Prescott's Macro Myths

I like Ed Prescott a lot more now that he's won a Nobel Prize.

Maybe it's just me, but for years I'd slog through his highly technical papers wondering whether he really understood any economics. I now see that he wasn't as short on that skill as I was on those needed to understand his work.

Anyway, here's the 5 myths that he thinks goof up our understanding of macroeconomics.

• Myth No. 1: Monetary policy causes booms and busts.
• Myth No. 2: GDP growth was extraordinary in the 1990s.
• Myth No. 3: Americans don't save.
• Myth No. 4: The U.S. government debt is big.
• Myth No. 5: Government debt is a burden on our grandchildren.

I'll give him half of the first one. I think monetary policy can cause busts, but probably not booms. This viewpoints is called you-can't-push-on-a-rope (or string). He's probably right about the other half; check back with me in a few years and I'll tell you if I've changed my mind on that too.

I don't have much opinion on whether growth was extraordinary in the 90s. What I do know is that if we are going to create a myth by labeling it as extraordinary, then we need to call this decade extraordinary too. For evidence, see the neat chart at Gongol.com showing what happens when we grade real GDP growth on my letter grade scale.

I'm not sure how Myth 3 has any legs at all. If we don't save, then we can't have much wealth (wrong on the face of it), and we can't get much income from anything other than our jobs (wrong on the face of it). Oh and, by the way, last time I checked people save because they think the future will suck. Isn't it a good thing if they're not thinking it will suck? You save when Darth Vader is your future, not Jean-Luc Picard. The Chinese save a lot because Darth Vader has been their present and future for a long time.

Myth 4 comes from the compared-to-what fallacy. Yes, U.S. national debt is really, monsterously big. But it is minute compared to the national assets of the U.S. Can anyone tell me why we shouldn't be happy if the government owes 10% on the wonderful thing called America? After all, I'm pretty thrilled with the huge home on which I owe about 70%.

Then there's Myth # 5. It takes a village to raise a child, and our village is just piling debt on their tiny little backs. I'm not sure what I should care about that: the richest person I may ever know well is probably going to be the adult child whose 40th birthday party I want to attend. The story of almost every single one of us in the U.S. runs something like mine: my father was born in the kitchen of the small house his parents rented; now 80, he travels 3,000 miles to the McMansion owned by his son, and sits in a kitchen that is so sunny he has to wear shades inside. What I wouldn't give to be able to send a check back to him in 1970 to help him through that rough patch ... but that's exactly what our government is doing when it borrows money from its own future taxpayers.

Prescott finishes with some simple lessons:

There are at least three lessons here. First: Context matters. Take what you read in the paper with a many grains of historical salt. Second: Current data often provide poor guidance for effective policy making. To make forward-looking policies you have to understand the past. Finally: Establish good rules, change them infrequently and judiciously, and turn the people loose upon the economy. Booms will follow.

Read the whole thing. It's in the December 11 issue of The Wall Street Journal, and it's called "Five Macroeconomics Myths".