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Commentary

Macroeconomics discovers debt

30 Aug 2011 by Jim Fickett.

Mainstream macroeconomics has, up to now, failed to include a role for debt in its models. With excessive debt quite obviously playing a central role in the recent crisis and current recovery, perhaps this will change.

Stuart Staniford at Early Warning recently pointed to a Jackson Hole conference paper by Stephen Cecchetti, M. Mohanty, and Fabrizzio Zampoli, entitled The real effects of debt.

As modern macroeconomics developed over the last half-century, most people either ignored or finessed the issue of debt. … With no active role for money, integrating credit in the mainstream framework has proven to be difficult.

Yet, as the mainstream was building and embracing the New Keynesian orthodoxy, there was a nagging concern that something had been missing. On the fringe were theoretical papers in which debt played a key role, and empirical papers concluding that the quantity of debt makes a difference. The latest crisis has revealed the deficiencies of the mainstream approach and the value of joining those once seen as inhabiting the margin.

In response to the challenge, macroeconomists are now working feverishly … writing down models in which debt truly matters and working through the implications.

As Staniford says,

The mind reels - they are just starting to think about how to include debt in their models now?

It never ceases to amaze me that investors pay attention to Bernanke's comments on where the economy might be going. Not only does he have a terrible forecasting record, but it is perfectly obvious that that record is due to a major flaw that is unlikely to change – he takes macroeconomic models seriously.