JAMES TOBIN (1918–2002)
Yale University, Office of Public Information
James Tobin 149
University Press, 1974); Essays in Economics: Consumption and Econometrics
(North-Holland, 1975); Asset Accumulation and Economic Activity (Basil
Blackwell, 1980); Policies for Prosperity: Essays in a Keynesian Mode (Harvester
Wheatsheaf, 1987) edited by Peter Jackson; and Full Employment and
Growth: Further Keynesian Essays on Policy (Edward Elgar, 1996).
Among the numerous articles he wrote, the best-known include: ‘The Interest-
Elasticity of Transactions Demand for Cash’, Review of Economics and
Statistics (1956); ‘Liquidity Preference as Behaviour Towards Risk’, Review of
Economic Studies (1958); ‘Money and Economic Growth’, Econometrica (1965);
‘A General Equilibrium Approach to Monetary Theory’, Journal of Money,
Credit, and Banking (1969); ‘Money and Income: Post Hoc, Ergo Propter
Hoc’, Quarterly Journal of Economics (1970); ‘Inflation and Unemployment’,
American Economic Review (1972); ‘How Dead is Keynes?’, Economic Inquiry
(1977); ‘Are New Classical Models Plausible Enough to Guide Policy?’,
Journal of Money, Credit, and Banking (1980); and ‘The Monetarist Counter-
Revolution: An Appraisal’, Economic Journal (1981).
We interviewed Professor Tobin in his office on 17 February 1993 and subsequently
corresponded in January/February 1998.
Keynes and Keynesian Economics
You began your study of economics at Harvard the very year that the General
Theory was published. What attracted you to economics?
It was an unbelievably happy combination of a subject that promised to save
the world and was fascinating from an intellectual puzzle-solving point of
view. I was also very much worried about the Great Depression and had every
reason to think that the massive failure of our economies was the key to many
other of the world’s ills, political as well as economic.
The General Theory is a very difficult book and reflects Keynes’s ‘long
struggle to escape’ previous ideas. What were your first impressions of the
General Theory?
I didn’t know enough to know it was a difficult book, which I had no business
reading. I was 19 years old. My tutor at Harvard, who had been in England
for a year, just said at our first one-on-one tutorial meeting ‘Why don’t you
and I read this new book I’ve heard about for our tutorial this year?’ I didn’t
know any better so I read it, and I didn’t feel it was that difficult. One of the
exciting things, of course, for a 19-year-old was the sense of intellectual
revolution, overturning the obsolete wisdom encrusted in the past, especially
when the new theory was on the side of promising to do something constructive
about the main problems that concerned me and people of my generation.
150 Modern macroeconomics
Skidelsky [1992] in his biography of Keynes [Volume 2] has argued that
‘Keynes’s inspiration was radical but his purpose conservative’. How did
Keynes reconcile these two opposing forces?
I think that what Skidelsky says is essentially right. Compare Keynes’s remedies
for the problems of the world at the time to those of Marxians and
Spengler’s Decline of the West – all those apocalyptic warnings of the death
of capitalism, because capitalism can’t ever succeed. Keynes comes along
and says that the basic problem is not really the organization of the economy
but rather the way that aggregate demand is controlled. Keynes had no great
complaint about the way the economy allocates the resources that it does
employ, just that it doesn’t employ them all.
It only took about twelve years for the General Theory to capture the hearts
and minds of the vast majority of the economics profession. Why did Keynes’s
ideas spread so quickly?
Well, because it did look as if they would work to remedy the problems of the
Great Depression. There was a lot of anxiety in all countries that after the
Second World War we would revert to the depression conditions of the prewar
period. Keynes’s ideas looked like a pretty good way to avoid that
possibility. In the USA, consider the spending for mobilization even before
we got in the war, and what it did to GNP and employment. That was a
dramatic living vindication of Keynes’s ideas.
You are widely recognized as being America’s most distinguished Keynesian
economist. Are you happy with the label Keynesian and what does being a
Keynesian mean to you?
