History of thought can be insulting

Please forgive overuse of the first person here. It is hard to provide a personal anecdote without being self-referential.

One source of contention in the ongoing macro wars involves the role that the history of thought should play in economics education.   So-called heterodox economists tend to favor a strong emphasis on history, while defenders of the mainstream[1] tend to be opposed. And I think I know the main arguments on each side.

The historians recognize that the prevailing paradigm can be a function of the economic environment itself, which means that old ideas may become useful again if the environment shifts abruptly.  For example, some would claim (it is disputed) that that the Great Recession forced us to remember Keynes — or Hicks/Hansen or whatever.

Also, economic theory is not necessarily embraced solely because of its ability to predict accurately. There is probably some path dependence in what the mainstream thinks, and it is probably a good idea to be aware of that. I elaborate a bit on this one below, with my own spin.

For the mainstream, the history of thought may be interesting, but it takes up too much time that would be better spent mastering the techniques embraced by the mainstream.  And too much emphasis on the history of thought might be interpreted as an implicit concession that economic theory is not necessarily progressive. If we have to dig up Keynes every seventy years or so, does that mean we are not achieving much in the interim?

Obviously, I am simplifying to make a point here and probably missing some nuance.  But I think those are roughly the main points of contention here.

In this post, I would like to offer another argument, possibly relevant to both sides, that is a bit out of left field, probably secondary, and certainly not proven.  I tend to be attracted to ideas with those qualities these days, because the downside to being wrong is so low at my current station.

I suspect that an emphasis on the history of thought might impugn the intellectual character of defenders of the mainstream by implying that they are anchored or blindly following charismatic leaders, as Paul Romer has recently argued, in his screed, The Trouble With Macroeconomics.

Please bear with me while I come at this a bit indirectly.  I spent eleven years working as a macro analyst at a long-short equity hedge fund.  I never traded equities, or anything for that matter. But I spent a lot of time around people who did and probably experienced some osmosis.

The analysts and PMs obviously spent a lot of time trying to figure out the “right” prices of the stocks they were involved in.  But somewhat more interestingly (to me), they were also very curious to understand why the people setting the current price were doing so.

To say the price is half what it should be because everybody else is stupid is not very convincing. But to say that there is a natural seller of an illiquid stock who will disappear from the market shortly is a lot more compelling.  Knowing why the price is “wrong” and being confident that reason is transitory can raise confidence, I think I noticed.

Near the end of my time at the fund, I figured I should probably get my own view on what effect the “taper” and end of QE purchases might have on equity prices (and bond yields).

I figured there might be a bit of beauty-contest selling on the announcement(s), but I was amazed at what struck me as an extreme overemphasis on the importance of QE. The Fed has rigged asset prices to the ceiling, and there will be hell to pay, etc. etc. etc..  Eyes rolling.

Given that QE was nothing more than an interest rate signal (which would easily be detached from it, and was) plus a shortening of the effective maturity of the federal debt, why were economists – even academics – making such a big deal of it?

I thought that was very odd, and I figured I could be more confident in my own take if I could come up with something extending a bit beyond, well they just cannot see what I am uniquely qualified to see.

I never fully got why people were so mesmerized by QE, which in fairness may be just evidence that my own take is wrong and that I am missing a valid argument, perhaps because of my own psychological priors.

But looking into the how the idea of QE evolved, at least in Ben Bernanke’s mind, I came to realize that he initially believed – almost certainly wrongly – that QE had something to do with the power of the “printing press” and with the efficacy of liquidity provision, even at the zero bound.  You can see this in his speeches in the late 1990s and early 2000s, which I referenced here.

And given Bernanke’s obvious authority, you can imagine how that might have distorted thinking, and broadly.  In my humble opinion, this bit of history is worth knowing if you start with my priors, that the importance of QE – going, as coming — has been overstated.

I am fully aware that this observation is going to come across as arrogant, as I am both outside the mainstream on the efficacy of QE and reading the intellectual motives of others. That is going to irritate, understandably.

But the irritation is actually central to the point I am raising here.  It goes to my idea that an emphasis on the history of economic thought is implicitly a criticism not just of the content of mainstream thought, but possibly also of the intellectual character of its main defenders. It is close to saying that the other guy is wrong because he is anchored in fashion. I definitely think that is true often, but it is also rude.

We can imagine some other examples, although in my case with a bit less confidence.  For example, faith in the importance of the NAIRU probably has something to do with Milton Friedman’s attack on the Phillips Curve.  Had the Phillips Curve never gained credence, there might be less emphasis on the NAIRU today. And anchoring may explain why people cling to the concept, despite its empirical failures. If you are skeptical of NAIRU, then knowing why others may be clinging may be helpful.

Separately, what I would call misplaced (although mercifully fading) faith in the Taylor Rule can perhaps be traced to the rules vs discretion debate in the 60s and 70s plus the failure of money growth rate rules during the early 1980s.

Even advocates of the Taylor Rule understand that it does not prescribe the “correct” policy rate. Rather, it prescribes a policy rate that is less incorrect than that offered by other approaches,  and whose damage is mitigated by stabilizing feedback embedded in the policy rule. This will be more obvious to people who have considered the history than to those who have not, I think.

Would neo-Fisherianism have any purchase if Neo-Keynesians didn’t insist on their models converging to equilibrium….  Would the NK micro-foundations, implausible as they are, be there without the Lucas Critique and the paleo-Keynesian overconfidence that preceded it….

I’ll stop here because I realize that my little history review here is amateur and probably irritating to some. But whether I am right or wrong on the substance of the economics, I do think that an emphasis on the history of thought can be seen as implicitly an attack on the intellectual rigor or character of so-called mainstream thinkers.  When you get in an argument with somebody, the last thing you want him to do is provide a psychological assessment of why you insist on being wrong.

[1] For the purposes of this post, I will spot defenders of the mainstream their premise that there is a mainstream, in macro.