Rip van Winkle and the Rebuttal of the Theoretical Convictions of the 1970s and 1980s on the Ineffectiveness of Economic Policy
Only a few economists and observers warned in those decades about - or have pointed out later - the fragility or the limits of the critique of the ineffectiveness of discretionary economic policy and the idea of a superiority of markets and strict policy rules.[33] In the early 2000s Alan Blinder (2004: 26) claimed that ‘a sharp revision of the naively optimistic views (about the capacity of economic policy to control the economy) held by some economists circa 1966 was called for.
But... the pendulum may have swung just a bit too far', producing similar naively optimistic views about the virtues of markets and central bank independence and conservativeness.Blinder's words are even more acute nowadays, as economic theory has further questioned the system of beliefs that had emerged in the twenty years or so after 1966, even if it still retains some assumptions that led to the propositions featuring that credo. Three decades later, Rip van Winkle's faith in this still-dominant credo would be crowded out by the analytical developments that have intervened in recent years.[34]
Think of
1. The limited practical relevance of the surprise effect;
2. The irrelevance of many critiques of the ‘classical' theory of economic policy (in particular, to Tinbergen's ‘golden rule' about controlling the economy) based on rational expectations (REs);
3. The theoretical and practical limits to time inconsistency and thus to related prescriptions of monetary policy rules that should replace discretionary action;
4. The existence of a non-vertical long-run Phillips curve;
5. The need for more active fiscal policy and regulation (especially of financial markets and institutions) once some unrealistic assumptions of current models are ruled out;
6. A critique of the arguments in favour of political independence of central banks;
7. The suboptimality of a conservative central bank in a monetary union with active trade unions; and
8. A critique of the Friedman rule and the need for an inflation target well above zero in the presence of public transfers.
The irrelevance of critiques to the classical theory of economic policy and the limits to time inconsistency will be dealt with in Chapter 4. Specific details on the other critiques are given in subsequent sections of this chapter.
3.3