If you’d asked me that, let’s say 25 years ago, I would have said that I don’t
like any label and that I’m just an economist working on problems that I
happen to be interested in; macroeconomic problems, monetary–fiscal policy
and all those things. There appeared to be a considerable practical consensus
about these matters. A lot of my work had been fixing up Keynes in various
ways where I found theoretical problems or a lack of ‘micro foundations’. In
fact the first thing I wrote and got published [in 1941] was a piece of anti-
Keynesian theory on his problem of the relation of money wage and
employment. So at that time I would have said let’s not label people, let’s just
do our work. After the counter-revolutions, when all these schools and labels
arose, I certainly would be proud to be regarded as a Keynesian, considering
the alternatives [laughter].
What are the fundamental propositions which Keynesians adhere to?
One way to put it is to say that there is a two-regime model of the economy.
Sometimes the economy is in a classical situation where markets are clearing
James Tobin 151
(demand equals supply) and the economy’s ability to produce output is supply-
constrained. You can’t produce any more because there are essentially no
idle resources (I exaggerate to simplify). Therefore the constraint on output is
capacity. That capacity constraint results in a price and income structure that
equalizes demand and supply at those prices. At other times the economy is
in a Keynesian situation in which the constraint on actual output is demand –
aggregate spending. Extra output would be produced if there were extra
aggregate real demand, and the inputs to make it are available at real returns
which won’t exceed what the factors of production could earn by their productivity
if they were employed. That situation obtains lots of the time, not
always, and there are then demand-increasing policies that will eliminate the
social waste involved. That I think is the distinction. Whereas for the real
business cycle theorists (like Ed Prescott) and new classical guys (like Robert
Barro) you are always supply-constrained. There is just one regime, and the
observed cyclical fluctuations are fluctuations in voluntary willingness to be
employed.
Some interpretations of the neoclassical synthesis which emerged in the late
1950s and early 1960s suggest that the General Theory represents a special
case of a more general classical model. What is your view on that particular
interpretation?
I wouldn’t interpret it that way. Rather there was a consensus on the tworegime
model just mentioned. I thought there was also a normative consensus,
in the sense that you shouldn’t regard any output that you get from putting
unemployed resources to work as free, because you have alternative ways of
putting unemployed resources to work. The same classical opportunity cost
considerations that determine allocation of resources in a classical equilibrium
determine the allocation of resources as among different ways of returning
to that supply-constrained regime. So I think in that sense there is no excuse
for wasteful projects to increase employment, like digging holes in the ground,
because you can arrange to employ people by investments or other projects
that are socially beneficial. In that sense the classical opportunity cost considerations
apply in either regime. But that’s only if you’re prepared to do
something to get out of the wasteful situation that you’re in.
Has too much been made of the Pigou effect as a way of diminishing Keynes’s
contribution to economic theory?
Of course. I’ve said that all the time in print. It’s a very slender reed on which
to assert the efficacy of self-adjusting mechanisms. For one thing the accounting
aggregation of credits and debts doesn’t necessarily imply behavioural
netting out of credits and debts. I believe that the effects of deflation on
aggregate demand can be perverse if debtors have a bigger propensity to
152 Modern macroeconomics
spend from wealth than creditors do – a reasonable expectation. Then there’s
the whole issue of how you get to the lower price level from where you are.
The immaculate conception effect of getting there suggests there’s no real
time involved – it’s just the static comparison of one price level to another
price level. As Keynes himself observed, although he didn’t make of it a point
of theoretical principle, the process of deflation – or disinflation for that
matter – involves an increase in the real interest rate and certainly produces
perverse effects.
Do you think that if Keynes had still been alive in 1969 (aged 86) he would
have been awarded the first Nobel Prize in economics?
Very likely. He would have got my vote. As for Keynes versus Tinbergen and
Frisch, the actual recipients, I don’t know. The prize says for economic
science. In some senses they might have been considered to have made
identifiable innovations more similar to those of Nobel-winning natural scientists.
