I posted Cochrane’s response to Krugman last week and in the interim this site has become the link to source. I tried to be as neutral in the posting as possible, but some may have interpreted as implicit support for Cochrane’s position. This is not the case. Indeed, at the time I wasn’t sure how I felt about either piece. Here are my thoughts as of now.


Krugman’s piece was, well, Krugman. A little abrasive and not particularly charitable to his adversaries, but smart and well reasoned nonetheless. Cochrane’s response, seemed to me, a bit out of scale to what Krugman wrote in the NYT Magazine. Now, if you’ve been following Krugman you know he has said much worse about those associated with Freshwater Macro.

Undoubtedly, this history of antagonization influenced Cochrane’s tone. Still, it felt like an escalation and that is unfortunate. I realize that this could be read as “rewarding” Krugman for being consistently rough around the edges. Its like Krugman’s caricatures don’t count because he’s always painting the other side in a bad light.

From the point of view of encouraging a civil discourse, however, I think that’s the correct approach. There are economist specific fixed effects. And, economists who are consistently abrasive already suffer an implicit discounting of their statements. Krugman often complains that he will never be forgiven for being “right too soon” about George Bush. This is probably correct and is simply another way of saying he will never escape the implicit discounting associated with his style.


Beginning with Eugene Fama’s post arguing that the stimulus could not work because it violated basic adding up constraints I have been deeply puzzled. The probability that I understand macro on a deeper level than Fama or Cochrane is low. Yet, it seems to me that basic error is being made. Fama and Cochrane appear to either be assuming that prices adjust seamlessly throughout the entire economy or that increases in the demand for money do not reduce the total quantity of transactions.  Both of these seem to be naive assumptions.

However, given our premise, that it is unlikely I understand something Fama and Cochrane do not, the logical conclusion is that I am missing something about their argument. Yet, when I look at how the crisis unfolded I am struck by how well the basic model I was working with performed.

In the spring of 2008, I told my graduate seminar class that if we had not already had the Great Depression that it would be starting now. Luckily I noted, we had learned many of the lessons and Ben Bernanke would not allow a general failure of the financial system if it could be avoided.

In the days after Lehman’s fail, just over one year ago, I wrote a letter to my colleagues in the School of Government telling them we were walking a fine line. The money market appeared to be shutting down and there was a non-trivial chance that Western Capitalism was about to collapse. This, I felt, could almost certainly be avoided but we should not delude ourselves about the risks we faced.

In October of 2008 I advised North Carolina officials that they were about to see an unprecedented drop in retail sales and that this would lead to massive losses in sales tax revenue. Credit was being cut and households who were spending more than they took in were going to have adjust rapidly.

All of these things seemed to be confirmed by events and they were all based on a vulgar New Keynesian model of the economy with a special role for the financial sector. I didn’t think any of these forecasts were particularly prescient. Indeed, I thought I was simply translating the conventional wisdom. Apparently not.

Cochrane argues that economists should not have been able to predict this crash. However, it seems to me that much of it was predicted. Zingales and others have argued that the panic which gripped the Fed and Treasury actually precipitated the worst of the crisis. Academically I can’t rule this out.

There is a basic identification problem here. If one side thinks that panicking causes crises and the other thinks that foreseeing a crisis causes panic there might not be a lot we can do to sort this out, save for the type of randomized experiments we could never justify actually performing on real economies.

In short, what puzzles me is how different the views of esteemed economists were from a pedestrian analysis. If they are right why did things happen the way I and others thought they would happen? Were we just lucky? If we are right, how is it that Fama and Cochrane are missing basic points about the economy?