Few people will remember it today, but when the Great Recession struck in 2008, there was considerable controversy over which economic theory was relevant in the situation and, therefore, what monetary policy should be applied. For example, well-known names like Robert Lucas and John Cochrane resembled the concept of Ricardian equivalence, with fiscal stimulus ineffective. Economist Noah Smith points out that Lucas’s claim turned out to be wrong. However, the whole thing speaks to how intense the economic debate was at that time. Today, according to Smith, we are in a completely different situation, which can be summed up in the statement: “Just give people money.”
Smith recalls that after 2007, the debate on economic theories was the same for fiscal and monetary policy. According to him, for example, central bankers intensively discussed the relevance of so-called DSGE models. That is, models of dynamic stochastic overall equilibrium, which Smith criticized and lectured on at the Bank of England. Speaking about their weaknesses, “delegates from the Swedish central bank banged their hands on the table and asked me to describe exactly which part I did not like – dynamics, stochastics or balance,” Smith writes to show how broad the debate has been since 2007. on the relevance of specific economic theories and approaches.
“Ten years later, all this seems to be something from another century. The recession caused by the pandemic is deeper than the Great Recession, and the government’s response to it is greater and bolder. Even so, macroeconomic theory is not yet being debated,” the economist continues. Only a few economists, such as Olivier Blanchard, occasionally mention a theoretical concept, but only general statements. In his presentation at Brookings, Blanchard specifically said that governments should not be afraid of debt growth at the moment. In this context, he mentioned the theory of long-term stagnation and the idea of loan funds. However, none of this was presented in any comprehensive framework or model.
Smith also mentions another well-known economist, Ken Rogoff, who “used to be a well-known budget hawk.” He, too, now appears to be in favor of the effectiveness of the current fiscal stimulus. Regarding debt sustainability, there is a consensus that rates are low, they have reached these levels in the long run, so it is safe to increase debt. There is less concern about the possibility of future rate hikes, but no comprehensive theory is presented to say when such a rise could occur and why. Instead, a “give people money” consensus has emerged, which Smith says will be welcomed by the incoming Biden government. Even Janet Yellen, who in the past expressed concerns about the sustainability of government debt, now believes that significant fiscal stimulus is needed in the current situation.
Why was there a shift from intense debates over theoretical foundations to the current simple consensus? According to Smith, politicians learned from the recent crisis, the DSGE models proved to be very weak during the problem, and central bankers again turned to simple models and intuition. Models that consistently predicted high inflation turned out to be wrong, and “if a tool doesn’t work, you just stop using it, even if you do something by hand.”
Smith also points out that there have been some attempts at fiscal tightening since 2008 with poor results, and this has helped to change the view of budgetary policy. It also occurred in the International Monetary Fund, which was previously considered a “bastion of budget hawks.” And last but not least, economists may be now paying more attention to what is happening in politics and society. In this context, Smith points to the unrest that prevailed in the United States before the 2019 pandemic.
As a result, even economists may be more inclined to believe that if the government makes a mistake, it is better to give people too much money than it will provide too little. “There is no DSGE model that says how to weigh public anger against each other and the risk of future rate hikes,” the economist writes. All of this can change if we create better economic models or when the costs associated with high government spending would be exact. Until then, however, the dominant economic theory may be the thesis: “Just give people money.”