But JMK would have been an early award-winner.
How do you feel about your award of the Nobel Prize in 1981? What do you
consider to be your most important contributions to macroeconomics?
I never thought I was going to get it. I was interested in straightening out
macroeconomics and the neoclassical synthesis as I understood them, in
generalizing monetary models to take account of the variety of assets, in
portfolio theory and its macroeconomic implications – that’s what I was
trying to do.
Why do you think there are so many conflicting interpretations of the General
Theory?
Well, I suppose one reason is that the book is ambiguous in many ways and
has a number of strands that could be cited to support different messages.
They allow people a variety of views about the world, in particular, on the
one hand, since people interpret the General Theory as a kind of general
equilibrium model of the determination of output, employment and interest
rates that could be used in both of the two regimes I referred to above. That’s
what J.R. Hicks was doing in his famous article. On the other hand you have
Chapter 12 on long-run expectations, which suggests that maybe there is not
an investment function at all. In the Hicks general equilibrium model you
have got to have an investment function. The second approach, stressing the
conventionality of expectations and animal spirits, may be seen as opening
the way to a different kind of model. This would be supported by Keynes’s
own tentative advocacy of the socialization of investment, his suspicion that
maybe investment wouldn’t be adequately stabilized by monetary and fiscal
policy, his feeling that you need some central planning to get it right. I guess
James Tobin 153
those ambiguities allow us to interpret it one way or the other. Of course,
some people hoped to extract from Keynes a much more radical position with
regard to the social and political institutions than he had explicitly expressed.
I have in mind Mrs Robinson and others who claim to be the true heirs of
Keynes. I never could get that excited about this kind of battle over Keynes’s
mantle, so to speak. The central part of the book, the central core of the
modelling, is on the other side, Hicks’s side, in my opinion. Certainly that’s
in practice the model that has been taught and has influenced policy making
and macroeconomic theorizing for more than 50 years.
Do you think teaching the IS–LM model is still an important part of an
undergraduate’s understanding of the macro economy given the criticisms of
the IS–LM model by people like Robinson, Clower and Leijonhufvud?
Yes I think the IS–LM model is the tool of first resort. If you’re faced with a
problem of interpretation of the economy – policy or events – probably the
most useful first thing you can do is to try to see how to look at it in these
terms. Since students are in that position, yes they need to know it. It’s not
the end of the matter by any means. I don’t say that it’s enough. I doubt if
Keynes or Hicks would have thought it enough. But it’s a start and lots of
times it’s exactly right.
Critiques of Keynesianism
Would you accept that many of the theoretical changes made in the 1970s,
and inspired by people like Lucas, were the inevitable consequence of defects
in the Keynesian model?
No I wouldn’t accept that. I do think the idea of model-consistent expectations
is a good idea. It would be a bad feature of any equilibrium model that
people chronically perpetuate mistaken expectations about variables, mistaken
in the sense that they are different from those that the model persistently
creates itself. But I think that applying that idea to dynamic situations where
learning is going on and people can have a lot of different opinions about the
world is carrying it too far.
How important do you think it is for macroeconomics to have neoclassical
choice-theoretic foundations?
Well, I think it’s important for the behavioural equations of a macroeconomic
model not to contradict choice-theoretic considerations, to be in principle
consistent with them. But I think the stronger version of ‘micro foundations’
is a methodological mistake, one that has produced a tremendous amount of
mischief. I refer to the now orthodox requirement of postulating representative
agents whose optimizations generate ‘macroeconomic’ behavioural
154 Modern macroeconomics
equations. That is a considerable sacrifice of the essence of much of macroeconomics.
Suppose you have a lot of different types of agents, who are all
maximizing. Then it’s their aggregation into a behavioural equation that you
want for a macro model. That aggregation won’t necessarily be the solution
for any single agent. To insist that it must be seems to me very wrong-headed.
