Another related issue Cochrane raises is in this blog post. The basic point that Cochrane wants to make is that an Old-Keynesian model (i.e. IS/LM AS/AD) and a New Keynesian model are very different animals. Indeed, New Keynesian models would be much more recognizable to Ed Prescott than to John Maynard Keynes, if we chose to resurrect the latter. One way in which these models differ is in how fiscal policy works. Old Keynesians typically assumed that the economy was non-Ricardian, which helped to feed the multiplier process. However, in a New Keynesian model, there is a complete set of contingent claims markets, and Ricardian equivalence holds. Fiscal stimulus works by increasing anticipated inflation, and lowering real interest rates, causing consumers to substitute intertemporally. Current consumption must go up, as it is assumed that consumption reverts to trend in the future.
Cochrane is willing to take the New Keynesian story seriously, but he would like it if the people who are promoting fiscal stimulus were to defend their policy recommendations in terms of that model. Unfortunately the fiscal stimulus folks are either confused, or are deliberately obfuscating. Some people want to argue as if New Keynesian models and Old Keynesian models are indeed the same animal. Policy issues are explained in Old Keynesian language - e.g. stimulus works by way of the multiplier process - and then people appeal to New Keynesian models as if that somehow ratifies these old results, which is false.
Now, predictably, this kind of talk gets Paul Krugman upset, as of course what Cochrane is describing is the way Krugman operates. What gets Krugman particularly upset is this (from Cochrane):
But people love the story. Policy makers love the story. Most of Washington loves the story. Most of Washington policy analysis uses Keynesian models or Keynesian thinking. This is really curious. Our whole policy establishment uses a model that cannot be published in a peer-reviewed journal. Imagine if the climate scientists were telling us to spend a trillion dollars on carbon dioxide mitigation -- but they had not been able to publish any of their models in peer-reviewed journals for 35 years.The problem here is the the story that people "love" is the Old Keynesian multiplier/paradox-of-thrift story. Somehow the average person finds it appealing, and so the story gets used all the time, in spite of the fact that it does not hold water - in the sense of being grounded in sound economic theory.
Krugman's reply to this is to argue that it's not Washington (or him for that matter) that is screwed up - it's the economics journals.
So consider two hypotheses. One — which Cochrane appears to believe — is that being inside the Beltway has rotted Janet’s and Olivier’s brains, not to mention that of all their researchers, causing them to revert to primitive concepts that “everyone” knows are false. The other — which is what I hear from young economists — is that there is an equilibrium business cycle claque in academic macroeconomics that has in effect blockaded the journals to anyone trying to publish models and evidence that stress the demand side.Of course, most of those two paragraphs is nonsense. Janet Yellen and Oliver Blanchard are well out in the right tail of the quality distribution of Washington policymakers. To my taste, both are a little too wedded to Old Keynesian economics, but they listen, and I don't think those are the people that Cochrane is concerned with.
Obviously you know which story I believe. The main point, though, is that trying to argue from authority is even sillier here than in most situations. There’s a huge difference between “nobody believes that” and “none of my friends will let that get published in the journals they control”.
On other matters, what is an "equilibrium business cycle claque" anyway? Who exactly would those people be? First, if Krugman were to say the word "disequilibrium" to me, I would know what he meant, but I would have to correct him by pointing out that all the macro models I have seen in my life are equilibrium models. Old Keynesian, New Keynesian, stochastic growth, whatever - all of those models have some equilibrium concept. For example, you can fix the prices and let the quantities adjust - it's still an equilibrium model. I think what Krugman wants to say is that there is some "equilibrium business cycle claque" which is a collection of powerful people who control some important institutions, and reserve the right to filter out people and research they don't like. Here's a story. Long ago there was a group of outsiders, who either could not find jobs on the inside - in Cambridge Massachusetts, for example - or were literally kicked out of the Ivy League. Those people didn't spend their time whining about how badly they were treated, as far as I know. They went to work at out-of-the-way institutions like Carnegie Mellon University and the University of Minnesota, and ultimately remade macroeconomics - for the better, I think. They managed to get their work published, they helped start journals and professional societies, and built research institutions from the ground up.
Krugman's academic life was nothing like that. He was a Cambridge insider from the get-go, and anointed at an early age - not much struggle there I think. If these "young economists" who can't publish their "demand side" work even exist, the papers they can't publish must be real stinkers, as I don't see severe limits to the market for such stuff. The NBER - particularly the Fluctuations group and the "Monetary Economics" group - is very friendly to Keynesian economics. The Society for Economic Dynamics, started by what Krugman might think of as an "equilibrium claque," typically has plenty of New Keynesian economics on the program at its annual meeting. The QJE, where Eggertsson and Krugman just published their paper, is of course notable as an outlet for Keynesian work. The Journal of Monetary Economics, has been edited for years by Bob King, who certainly has Keynesian sympathies. That journal will soon be run by Ricardo Reis and Urban Jermann. I think it's fair to say that the former is a Keynesian. The editor of AEJ Macro (a newer and prominent macro journal) is John Leahy - a prominent Keynesian. In the group of co-editors at the AER, the only macroeonomist appears to be Marty Eichenbaum, who as we all know is now a hardcore Keynesian.
What could Krugman be thinking? We've found better ways to do macroeconomics than twiddling IS-LM models. Get over it.