For many observers, it seems obvious that the roots of the current recession lie in the crisis in the banking sector. In the Economist’s Voice (a non-technical, yet academic, electronic journal), Robert Barbera attacks University of Chicago Economist Casey Mulligan and other real business cycle theorists for having a framework that cannot either predict or even describe important economic phenomena.
Barbera chides for Mulligan for predicting in the Fall of 2008 that we wouldn’t see large decreases in employment because of the weak linkage between the financial sector and the rest of the economy. Mulligan argued, and still does, that gyrations in the financial sector are not closely linked to performance of the economy overall. In other words, the obvious is not obvious.
In a sharp response, Mulligan correctly points out that Barbera’s critiques are not based on any theoretical critique of the large literature on this topic, but merely on Mulligan’s incorrect prediction. Mulligan acknowledges he was wrong, but points out that that obvious story cannot easily account for two important facts. First, that even though employment fell sharply, GDP and consumption did not. Second, the massive infusion into the financial sector did relatively little to increase lending. [It all seemed to go into the monetary base, which caused know-nothings like Glenn Beck to rant about how this was going to cause rapid inflation and financial catastrophe.]
Mulligan does have an alternative account of the current recession. He thinks it was caused primarily by distortions in the labor market, namely three successive increases in the minimum wage and a mortgage modification program that was associated with an marginal tax rate of over 100%. He does acknowledge that there might be monetary or capital sector stories that could be explored, but I find the labor market story intriguing.
I’m highly suspicious that the banking sector crisis was completely unrelated to the current recession (and I suspect Mulligan would allow for some role). But, on the other hand, Mulligan’s argument is based on careful modeling, data analysis, and peer review. Barbara’s argument is based on huffing and puffing about what is obvious. Mulligan admits the full story isn’t known, but he is none to kind of the resurgence of Keynesian thinking in the public sector:
Recent events only reinforce the prescription that economic analysis should be rooted in incentives, not voodoo incantations of multipliers and contagion. But the latter will continue to enjoy prominence in the political marketplace, where there’s nothing like telling taxpayers “Give me your money and, trust me, your gift will make you richer.”
Often when people say something is obvious it means they don’t have a good argument.
Addendum: One of the commentators below references the views of Scott Sumner, who always has intelligent things to say. In particular, back when Paul Krugman was screeching that we simply HAD to have a giant stimulus because we were in a liquidity trap and therefore out of monetary tools, Sumner wrote a nice little piece in The Economist’s Voice arguing that of course we still had tools. If you are interested, you can also read my little comment on Sumner and on Brad DeLong’s mischaracterization of our available policy options (DeLong argued that the only way to do deficit spending was to increase spending, neglecting to mention cutting taxes). It is my simple-minded attempt to be a macroeconomist–something I will avoid in the future, except when blogging!