It has put us on the wrong track in macroeconomics or what passes for
macroeconomics.
In the late 1960s you had a considerable debate with Friedman who at one
stage argued that the main differences between macroeconomists were over
empirical matters. Surely the 1970s demonstrated that there were some fundamental
theoretical differences between macroeconomists?
What Friedman was saying was disingenuous. He had a theory of the demand
for money which put a lot of variables in the demand function including
various interest rates, and yet his monetary policy propositions were based on
the assumption that interest rates were not in the function. He asserted empirical
results that he was unique in finding – that the interest elasticity of the
demand for money was negligible. When he was really stuck by the weight of
evidence, he then wrote that the question of the size of interest elasticity of
the demand for money had nothing to do with anything. The only way one
could make sense of that particular proposition was that you were going to be
at full employment anyway, no matter what the stock of money was, and so
the interest rate would have to be what was consistent with the demand and
supply of savings at full employment. But that was a complete evasion of the
original issues of our debate. He had never before said that monetary policy
would have no effects on real variables. He said they have a lot of effects on
real variables. He had some kind of Phillips curve (although he didn’t call it
that) in his mind, and even when he invented the natural rate he still did. He
didn’t deny that monetary policy would have some effects on real output
during cyclical fluctuations – so he was caught between being a true new
classical economist, in which case he was going to have to say that money
doesn’t ever matter, or being a pragmatic monetarist, where he didn’t have a
good theoretical or empirical basis for what he had been saying.
What exactly is the difference between Friedman’s concept of the natural rate
of unemployment and NAIRU – the non-accelerating inflation rate of unemployment?
Is there some important difference between these two concepts?
I don’t think there is a big practical difference. Maybe what was in the mind
of Modigliani when he started that acronym was that Friedman said that the
natural rate was the amount of unemployment that was the solution to Walrasian
general equilibrium equations – a proposition that neither he nor anybody
else ever proved as far as I know – complete speculation. I mean, why would
James Tobin 155
Walrasian equations have any unemployment at all in their solution? [laughter].
That identification of the natural rate doesn’t make any sense, and it’s
certainly not true. When Modigliani and others started talking about NAIRU,
they were talking more about a pragmatic empirical idea.
At the end of the day politicians make economic policy. The public choice
school, as well as the work of your colleague William Nordhaus on political
business cycles, suggests that politicians may actually use economic policy
for their own gain. Do you think that Keynes was perhaps naive in thinking
that we could hand over policy making to politicians and they would follow
the advice of economists?
I won’t quote the last paragraph of the General Theory, which says that in the
long run ideas matter. I think that’s true, but I think my point would be a little
different. If we are advising government officials, politicians, voters, it’s not
for us economists to play games with them. It’s not for Keynes to say, I am
not going to suppress the General Theory and not tell the House of Commons,
the Labour Party, the Tories, whomever, that it would be possible to
reduce unemployment by public works expenditure. If I am giving advice to
them about war finance – or whatever else my advice will be not to do bad
things – I am not going to decide myself that they are so evil and irresponsible
that I don’t give them advice about what actions will do what. I don’t
think that Jim Buchanan has, or I have, the right to withhold advice from
Presidents of the United States or Members of Congress or the electorate on
the grounds that if they knew what we know, they would misuse it. I don’t
think that is for us to decide.
You have said that good papers in economics contain surprises and stimulate
further work. On this criterion the 1970s contributions of people like Lucas,
Sargent, Wallace and Barro were good. Do you feel that new classical macroeconomics
has changed macroeconomics for the better?
