One troublesome aspect is the place of rational expectations macroeconomics in the often political debate over Keynesian economics. At least implicitly, many people feel that what's bad for the rational expectations viewpoint is good for the Keynesian one, and vice versa. But it is hard to see how the problems in using the rational expectations approach to explain monetary nonneutrality can alleviate the theoretical and empirical shortcomings of the Keynesian model.
If we look beyond the issue of monetary nonneutrality, then we do find areas of macroeconomics that use rational expectations and in which important recent progress has been made.
My views are more akin to the nineteenth-century liberal philosophy espoused by Milton Friedman, especially in his Capitalism and Freedom. In that work, he proposed many policies that are harmonious with free markets and are receiving serious attention in the United States and other countries. This list includes school choice, the flat-rate income tax, rules for monetary stability, privatized social security, and the elimination of affirmative-action programs.
I learned later that economic reasoning was not just mathematics and could be applied to a wide variety of social problems. Now, I think that no forms of social interaction—including religion, love, crime, and fertility choice—are immune from the power of economic reasoning. Hence, even widely held beliefs—for example, that beauty is an illegitimate credential of a worker or that democracy is important for economic growth—are not sacred truths and are subject to analysis.
My recent work on macroeconomics has stressed long-term issues, including the determinants of long-run economic growth. From the standpoint of fighting world poverty, nothing is more important than figuring out which policies differentiate the fast-growing countries from the slow-growing ones.
For me, a key lesson is that Friedman’s influence was achieved mainly through the force of ideas, not by direct participation in the policy process.
Adam Smith is, of course, justly lauded for his advocacy of free markets and limited government. Particularly famous is his idea that each person’s pursuit of self-interest leads, as if by an invisible hand, to socially efficient outcomes.
In contrast to Smith’s incomplete modeling, his follower, David Ricardo, provides a coherent setting— basically, the first macroeconomic model—that can be tested, modified, and applied. Although Ricardo is surely narrower and less imaginative and insightful than Smith, he is also a lot better organized. That is why Ricardo’s analysis of macroeconomics—for example, of the implications of public debt—is more coherent and useful than Smith’s.
One hypothesis about the delay for the award is that the prize committee realizes that recipients tend to shirk once they get the prize. This consideration was particularly important in Gary’s case because he had continued to exhibit high productivity. Thus, the drop in output caused by an early prize for Gary might have had severe adverse consequences for economic research.
Mundell’s models allowed a significant role for fiscal policy, especially under fixed exchange rates. However, the treatment was entirely Keynesian—an increased budget deficit operated solely by raising the aggregate demand for goods. Moreover, increases in government spending and cuts in taxes had pretty much the same effect on the economy.
The role of expectations is not limited to monetary policy but is crucial in many areas of economics, as Bob showed in his later research on investment, unemployment, taxation, public debt management, and asset pricing. In all of these situations, the appropriate evaluation of policy takes account of the way that expectations would be rationally formed.
Things would have worked out a lot better if we had bought our first television set a year earlier, in 1950, so that I could have watched DiMaggio while he was still great. Then I could have shared with my father and other people the vision of the eternal baseball star. It might even have helped me to have more appreciation for some of my elders in the economics profession. But maybe I should be worrying instead about what the young hot shots in economics are thinking of me.