Riddle me this, macroeconomists

Can the Fed intervene to 'stop panic' and, at the same time, make new rules so that future crises don't occur?

By , Guest blogger

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    In this Oct. 27, 2009 file photo, James Dimon, chairman and CEO of JP Morgan Chase & Co., speaks in New York. Mr. Dimon said recently that he's afraid the Fed is actually slowing down the recovery. Could he be right?
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As a failed macroeconomist (and thus a current applied micro scholar), I would like to pose some riddles for my "macro" brethren. To set the scene, here is a high quality piece by Greg Mankiw sketching a short history of what macroeconomists do all day long. They are ambitious! Now let's fast forward to June 2011 and take a look at Andrew Ross Sorkin's piece in the NY Times today.

A Wall Street Wizard named Jamie Dimon has the audacity to challenge Professor Ben Bernanke with a tough counter-factual. Here is a quote from Dr. Dimon;
“I have this great fear that someone’s going to write a book in 10 or 20 years, and the book is going to talk about all the things that we did in the middle of a crisis that actually slowed down recovery,” he told Mr. Bernanke at a televised meeting of bankers in Atlanta, ticking off a laundry list of new regulations like higher capital requirements and a tax on systemically important financial institutions.

“Do you have a fear like I do that when we will look back and look at them all, that they will be the reason it took so long” for our banks, our credit and our businesses and “most importantly job creation” to get going again?, he asked Mr. Bernanke. “Is this holding us back?”
How did the leading Princeton macroeconomist (and head of the Fed) respond?

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"When Mr. Bernanke answered Mr. Dimon’s question, he said, “Has anybody done a comprehensive analysis of the impact on credit? I can’t pretend that anybody really has. You know, it’s just too complicated. We don’t really have the quantitative tools to do that."

I respect Dr. Bernanke's honesty but this is a pinch troubling. We know that we do not know the correct model of how our macro-economy works but the Fed is engaging in massive interventions to simultaneously "stop panic" in the short run but to create good "rules of the game" so that future crises don't occur. This sounds ambitious. I have wondered whether we have paid too much to slow down the recession. Can this conjecture be tested?

Jamie Dimon asked a tight (and self serving) question. This is exactly the type of question that macroeconomists should be able to answer. It is certainly a tough question. The fundamental challenge in macro is that the empirical researchers accumulate one data point per year and if the economy is "changing" over time then you are studying a moving target. It is very difficult to pose well defined "what if" questions in this case.

So, what is to be done? I'm not a macro economist and I don't believe that all of the answers are in Keynes. I think that the macroeconomists need to return to the basic ideas in strategic game theory and think through issues of credibility and ways to make markets more competitive. When asset firesales occurs, where are the Sovereign Wealth Funds and China to purchase cheap assets? How to allow for more international capital to flow so that markets do not freeze up in a future panic cascade? In terms of the proper role for government, we need them to provide precise statements about what is the "market failure" that justifies government intervention? Why can't competitive free markets be allowed to work to respond to the ever arriving "new news"?

I know that economists are making progress on studying the crisis; some evidence is here and here. The challenge is how we suggest "good public policies" when we don't know what will be the consequences of such policies and we don't know how diverse large players will respond to these policies. Ideally, ideas of robustness will be introduced here but I don't understand how to take the Hansen and Sargent research program and apply it here.

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