In some respects I think Lucas’s ideas about policies being anticipated by
actors, so you can’t be sure that behaviour will stay put when you change
policy, is an important idea, one we have to worry about. I don’t think it is as
important an idea as he seemed to think it was. I thought his ingenious
explanation of how you can have observations that look like Phillips curves
yet have none of the operational policy implications of the curve – that was
neat. However, I think it turned out not to be a good idea. It didn’t survive
because of the implausible notion that people are confused about what the
money supply is. If they’re confused, why don’t we publish the money supply
data every Friday afternoon – which in the USA we do of course and have
been doing for a long time. I observe that the new classicals no longer pay
any attention to this misperception story. They have become much more
156 Modern macroeconomics
extreme. Barro’s [1974] paper was provocative and stimulated a lot of theoretical
and empirical work. I had a paper in my Jahnsson lectures [Tobin,
1980a] that gave, I don’t know, say 15 reasons why Barro’s neutrality proposition
doesn’t work, and I think there have been numerous articles since on
each of them.
We have seen a lot of contributions recently from what are called new
Keynesian economists. What is the central difference between your view of
Keynesian economics and the new Keynesian contributions? Is it that they
accept rational expectations and a lot of monetarist ideas?
Yes, they accept rational expectations. Moreover they accept the methodology
of choice-theoretic foundations and representative agents, much more
than I would. They accept market clearing, except as it is modified by imperfect
competition, much more than I would. They regard their task as to give a
rationale for the alleged rigidity of money wages and money prices, a rationale
that allows nominal shocks to create real consequences. I think that was
not Keynes’s idea. Keynes was primarily concerned not with nominal demand
shocks but real demand shocks, which would create problems even if
prices were flexible. They have said that all they are going to do is show how
it is rational for nominal prices to be inflexible and derive unemployment
results from that. I don’t find it extremely convincing – and I’m sure Keynes
wouldn’t have – that the whole effective demand problem is that there are
real costs of changing nominal prices on the menu at the restaurant. I think
Keynes would have laughed at the idea that menu costs are a big enough
resource-using problem to cause the Great Depression or any other substantial
losses of economic activity. It’s not credible. If I had a copyright on who
could use the term Keynesian I wouldn’t allow them to use it [laughter].
What do you think of the real business cycle approach?
That’s really the enemy at the other extreme of macroeconomics. Real business
cycle theory suggests that society is a moving equilibrium responding
continuously to technological–productivity–supply shocks all the time, and
that the economy is doing the best job possible in responding to them. It’s
those benign responses that generate the fluctuations we call business cycles.
There isn’t any unemployment in the Keynesian sense. There are simply
intertemporal substitutions of employment now and employment later, which
are rational responses to the stochastic environment in which people live. I
don’t see any credibility to the idea that people are doing a lot of intertemporal
substitution as to how much they want to work. To interpret the rise in
unemployment in this country from 5.7 per cent in 1978 to 11 per cent in
1982 as a desire on the part of workers to take leisure in preparation for
working when real wages will be higher – that is ridiculous (laughter).
James Tobin 157
Should we take Lucas’s [1978a] advice and abandon the concept of involuntary
unemployment?
Certainly not. Any time that you don’t have supply and demand equal at
existing prices then there is involuntary something. Some people would like
to supply more, or some people might like to demand more, at those prices
but are not able to do so. The only way you can say that everything must be
voluntary is to assume market clearing all the time – that at every moment in
time the economy is in market-clearing equilibrium.
In new classical models full employment is equated with actual unemployment.
How should we define full employment?
I would define it, as Keynes did, in a classical way at the point where people
are on the supply curve for labour, getting all the work they are willing to
accept at real wages that employers can and will pay for them. Keynes
himself allows for intersectoral flux and frictional unemployment, but essentially
I wouldn’t define equilibrium full employment any differently from a
classical model.
There seems to be more consensus amongst economists on microeconomic
issues than macroeconomic issues. Why do you think this is the case?
Let’s go back to what Keynes said. He didn’t have any big reservations about
the way the market economy allocates the resources it does employ. I think
myself, and many microeconomists and economists in general would say,
that Keynes gave away too much. He should have recognized more externalities
in the ordinary market allocation of resources, and he should have worried
more about the possible social wastes of monopolistic competition than he
did. In many areas of microeconomics like rent control and minimum wages,
choice-theoretic opportunity-cost methodology is being used the way we are
trained to use it. That’s the secret that we know, and sociologists and other
social scientists don’t know. We are a more scientific discipline, but I don’t
think that all is well in those respects. What rational expectations has done to
macroeconomics is what game theory has been doing to microeconomics.
