If you are inclined to believe that government should steer clear of any intervention in the economy, or stand with partisans who lean to the right-wing side of political economy debates, then you will likely agree with Donald Luskin that John Cochrane's riposte to Paul Krugman's "How Did Economists Get It So Wrong?" is "devastating."
John Cochrane, an economist at the University of Chicago, is spitting mad. He is also a forceful writer, and he makes a compelling case that in the course of his argument explaining why conservative (and liberal) economists missed the boat on the financial crisis, Krugman oversimplified the state of macroeconomic affairs over the past several decades.
As FreeExchange observes, however, Cochrane makes the same mistake he accuses Krugman of, by caricaturing and oversimplifying Krugman's argument, and, even worse, complaining that Krugman is only interested in making personal attacks on an ever-growing "enemies list," while engaging in his own litany of vicious slander. Cochrane's assertion that Krugman "wants to be Rush Limbaugh of the Left," betrays a bizarre disconnection with reality. And he proves, over and over again, that one of Krugman's central accusations -- that Chicago School economists have nothing but scorn and sneers to pile on John Maynard Keynes -- is absolutely correct.
Instead, [Krugman] calls for a return to the eternal verities of a rather convoluted book written in the 1930s, as taught to our author in his undergraduate introductory courses. If a scientist, he might be a global-warming skeptic, an AIDS-HIV disbeliever, a stalwart that maybe continents don't move after all, or that smoking isn't that bad for you really.
I find it hard to read that paragraph in any other way than to assert that believing that Keynes had something insightful to offer as to how government should respond to a recession or depression is equivalent to disbelieving in global warming or plate tectonics.
Krugman's initial response to Cochrane et al. is even less satisfying. From what I can tell -- "I gather, though, that the usual suspects are utterly outraged at my suggestion that freshwater macro has spent several decades heading down the wrong path" -- he hasn't read Cochrane's attack, although I guess we can excuse him for being on vacation with sporadic Internet access. Once he returns, however, it would be educational to see him respond to some of Cochrane's more substantive assertions as to how economists are continuing to extend the state of the art.
But to a certain extent the real dispute is over something so fundamental that no amount of parrying with the nitty-gritty of how well the latest macroeconomic model captures reality will resolve it. Cochrane is straightforward: Here, he says, is "the main point."
The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse. Free markets are the worst system ever devised -- except for all of the others.
Of course Krugman has never argued in favor of government "control" of markets. But that's a side issue. Cochrane and his brethren believe the less government the better -- Krugman believes there's a clear role for government, not just in properly regulating markets, but also in intervening when markets fail.
Which brings us to Cochrane's key point, aptly seized upon by Nick Rowe at Worthwhile Canadian Initiative. Cochrane's central critique of Keynesianism is summed up in one declaration.
Paul's Keynesian economics requires that people make plans to consume more, invest more, and pay more taxes with the same income.
Cochrane states this formulation as if it is an outright absurdity, and at first glance, maybe it does look crazy. But from a Keynesian point of view, Cochrane is totally misunderstanding how economies work. If people consume less, companies sell fewer goods and services, requiring them to lay off people, who in turn spend even less. This is the famous "paradox of thrift." This is exactly what we are living through right now. The total money supply doesn't change, but the economy goes into recession because that money is not circulating. The opposite also holds true. If people consume more, companies aiming to meet that demand hire more workers who then have the income to spend on more products. As Keynes wrote in "The Great Slump of 1930":
Yet, all the time, the resources of nature and men's devices would be just as fertile and productive as they were. The machine would merely have been jammed as the result of a muddle. But because we have magneto trouble, we need not assume that we shall soon be back in a rumbling waggon and that motoring is over.
Government -- there, when you need it, to unjam the machine. When two sides are in disagreement over such a foundational issue, it's hard to see how any amount of slash-and-burn Internet argument will ever reach resolution.