The Anti-History Boys

BERKELEY – If you asked a modern economic historian like me why the world is currently in the grips of a financial crisis and a deep economic downturn, I would tell you that this is the latest episode in a long history of similar bubbles, crashes, crises, and recessions that date back at least to the canal-building bubble of the early 1820’s, the 1825-1826 failure of Pole, Thornton & Co, and the subsequent first industrial recession in Britain. We have seen this process at work in many other historical episodes as well – in 1870, 1890, 1929, and 2000. For some reason, asset prices get way out of whack and rise to unsustainable levels. Sometimes the culprit is lousy internal controls in financial firms that over-reward subordinates for taking risk. Sometimes the cause is government guarantees. And sometimes it is simply a long run of good fortune, which leaves the market dominated by unrealistic optimists. Then the crash comes. And when it does, risk tolerance collapses: everybody knows that there are immense unrealized losses in financial assets and nobody is sure that they know where they are. The crash is followed by a flight to safety, which is followed by a steep fall in the velocity of money as investors hoard cash. And that fall in monetary velocity brings on a recession. I will not say that this is the pattern of all recessions; it isn’t. But I will say that this is the pattern of this recession, and that we have been here before. But if you ask the same question of a modern macroeconomist – for example, the extremely bright Narayana Kocherlakota of the University of Minnesota – you will find that he says that he does not know, and that macroeconomic models attribute economic downturns to various causes. Most, he points out, “rely on some form of large quarterly movements in the technological frontier. Some have collective shocks to the marginal utility of leisure. Other models have large quarterly shocks to the depreciation rate in the capital stock (in order to generate high asset price volatilities)...” That is, downturns are either the result of a great forgetting of technological and organizational knowledge, a great vacation as workers suddenly develop a taste for extra leisure, or a great rusting as the speed at which oxygen corrodes accelerates, reducing the value of large things made out of metal. But modern macroeconomists will also say that all these models strike them as implausible stories that are not to be taken seriously. Indeed, according to Kocherlakota, nobody really believes them.: “Macroeconomists use them only as convenient short-cuts to generate the requisite levels of volatility” in their mathematical models. This leads me to ask two questions: First, is it really true that nobody believes these stories? Ed Prescott of Arizona State University really does believe that large-scale recessions are caused by economy-wide episodes of forgetting the technological and organizational knowledge that underpin total factor productivity. One exception is the Great Depression, which Prescott says was caused by real wages far exceeding equilibrium values, owing to President Herbert Hoover’s extraordinary pro-labor, pro-union policies. Likewise, Casey Mulligan of the University of Chicago really does appear to believe that large falls in the employment-to-population ratio are best seen as “great vacations” – and as the side-effect of destructive government policies like those in place today, which lead workers to quit their jobs so they can get higher government subsidies to refinance their mortgages. (I know; I find it incredible, too.) Second, regardless of whether modern macroeconomists attribute our current difficulties to causes that are “patently unrealistic” or simply confess ignorance, why do they have such a different view than we economic historians do? Regardless of whether they have rejected our interpretations and understandings or simply have built or failed to build their own in ignorance of what we have done, why have they not used our work? The second question is particularly disturbing. After all, economic theory should be grappling with economic history. Theory is crystallized history – it can be nothing more. Someone observes some instructive case or some anecdotal or empirical regularity, and says, “This is interesting; let’s build a model of this.” After the initial crystallization, theory does, of course, develop according to its own intellectual imperatives and processes, but the seed of history is still there. What happened to the seed? This is not to say that the macroeconomic model-building of the past generation has been pointless. But I do think that modern macroeconomists need to be rounded up, on pain of loss of tenure, and sent to a year-long boot camp with the assembled monetary historians of the world as their drill sergeants. They need to listen to and learn from Dick Sylla about Alexander Hamilton’s bank rescue of 1825; from Charlie Calomiris about the Overend, Gurney crisis; from Michael Bordo about the first bankruptcy of Baring brothers; and from Barry Eichengreen, Christy Romer, and Ben Bernanke about the Great Depression. If modern macroeconomists do not reconnect with history – if they do not realize just what their theories are crystallized out of and what the point of the enterprise is – then their profession will wither and die. J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a Research Associate at the National Bureau of Economic Research. 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The Anti-History Boys