Game theory has the problem that it leads to multiple solutions all the time,
so it doesn’t seem to get results. It’s got the same fascination for people
looking for ways to use their mathematical and puzzle-solving prowess as
rational expectations has, and that comes at the expense of more pragmatic,
and empirical, and institutional industrial organization studies. So, I am not
so sure that all is well in microeconomics either. A lot of good policy work
continues in more applied areas.
Do you see any signs of an emerging consensus in macroeconomics?
It may be coming, but I don’t see it. There is still great conflict.
158 Modern macroeconomics
Economic Policy
When in office Mrs Thatcher repeatedly stated that in her view inflation was
the most important target for macroeconomic policy. How do you react to this
view?
Well, that’s substituting a subordinate target for a real target. To the extent
that inflation is damaging to real standards of living now or in the future, then
inflation is something to worry about. But you could easily make greater
sacrifices of real output and real consumption in the name of inflation than
the benefits of reducing inflation are worth.
Structural budget deficits have been a feature of the US economy in the 1980s
and indeed at the moment there is a lot of talk of the problem of growing
budget deficits. Are budget deficits damaging? Do you think that the structural
budget deficit of the US economy is a real problem, and what should be
done about it?
Well, again you have to keep your eye on the ball and not confuse ends and
means. When you think about the objectives to which fiscal policy may be
relevant, it is the growth of our capacity to provide higher standards of living
to people in the future. For the USA we are talking about a deficit that is in
dollars, a debt that is in the currency that we print. It’s not a debt in sterling,
in yen, or anything else. It’s largely an internally held debt and when you
think about international wealth balance sheets it’s not important whether
foreigners hold our federal public debt, or hold other assets. There is a
burden, however, in that the public debt diverts some private wealth that
could be placed in privately owned productive capital to holding government
paper that was generated to finance private or collective consumption. In that
sense deficits which increase the debt have been using savings that could
have been used for productive investments in capital that would have raised
real wages that our grandchildren would earn. But that doesn’t mean we need
a deficit reduction this year, when the economy is in a slump. Today GDP is
not supply-constrained; the amount of investment in the economy is not
constrained by the supply of saving. In fact deficit reduction in a weak
economy would be counterproductive, reduce GDP, reduce investment. We
would be doing not as well for our children and their children as we would if
we did some spending on public investment or cut taxes in ways that stimulate
private investment. All this is terribly mixed up in the political discussion
about deficits. I have been one of the principal opponents of the kind of fiscal
policy that the Reagan and Bush Administrations ran for 12 years. And at the
same time, to rush into a blind policy of deficit reduction that begins too
soon, before we are out of the slump – I wouldn’t do that either. It all gets
back to trying to suit the medicine to the circumstances of the patient.
James Tobin 159
Are you still an advocate of incomes policies? Some Keynesians like Alan
Blinder have little enthusiasm for such policies, whereas you seem to think
that incomes policy has a role to play in addition to demand management.
Well I thought incomes policy did have a role in the 1970s, and especially in
the disinflation that was going to take place beginning in 1979. I think we
could have done that disinflation with less loss in output and employment if
we’d used some kind of incomes policy then. Right now, I’m not very excited
about incomes policy. One thing that has come out well in the 1980s, partly a
matter of good fortune, is that we haven’t had any more oil shocks. Wage
pressures are also very moderate. In 1979/80 there were very few economists
who would have said it was possible to get unemployment down to almost 5
per cent in 1988 and have virtually no inflationary consequences. I wouldn’t
have said that ten years earlier – yet it happened. We don’t have an inflation
problem right now. If it comes back, then incomes policy may be a possible
thing to do, but I wouldn’t muddy the waters and get excited about it right
now.
