Glorious Counterrevolution

It's September of 2007. Though almost no one realizes it, the so-called Great Moderation is ending. The housing bubble has just peaked, a rolling financial conflagration has already started, and the US economy is descending into its steepest downturn since the 1930s.

And a well-known economist is saying:

One of the most striking facts about macropolicy is that we have progressed amazingly. ... In my opinion, better policy, particularly on the part of the Federal Reserve, is directly responsible for the low inflation and the virtual disappearance of the business cycle in the last 25 years. ..

The story of stabilization policy of the last quarter century is one of amazing success. We have seen the triumph of sensible ideas and have reaped the rewards in terms of macroeconomic performance. The costly wrong turn in ideas and macropolicy of the 1960s and 1970s has been righted and the future of stabilization looks bright.

Who is it?

Must be one of those smug right-wing Chicago types, right? Maybe Robert Lucas, whose claim that the “central problem of depression-prevention has been solved” was so widely mocked when the crisis broke out?

Nope. It's Christina Romer, soon to be Obama's top economist.

As Obama's CEA chair, by all accounts Romer led the pro-stimulus forces in the administration against the forces of austerity. Yet there she is, in Berkeley in 2007, speaking without irony of the "glorious counterrevolution" against Keynes in the 1980s:

The 1960s represented the beginning of a long dark period for macroeconomic policy.... [But] since 1985, inflation has been below 4% every single year and has averaged just 2.5%. Real short-run macroeconomic performance has been similarly splendid. … As someone who started her career saying there had not been a stabilization of the postwar economy, I now have to admit there most certainly has been – it just started in 1985, not 1947. ..

What stops this story from being a good morality play is that good hasn’t triumphed entirely. At the same time that we have seen a glorious counterrevolution in the ideas and conduct of short-run stabilization policy, we have seen a remarkable lack of progress in long-run fiscal policy. In this area, the legacy of 1960s beliefs is still very much with us and may threaten the long-run stability of the American economy. ... The revolutionary idea of the 1960s concerning long-run fiscal policy was that it was not important to balance the budget even over a period of several years. Rather, persistent budget deficits could actually be desirable because they would lower unemployment and move the economy toward a more desirable path for real output.

In other words, there is one flaw in the amazingly amazing progress in economic policy since the 1980s. It's not rising private debt, financial deregulation, or stagnant wages and soaring income inequality, none of which she mentions. It's that people need to worry more about the federal debt.

True, she admits, there's no concrete evidence for any economic costs to public indebtedness over its historic range.[1] But that shouldn't stop us worrying:

The consequences of persistent deficits may only be felt over a very long horizon. … It is also possible that the effects of persistent deficits are highly nonlinear. Perhaps over a wide range, deficits and the cumulative public debt really do have little impact on the economy. But, at some point, the debt burden reaches a level that threatens the confidence of investors. Such a meltdown and a sudden stop of lending would unquestionably have enormous real consequences.

Maybe. But ideas have consequences, too. For instance, Romer's argument here is the same argument, almost verbatim, that would be used by her opponents in the administration just a year and a half later, when she was pushing for a larger stimulus:

Romer’s analysis, deeply informed by her work on the Depression, suggested that the package should probably be more than $1.2 trillion. The memo to Obama, however, detailed only two packages: a five-hundred-and-fifty-billion-dollar stimulus and an eight-hundred-and-ninety-billion-dollar stimulus. Summers ... argued that the stimulus should not be used to fill the entire output gap; rather, it was “an insurance package against catastrophic failure.” ... He believed that filling the output gap through deficit spending was important, but that a package that was too large could potentially shift fears from the current crisis to the long-term budget deficit, which would have an unwelcome effect on the bond market. In the end, Summers made the case for the eight-hundred-and-ninety-billion-dollar option.

That's Ryan Lizza via Paul Krugman; in Krugman's version, Romer is the hero. But what he doesn't say is that the arguments being deployed against her here are ones she herself was making just a year or two earlier: Shortfalls in demand are less dangerous than policymakers think, but deficits are much more so; and thanks to nonlinearity you can't wait until there's some visible cost to deficit spending to curtail it.

Now, let's be fair: We'd all be better off if Romer had won her debate with Orszag and Summers. (And if Summers had then been remanded to a job in chicken manure management.) Still, it's important to remember how small is the gap between the wings of mainstream economics, despite the vitriol. 

In her Berkeley address, Romer says

The reason that I have talked in some detail about the economic beliefs that policymakers held in the 1950s is that I believe the policies they undertook and the economic outcomes derived largely from those beliefs.

I agree. In 2007, Christina Romer was using her podium to say that we don't need to worry about major recessions, that the greatest mistake in economic policy in recent decades was faith in fiscal policy, and that the most important intellectual task for macroeconomists is to convince policymakers of the dangers of budget deficits. Now, those same arguments are being used to tell us we should accept 9-10% unemployment as far as the eye can see. If we didn't want to end up here, we should have started somewhere else.



[1] Here is, literally, the entirety of her argument on the costs of higher deficits: "On the idea that persistent deficits don’t matter, I think there is widespread consensus that that is not true. There may be differences in our estimates of the size of the eventual effects, but most economists agree that deficits over decades unquestionably reduce national saving and have consequences for long-run standards of living.” No names, no cites, no data, no examples. Just, “most economists agree.”