The Anxiety of Economics

We live in especially anxious times. The past half-century has seen a decided turn away from public provisioning – a shift known as neoliberalism or the Washington consensus depending on what side of the Tropic of Cancer you live on.

Certainly this shift was primed by the simultaneous experience of the Cold War and decolonization which motivated a model of economic development that relied on private investment over government enterprise. While it would be convenient to tell this story as merely one of corporate rapaciousness seeking ever broader frontiers, it wouldn’t tell the whole story. The full story involves a shifting in the way economists view economic policy itself.

Katherine Moos, a PhD student at the NSSR & lecturer at Sarah Lawrence College, points to the Lucas Critique as the pivotal point in this turn away from policy. In her work-in-progress “The Transvaluation of Values,” Moos argues that this represented not merely a recalibration of fiscal management, but a philosophical anxiety about the possibility of good public policy itself.

Measures and Targets

The oil price shocks & subsequent stagflation from the early 70’s to the early 80’s undermined some of the core predictions of Keynesian economics. The twin problems of inflation and unemployment were an eventuality not predicted by the various extensions to the Keynesian model made by A.W. Phillips, Milton Friedman, and Edmund Phelps.

Prevailing wisdom had it that policy makers could adjust the size of government to guide the economy between the Scylla and Charybdis of inflation and unemployment. According to the Keynesian mythology, an Odyssean government would expand when unemployment picked up and decrease it when prices began to rise.

When a global spike in oil prices forced business owners to push prices up and lay off workers in order to remain profitable, the conventional wisdom was unable to offer a coherent policy strategy to deal with it. Whereas the economic wisdom could have conceivably been modified for the new economic reality, Robert Lucas took a different tack.

The Devaluation of the Highest Values

In his 1976 paper “Econometric Policy Evaluation: A Critique,” Lucas advanced an argument that called into question the very statistical tools economists used for policy analysis. The Lucas critique did not contradict the conclusions of Keynesian macroeconomics, but rather the possibility of drawing policy-relevant macroeconomic conclusions at all.

The Lucas logic was simple. Econometric policy analysis proceeds on the belief that past aggregate relationships between changes in autonomous expenditures (usually government spending) and resulting changes in output can be extrapolated for the purpose of policy. Lucas argued that such a model fails to take into account consumer reaction to announced changes in government policy. Such changes, Lucas argued, would likely change the relationship between policy variables and their resulting effect since it is presumed that such changes bear out through the consumer market.

The Lucas critique, Moos argues, constituted not a dethroning of a logically inconsistent theory. Rather, it instilled a radical uncertainty towards the ability to test macroeconomic theories at all, much less derive policy prescriptions from them.

Borrowing from K. Vela Velupillai, she refers to this theoretical shift as “policy nihilism.” Like philosophical nihilism, it involves the “devaluation of the highest values.” The Lucas critique demonstrated that econometric policy analysis was a belief system.

Unbelieving Belief

At the end of the 19th century, an increasingly industrial global capitalism reshaped society, upending traditional ways of life in the search for profit. The effects of this economic and political process presented themselves most violently in the Global South in the form of militarily enforced terms of trade, destruction of community institutions, and erased culture through colonial education. In the North, the shift was felt through an increasing work day and increasing separation of Christianity from the state. By the early 20th century, Nietzsche declared that “God is dead” as religion became more a personal moral belief than an assumed system of natural law.

This process of exposing Christianity as a belief was irreversible. With such a social consciousness, to believe in Christianity was now a willed act. Hence, rather than holding a place as a totalizing, unquestionable social system, Christianity became a reasoned choice which contradicts the very nature of belief itself.

In much the same way, policy nihilism broke down the faith in the engineering approach to macroeconomic governance. By showing that using aggregate data to estimate parameters for policy says nothing about the decision making behavior of economic actors, Lucas exposed the Keynesian account approach to be a belief in the stability of the existing regime – one that had experienced tumultuous upheaval.

But like with philosophical nihilism, the Lucas critique did not usher in completely new thought for a new age. Rather, it merely created empty rhetorical space to be filled by whatever traditions could fit in the new paradigm. Where nihilism created a space that was filled with the fascist restatement of feudalism, the Lucas critique ushered in the rational expectations and VAR restatement of neoclassical economics.

Whose Crisis?

When I last saw Katherine present this paper (I have seen her present it three different times, each time with a different title), a few of the comments introduced an interesting alternative narrative. Moos forcefully argues that the Lucas critique was the final nail in the coffin of Keynesian economics.

Some of the commenters suggested that perhaps the Lucas critique was a response to the crisis of neoclassical economics under the capital critique. In this reading, by dispensing with the possibility of aggregate econometric policy analysis. While this is a handy explanation for why the critique was so eagerly embraced by economists who were losing the battle to save the marginal productivity theory of factor pricing, it doesn’t offer much in explaining why it had the effect of upending Keynesian economics specifically. Further, it does little to explain why the solution was to tweak DSGE models to include expectations-augmentation and VAR approaches in particular (as opposed to, say, algorithmic or structuralist approaches).

Further, neither Moos’ story nor that of her commenters explains why, in the face of uncertainty, we fall back to the traditional and familiar instead of creating anew. Caught in the fray of anxiety over policy, economists did not advocate “non-policy” because there is no such thing. Cutting public services is as much a policy decision as expanding them.

Where the mania of Keynesian policy analysis led to its own crisis, so too did the anxiety of the Lucas Critique. In the rush to privatize and deregulate to accommodate the dominance of individual rational expectations, the social nature of herd behavior led to a crisis which its market-driven faith could not solve. Only this year has the IMF announced that the austerity politics of the age of the Lucas critique was an abysmal failure.

This new age of anxiety presents us with the opportunity to forge ahead with new ideas for a new era, but only if we fight the regressive forces of the old guard.

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