Why has Keynesian economics experienced something of a restoration in the
last decade?
Well, it’s because you have had Keynesian problems for the last five years.
Keynesian economics got a bum rap in the 1970s. I see it all the time. People
say ‘Why do you want to go back to the failed policies of the 1970s and the
late 1960s?’ Keynesian policies were thought to be responsible for inflation
and stagflation – people never mention, or erase from the memory, the oil
shocks and the Vietnam War. Now we are back to a more normal environment
and the new classical ideas are not so appealing to a new generation of
economists, who have grown up subsequent to the high tides of the counterrevolutions.
If you were advising Clinton about the economic strategy to be pursued over
the next four years, what are the important things you think he should do?
Well, that’s a tricky thing for reasons we already discussed. The problem he
has right now is to pep up the economy and the recovery. The economy is
doing a little better than it was six months ago, but it is still not doing great.
At the same time there is all this pressure to do something about the federal
deficit. He is trying to do both. Since one really requires more deficit while
the other requires less deficit, it’s rather difficult. I’m afraid the stimulus he is
going to give is not very big, and it’s not going to last long enough. There is
going to be a deficit-increasing phase of his programme this year and maybe
next year [1994] his budget is going to be deficit-neutral. Thereafter tax
increases and cuts in entitlements and other outlays are going to be phased in,
so eventually for the fiscal year 1997 he will be able to say that he will have
160 Modern macroeconomics
done what he said. He is asking for both these things at once. It’s sort of like
saying we’re going to have to perform some surgery on this patient but right
now the patient is a little weak, so we’ll have to build the patient up first.
There are two difficulties. One is that the dual approach is a rather subtle
point to explain – why we do one thing now when we are going to do the
opposite later. In fact, he hasn’t even explained it yet.
Maybe he doesn’t understand it.
Oh he does, this is a smart guy. This is as smart a politician as I have ever met
– he understands it.
Additional Questions Answered by Correspondence January/February
1998
In your 1995 paper ‘The Natural Rate as New Classical Economics’ you
suggested that Friedman’s [1968a] paper ‘The Role of Monetary Policy’ is
‘very likely the most influential paper ever published in an economics journal’.
In what important ways did that paper change macroeconomics and do
you regard the natural rate hypothesis as part of the ‘core’ of mainstream
macroeconomics?
Perhaps that was hyperbole, but the article was certainly very influential in
the profession and, in its implications for policy all over the world, far
beyond. If, as I argued in my 1995 paper, the article was a giant step towards
new classical macro and real business cycle theory, then the initial impact of
the Friedman paper was greatly multiplied. If those doctrines are now the
core of mainstream macroeconomics, then the natural rate idea is likewise.
While this may be true of academic macro theory, I think it is not true of
practical macro as used in government policy and business practice. There
the NAIRU is the preferred concept, and as I have argued in the 1995 paper
and elsewhere it is not the same as the natural rate. Both concepts have
suffered from the empirical surprises of the last few years, when previous
estimates of the NAIRU turned out to be wrong. Moreover, the idea that there
is a vertical Phillips curve in the long run has lost ground relative to my own
idea that a trade-off persists at low rates of inflation, a proposition recently
supported by Akerlof, Dickens and Perry [1996] in Brookings Papers.
The US economy currently [January 1998] has an unemployment rate of 4.7
per cent and an inflation rate of just over 2 per cent. Given that most
estimates of the natural rate of unemployment for the US economy are around
6 per cent, how would you account for this current situation?
