The Saltwater-Freshwater divide
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There’s been a shakeup at the Minnesota Fed, and no one quite knows why. The news that president Narayana Kocherlakota dismissed two of the institution’s research economists — Patrick Kehoe and Ellen McGrattan — has sparked a debate in the macro community.
Jeffrey Sparshott argues the dismissals could be tied to changes in Kocherlakota’s own views on macroeconomic policy. Last year, the WSJ called this change an “extreme swing from hawk to dove”. Kocherlakota, Sparshott says, “went from thinking the cause [of persistently high unemployment] was largely structural (and thus could not be fixed with monetary policy) to thinking it was largely due to weak demand (which means it could be addressed through policies aimed at boosting demand)”. The two fired (rather, not rehired) economists haven’t changed their minds similarly.
Miles Kimball and Noah Smith write that the dismissals could be indicative of a larger conflict in the econ world: the Freshwater vs. Saltwater debate. The Freshwater school of economists, which includes Kehoe and McGrattan, believes that people are rational in their economic decisions, that recessions are just part of the normal ebb and flow economy, and therefore the government shouldn’t do much to fight downturns. On the other hand, “the Saltwater macroeconomists,” Kimball and Smith write, believe that “recessions were economic failures,” and the monetary and fiscal policy should be used to fight back. (Kimball and Smith fall into the Saltwater school).
In 2008, Ryan Avent took issue with a paper co-authored by Kehoe, that argued the financial crisis never really threatened the real economy and government bailouts weren’t needed: “In the best tradition of lazy undergraduates everywhere, they plot lines on graphs and draw wild conclusions”, Avent wrote of the paper.
Krugman suggests the dismissed researchers were just too tied to their doctrine: “If you, as an economist, try to weigh in on events as they happen, you will get things wrong, and sometimes you may get them wrong in a big way. The crucial question is what you do next. Do you engage in self-analysis … Or do you double down on your preconceptions?”
Mark Thoma, (who has a post today about how different macroeconomic models should be used in different economic situations) thinks it might not be about freshwater-saltwater at all: “My theory about what is happening at Minneapolis is that it is mostly about poor communication and insufficient leadership”. Brad DeLong agrees.
Nick Rowe thinks the problem was both about bad communication and a policy fight: “The main job of your advisers is to stop you saying something stupid in public”, he says. In Rowe’s telling, Kocherlakota said a few stupid things in public, his advisors didn’t stop him, so they got fired. — Shane Ferro
On to today’s links:
A profile of the self-described “the largest investor in hedge funds in the world” – DealBook
Related: Hedge funds are still for suckers – Bloomberg Businessweek
Buy stocks, say people who sell stocks – Matt Phillips