Macro and the Perfect Storm

I am currently teaching two macro courses at the University of Washington in Seattle. I get free purple rain wear and as much Starbucks coffee as I can drink. It’s a nice deal. I can harass MBA students and my son’s family during my stay here. What could be better than that?

Introducing macro to a new group of MBAs is always challenging. People choose to attend MBA programs to pursue careers in marketing, finance, accounting, and so on. They do not come to business schools to study macroeconomics. The wisdom at many MBA programs is that macro is a tool these students need. Alternatively it is an excellent means to punish them for past sins. Whichever is true, my 119 years of teaching macro at Kelley has left me with a lot of scars and a lot of great memories.

Teaching macro today is even more challenging. Just as capitalism and free trade are under the microscope, so is macro. Events since the popping of the housing and stock market bubbles have left many people ready for revolution. Bernie wants to replace markets with more government control. Trump  wants to replace free trade with Trumpian Trade.  Congress won’t approach anything that resembles an economic plan and the central banks around the world think low or negative interest rates are beneficial despite Keynes’ warnings about liquidity traps.

Meanwhile the average bloke thinks the economy is either broken beyond repair or run by rich, selfish people. They are ready for revolution and macro is part of the heap they want to toss out and replace with something better. I am not ready to give in to a premature burial for macro but I realize that students will not take for granted that studying a dying science is worthwhile. I can’t say “shut up and eat your macro; it is good for you.”So it is up to me to try to motivate why they should spend the time and energy on macro.

Part of understanding the strengths of macro is to admit its weaknesses.  Macro lopes along. The basics of supply and demand stay the same but when the world changes, macro must too. One kind of macro seemed to be helpful in the 60s until inflation picked up. Macro wasn’t too sure about itself in the 70s but then new theories helped to improve its explanatory power as time wore on. We invented the word stagflation around that time to name a new unsatisfactory phenomenon. Macro was not so good at explaining the impacts of energy price increases and then decreases – so we had to dress it up a little more to improve predictability when energy or for that matter when food prices went haywire. Macro clearly was not ready to deal with a dot.com bust and then years later with housing and stock price bubbles. Macro is having a struggle today to digest globalization, declining productivity, and labor market disappointments. 

Macro is evolutionary. I remember being a young graduate student (with hair and teeth) and hearing a professor proclaim that macro knew everything it had to know. We had Keynesian macroeconometric models that could forecast the economy almost perfectly. What hubris!  That bubble burst in the late 60s as inflation rose and kept rising. The world is always changing.  Macro’s charge is so broad that its models have to incorporate many variables and many phenomena. So it is easy to understand why macro models will never be perfect. But even when they are bad, they are helpful. When they are bad economists scurry around until they figure out how to make them better. As we scurry the picture is not pretty – sort of like making sausage.

Right now we find ourselves in that sausage-making stage. Watching all this most of us would prefer a nice banana. In the meantime we have to make decisions. Households have to find ways to save money for the future. Business firms must decide when to build another store or factory. Multinational corporations have to position supply-chains. Investors have to come up with a mix of stocks, bonds, and other investments. As we remake the macro sausage none of those decisions are easy and they can be very frustrating. It’s hard to know which Ark to choose when the water is rising.

In the meantime as we filter through what will someday be the next stage of the macro model, the old model helps us make at least imperfect decisions. Supply and demand are concepts that help us think through the haze. We can apply supply and demand tools to any market. For example, the world has a very pronounced tendency to favor demand-side remedies. But in 2016 it looks like traditional monetary and fiscal policy thinking are not working. That does not mean macro is a  failure. It means that policymakers can think about supply approaches. 

Some politicians are promoting revolution where revolution is just short-hand for more government control and oversight.  Maybe more of that is necessary these days but macro always warns about unintended negative consequences. What happens to international trade when we treat Mexicans (or Chinese)  as naughty step-children? What happens when we penalize companies for making global decisions? What happens when bankers feel a constant threat of legal action over everyday banking decisions? 

I don’t blame anyone for feeling seasick. The world economy today is like a small boat in a perfect storm in which the boat never stops moving up and down. A bubble bursts in 2007. A recession hits in 2008 in the US. It spreads to the rest of the world and then the economic waves of their downturns reverberate to our shores. Policymakers get active and we get cash for clunkers – another wave. In Europe they stimulate and then turn to austerity. Bam again. Earthquakes and tsunamis. Bam. Energy prices decline. Bam. Negative news about China. Bam. None of this is usual or normal or easy.

We are seasick but it is not time to desert the boat. Even a perfect storm subsides. It exits slowly and as we recover the scenery is cloudy and unclear. And yet we have to go on making decisions. I am happy to teach my courses and to write my blog and keep reminding us that while macro is not perfect, it can be helpful and is among the tools we all need to keep making decisions in a complicated and uncertain world.