions we faced throughout the Great Recession, issues such as a liquidity trap, the paradox of thrift, and how policymakers should react in such an environment. Why is it surprising that a model built to explain a particular set of questions does better than a model built to explain other things? Especially when the model is used in a way that incorporates the lessons we’ve learned in the intervening decades about its shortcomings.
OK. But what about all the other models out there, which represent critiques of and alternatives to mainstream economics? Models (from both the Marxian and Post Keynesian traditions) in which the boom and bust cycles of capitalism occur as endogenous events, as a result of the inner workings of a capitalist economy. Why aren’t they included in the choice of appropriate models?
The fact is, macroeconomists have little to offer in terms of understanding either the causes and consequences of the current crises—which, remember, have now been going on for over six years, with no end in sight—much less effective solutions for the economic mess we’re in. Merely tweaking and tinkering with the hydraulic mechanisms of either class of models is simply not going to get us very far.
And we’re going to remain stuck here unless and until we confront the limitations imposed by the dismal choice between the IS/LM and New Keynesian models, which are the only ones mainstream economists teach and use to make sense of what is going in the world today.