Robert Lucas: Modern Macroeconomics: “I was convinced by Friedman and Schwartz…
…that the 1929-33 down turn was induced by monetary factors (declined is money and velocity both) I concluded that a good starting point for theory would be the working hypothesis that all depressions are mainly monetary in origin…. As I have written elsewhere, I now believe that the evidence on post-war recessions (up to but not including the one we are now in) overwhelmingly supports the dominant importance of real shocks…
With respect to impulse and propagation mechanisms for macroeconomic shocks, when I think about impulses I think about:
- “Real” shifts in technologies and tastes–like the invention and diffusion of microprocessors, the invention and diffusion of the pill, or sociological changes in what kinds of activities are broadly thought to be appropriate for the sexes.
- “Supply shocks”–like a catastrophic harvest, or a decision by a swing organization like OPEC with a lot of market power over an important commodity to triple or halve the world price of oil.
- “Demand”–shifts in the stock of money or in other assets supplied by governmental actors like central banks, and shifts in attitudes toward risk and liquidity on the part of those who hold such assets in their portfolios.
With that in mind, take a look at the U.S. time series on real GDP per capita:
(1) by necessity must diffuse firm by firm and individual by individual, and so take quite a while on the business-cycle time scale to affect real GDP per capita. To such factors we can possibly attribute the relatively rapid trend growth of the 1990s and early 2000s as the internet takes hold, and the maintenance of trend growth in spite of adverse supply disruptions in the 1970s and 1980s as the proportion of the population in the labor force rises sharply. But what evidence, let alone what overwhelming evidence, is there that the business-cycle fluctuations at frequencies higher than 15/π were driven by such factors? I see none at all.
(2) by necessity are the results either of identifiable decisions by actors with market power or of very sharp increases in the relative prices of commodities with important economic weight. To such factors we can plausibly attribute a share of the mid-1970s and the cusp-of-the-1980s downturns (and the late-1980s advance). But such impulses ought to leave a particular signature on the macroeconomic time series: production will be less and prices will be higher than was confidently expected a couple of years before. We do indeed see such a signature in the mid-1970s and cusp-of-the-1980s downturns (and, less clearly, in the late 1980s advance). But what evidence, let alone what overwhelming evidence, is there that the other business-cycle fluctuations at frequencies higher than 15/π were driven by such factors? I see none at all.
(3) would leave a signature in the decisions of central banks to reduce or increase the supply of liquidity relative to the demand they expect, in the decisions of governments to borrow-and-spend more or less, and in large fluctuations in the intertemporal and cross-risk price structure as fads and fashions and waves of optimism and pessimism and trust and distrust of financial intermediaries transmit themselves via sociological contagion through the financial sector. We do appear to see strong signatures of all of these. What evidence, let alone what overwhelming evidence, is there that these signatures of demand impulses at business-cycle fluctuations at frequencies higher than 15/π are not causes but rather consequences of real shocks? I see none at all.
What is Lucas talking about?
If you go to Robert Lucas’s Nobel Prize Lecture, there is an admission that his own theory that monetary (and other demand) shocks drove business cycles because unanticipated monetary expansions and contractions caused people to become confused about the real prices they faced simply did not work:
Robert Lucas (1995): Monetary Neutrality: “Anticipated monetary expansions…
…are not associated with the kind of stimulus to employment and production that Hume described. Unanticipated monetary expansions, on the other hand, can stimulate production as, symmetrically, unanticipated contractions can induce depression. The importance of this distinction between anticipated and unanticipated monetary changes is an implication of every one of the many different models, all using rational expectations, that were developed during the 1970s to account for short-term trade-offs…. The discovery of the central role of the distinction between anticipated and unanticipated money shocks resulted from the attempts, on the part of many researchers, to formulate mathematically explicit models that were capable of addressing the issues raised by Hume. But I think it is clear that none of the specific models that captured this distinction in the 1970s can now be viewed as a satisfactory theory of business cycles…
And Lucas explicitly links that analytical failure to the rise of attempts to identify real-side causes:
Perhaps in part as a response to the difficulties with the monetary-based business cycle models of the 1970s, much recent research has followed the lead of Kydland and Prescott (1982) and emphasized the effects of purely real forces on employ- ment and production. This research has shown how general equilibrium reasoning can add discipline to the study of an economy’s distributed lag response to shocks, as well as to the study of the nature of the shocks themselves…. Progress will result from the continued effort to formulate explicit theories that fit the facts, and that the best and most practical macroeconomics will make use of developments in basic economic theory.
But these real-side theories do not appear to me to “fit the facts” at all.
And yet Lucas’s overall conclusion is:
In a period like the post-World War II years in the United States, real output fluctuations are modest enough to be attributable, possibly, to real sources. There is no need to appeal to money shocks to account for these movements…
It would make sense to say that there is “no need to appeal to money shocks” only if there were a well-developed theory and models by which pre-2008 post-WWII business-cycle fluctuations are modeled as and explained by identified real shocks. But there isn’t. All Lucas will say is that post-WWII pre-2008 business-cycle fluctuations are “possibly” “attributable… to real shocks” because they are “modest enough”. And he says this even though:
An event like the Great Depression of 1929-1933 is far beyond anything that can be attributed to shocks to tastes and technology. One needs some other possibilities. Monetary contractions are attractive as the key shocks in the 1929-1933 years, and in other severe depressions, because there do not seem to be any other candidates…
as if 2008-2009 were clearly of a different order of magnitude with a profoundly different signature in the time series than, say, 1979-1982.
Why does he think any of these things?
Vir: Brad DeLong, The State of Macroeconomics? Not Good…