Indicators of labour market tightness other than the unemployment rate suggest
that labour markets are considerably less tight than the unemployment
James Tobin 161
rate itself would suggest, given the experience since the mid-1970s. Vacancies
(proxied in the USA by help-wanted indexes) are more plentiful, quitting
jobs less frequent relative to losing jobs, and persons counted as out of labour
force more available for work. The Beveridge curve seems to have shifted
back to its location in the 1950s and 1960s. Other factors include the decline
in trade union membership and power vis-à-vis private business employers,
the increased acceptability of downsizing employment to improve the bottom
line and stock prices, even at the expense of long-time employees, import
competition, yes, but especially domestic competition, and of course the
absence of supply shocks, which has more to do with the stagflation of the
1970s than new classicals want to remember. It very well may be possible to
reduce unemployment to 4 per cent, the target of the Kennedy administration
in the 1960s, while keeping inflation below 3.5 per cent.
Although unemployment in the US and UK economies is relatively low at the
moment, the average rate of unemployment in the European Union economies
is relatively high. How can we explain the considerable unemployment
differentials that exist at the moment between the USA and countries such as
France and Germany? Do you think that EMU is likely to exacerbate the
unemployment problem in Europe?
I am incorrigible. I still believe that wilfully bad macro policy is responsible
for much of the excess unemployment in Europe. It can’t be that the natural
rate keeps rising along with the actual rate, from single to double digits. The
Europeans conclude that if they don’t see significant deflation at whatever
actual U-rate, then that rate must be equal to or less than the natural rate, so
that any expansionary monetary or fiscal policy will cause inflation to increase.
But it may be that the short-run Phillips curve is pretty flat, so that
this inference is not justified. Anyway they never try the experiment of
expansionary policy. I can believe that there are more structural obstacles to
reducing unemployment in continental Europe than in America and Britain. I
can believe that Thatcher’s bashing of labour unions helped, although I didn’t
see UK wages and prices tumbling when sterling was pegged to the DM. I
think some of the structural problems on the continent reflect hysteresis. The
governments and central banks never tried to recover from the 1979–82
recessions, unlike the USA, so the cyclical unemployment achieved by those
recessions became ‘structural’. Whatever the nature and cause, European
unemployment is a disgrace and should be within the power of European
governments to correct in some way, rather than complain about, as if it has
been imposed on them by the USA.
I don’t expect EMU to change the unemployment situation much either
way. If anything, it will get worse. EU members haven’t done much under the
EMS to improve their own macro outcomes. But to the extent they have done
162 Modern macroeconomics
anything individually, they won’t have any macro policy tools once they are
in EMU. Nor will the new central bank act differently from the Bundesbank,
and the Union has no fisc with which to conduct fiscal policy.
Do you feel that there has been any move towards greater consensus in
macroeconomics since we last talked to you in 1993?
Maybe there’s more consensus in macro theory, in the sense that Keynesian
theory is just ignored and graduate students don’t learn anything about it.
Maybe there’s more consensus in practical macroeconomics, because it can’t
help having large Keynesian elements and because mechanical monetarism is
dead.
Many prominent macroeconomists (for example Barro and Sala-i-Martin,
1995; Lucas, 1987) have argued that the part of macroeconomics that really
matters is growth. Do you agree with this view and have the endogenous
growth theories of the past decade improved our understanding of growth
processes?
Yes, without doubt increasing the productivity, health and life expectancy of
billions of people in poor and underdeveloped countries throughout the world
adds more utility than reducing the unemployment in Western Europe by
three or four points. I don’t think the macroeconomists studying growth have
answers on how to do that. Aggregate demand problems are a luxury available
to advanced industrial capitalist countries. The basic problem of poor
countries is poverty of supply. It’s possible that aggregate demand shortage –
the social disorganization of unnecessary poverty in the midst of potential
plenty in the Great Depression – is no longer a high-priority problem because
macroeconomics solved it, not because it never was a problem and the macro
theory and policy it evoked was wrong. The fact that there are few auto
accidents at intersections doesn’t suggest that traffic lights are unnecessary.
Barro and Lucas, it seems to me, trashed demand-oriented macroeconomics
and then left the field, saying it’s not interesting anyway. The endogenous
growth theories, which interestingly enough rely on externalities of one kind
or another to ove
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