Analyzing the present

I got to the middle of page 2 of Christopher A. Sims' Paper Money (PDF, 40 pages) before I had my first reaction: He is analyzing how the economy works now, rather than how we got into this situation.

I don't think his is a productive approach.


Yes, actually: analyzing how the economy works now. You can see it in the opening sentence of the paper's Abstract:

Drastic changes in central bank operations and monetary institutions in recent years have made previously standard approaches to explaining the determination of the price level obsolete. Recent expansions of central bank balance sheets and of the levels of rich-country sovereign debt, as well as the evolving political economy of the European Monetary Union, have made it clear that fiscal policy and monetary policy are intertwined. Our thinking and teaching about inflation, monetary policy and fiscal policy should be based on models that recognize fiscal-monetary policy interactions.

Well, maybe, it'll be useful if it leads to an improved analysis of how we got into this situation, so that we can understand what's wrong with where we are today.


Skipping to the conclusion. Sims writes:

The kinds of models that have been the staple of undergraduate macroeconomics teaching, with price level determined by balance between “money supply” and “money demand”, and money supply described using the “money multiplier”, are obsolete and provide little insight into the policy issues facing fiscal and monetary authorities in the last few years. There are relatively simple models available, though, that could be taught in undergraduate and graduate courses and that would allow discussion of current policy issues using clearer analytic foundations.

Existing models are "obsolete", he says. They "provide little insight into the policy issues facing fiscal and monetary authorities". Sims prefers different models, ones that better describe how the economy seems to operate in the years since the crisis.

I cannot emphasize enough how wrong this is. If we base policy on current conditions, we are accepting current conditions as normal. But these are abnormal conditions. The fact that policy has so far failed to rectify the situation, and that the abnormal has continued on now for several years, does not make the abnormal normal.

It's up to you, I guess. If you want to accept higher unemployment and lower GDP growth as normal, then you will choose to look at things the way Christopher Sims looks at things. But if you want to fix those problems, then you need to look at the economy when it was good and see what changes there have been since that time, and try to work out an explanation along those lines.

// Coincidentally related: Jim Tankersley: "Is slow growth America’s new normal?"