Tuesday, November 26, 2013

What constitutes Freshwater macro?

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UPDATE 12/19/13: A follow-up to this post is here.

By now everyone knows about events at the Minnesota Fed. Miles Kimball and Noah Smith have a note trying to explain the Freshwater/Saltwater divide (is that still a thing?) to outsiders. Paul Krugman piles on. For the most part, I don't really want to get into this fight, but I'm curious about a few things. This is probably due to my inability to identify the line between Freshwater and Saltwater economics. I use a shorthand of New Keynesian vs. non-New Keynesian. Maybe someone will help me out.

Kimball and Smith write,

In the case of Freshwater macroeconomics there is a large set of purity taboos prohibiting certain model elements (elements Saltwater economists think are necessary to explain the world).

What are we talking about here? The main difference between standard RBC and New Keynesian models is nominal rigidities. Calvo pricing, while useful, does not "explain" anything. It's an assumption, not a model outcome. It's an extremely useful assumption, but it is ad hoc. (There is another big difference--local vs. global solution methods, in many cases--and I don't think that one comes down in favor of the New Keynesians...). Maybe if it would be useful for "Freshwater" types to take "Saltwater" ideas more seriously, it would also be useful for New Keynesians to think hard about some of the weaknesses of that model (e.g., here--yes, I went there).

Maybe we're not talking about Calvo pricing.

There is also a conventional wisdom among many people that the Freshwater school has no ability to explain the Great Recession. K&S: "The Saltwater New Keynesians--who included Fed chairman Ben Bernanke--had an answer." Here is where I don't think the Freshwater vs. Saltwater divide is very useful. What kind of insights was Bernanke drawing on? New Keynesian ones? Bernanke's actions could easily have been motivated by Bernanke/Gertler/Gilchrist financial accelerator and/or Kiyotaki-Moore concerns. Are those ideas that "Freshwater" people would reject? I suppose I have no idea, but a lot of RBC models are incorporating these kinds of frictions.

I happen to have attended the Midwest Macro conference in Minnesota a few weeks ago. That by no means makes me an expert on the subject, but I saw lots of papers--including some by Minnesota people--that incorporated a variety of deviations from the bare bones RBC model that had a lot of explanatory power. Is Fisherian debt-deflation a Freshwater thing, or a Saltwater thing? The non-New Keynesian research agenda is very dynamic, while K&S suggest that the Freshwater "template is seldom reexamined."

Again, I probably just have no idea what Freshwater means.

Then we have Krugman, who mentions RBC inflation predictions in the Great Recession. But has inflation matched New Keynesian predictions? Doesn't the standard NK model say we should have had a lot more deflation? That's a tricky model. Oh, and by the way, are the events in Minnesota consistent with Krugman's complaints about practitioners of demand-side macro being oppressed in the discipline?

I'm just trying to articulate my confusion. I'm wondering if our assessment of the usefulness of "Freshwater" macro depends on how narrowly we define it. It might be helpful for Kimball and Smith to give us a more precise definition of the distinction.