The Managed Economy (1945-1970): Modeling and Controlling the Economy

1. History of Modern MacroeconomicsLecture 5. The Managed Economy (1945-1970):Modeling and Controlling the EconomyKevin D. HooverDepartment of EconomicsDepartment of PhilosophyCenter for the History of Political EconomyDuke University Econ 314S History of Modern Macroeconomics Fall 2017

2. The Problems of Forecasting • Predictions: • Immediate postwar (c. 1944): • Most economists: deep recession like post-World War I ✗ • Lawrence Klein: no deep recession ✔ • Longer term: • Lawrence Klein (1947):“The postwar boom in which we are now living is not likely to last long. In the decade of the 1950’s (or even sooner), we may be confronted again with the problem of unemployment, unless we take adequate steps to prevent another catastrophic depression.”The Keynesian Revolution, p. 169 ? Econ 314S History of Modern Macroeconomics Fall 2017

3. The Beginning of the Long Boom Econ 314S History of Modern Macroeconomics Fall 2017

4. The Long Boom – 1 Best 20-year period of GDP growth – 1950-1970: total 126% or 4.2%/year; Longest expansion in history up to that time: 1961-1970 Other recessions mild by historical standards Econ 314S History of Modern Macroeconomics Fall 2017

5. The Long Boom – 2 Econ 314S History of Modern Macroeconomics Fall 2017

6. The New Economics and American Keynesianism • The New Economics • American institutionalist (e.g., Hansen, Samuelson) • progressive technocrats • incorporating formalizable elements of Keynes’s General Theory • Scientific Economics • John Neville Keynes’s Scope and Method of Political Economy • positive/normative/art • John Maynard Keynes’s: scientific assessment through policy = art • Samuelson, Lerner, Klein: same science for all ideologies • Klein: Marxist analysis – ideology distorts policy art Econ 314S History of Modern Macroeconomics Fall 2017

7. Prewar Economic Metaphors The economy as machine The economist as engineer The policymaker as machine operator The economy as organic body The economist as medical researcher The policymaker as physician Econ 314S History of Modern Macroeconomics Fall 2017

8. The War Economy: Victory of the Economic Engineers Econ 314S History of Modern Macroeconomics Fall 2017

9. Hydraulic Keynesianism – 1 C =a + bY Y = C + I + G Source: Samuelson, Economics (1948) Econ 314S History of Modern Macroeconomics Fall 2017

10. Hydraulic Keynesianism – 2 C = C(Y) I = I(r) MD = M(Y, r) Y = C + I + G MS = MD The Phillips Machine (or Moniac) Econ 314S History of Modern Macroeconomics Fall 2017

11. Phillips Machine: Schematic Econ 314S History of Modern Macroeconomics Fall 2017

12. Phillips Machine: Details Econ 314S History of Modern Macroeconomics Fall 2017

13. Phillips Machine in Punch Econ 314S History of Modern Macroeconomics Fall 2017

14. Theory or Practice? Econ 314S History of Modern Macroeconomics Fall 2017

15. The New Empirical Macroeconomics • Walrasian: • general equilibrium • individual optimization (microfoundations) • IS-LM Keynesian • Aggregation • practice demands • must be eliminable in theory • work towards maximum disaggregation • Cowles-Commission Econometrics Lawrence Klein (1920- 2013 ) Econ 314S History of Modern Macroeconomics Fall 2017

16. Cowles Commission • Founded 1932 in Colorado Springs • At University of Chicago 1939-1955 • Focus • initially stock forecasting • econometrics • Haavelmo’sThe Probability Approach in Econometrics (1944) • Klein’s Economic Fluctuations in the United States, 1921–41 (1950) • general-equilibrium theory • Kenneth Arrow • operations research Alfred Cowles III (1891-1984) Trygve Haavelmo (1911-1999, Nobel Prize 1989) Econ 314S History of Modern Macroeconomics Fall 2017

17. IS-LM-AS Sets the Agenda for Macroeconmetric Models Econ 314S History of Modern Macroeconomics Fall 2017

18. Klein’s Modeling Agenda In contrast with the parsimonious view of natural simplicity, I believe that economic life is enormously complicated and that the successful model will try to build in as much of the complicated interrelationships as possible. That is why I want to work with large econometric models and a great deal of computer power. Instead of the rule of parsimony, I prefer the following rule: the largest possible system that can be managed and that can explain the main economic magnitudes as well as the parsimonious system is the better system to develop and use. [Klein 1992] Econ 314S History of Modern Macroeconomics Fall 2017

19. An Opposing Current the focus should be on the analysis of parts of the economy in the hope that we can find bits of order here and there and gradually combine these bits into a systematic picture of the whole [1951] A hypothesis is important if it ‘explains” much by little, that is, if it abstracts the common and crucial elements from the mass of complex and detailed circumstances surrounding the phenomena to be explained and permits valid predictions on the basis of them alone. [Friedman 1953, p. 14] We curtsy to Marshall, but we walk with Walras [1949] Milton Friedman (1912-2006) Econ 314S History of Modern Macroeconomics Fall 2017

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22. Genealogy of Klein’s Macroeconometric Models Econ 314S History of Modern Macroeconomics Fall 2017

23. Complexity of Klein’s Models Econ 314S History of Modern Macroeconomics Fall 2017

24. Brookings Model (1965) Econ 314S History of Modern Macroeconomics Fall 2017

25. Phillips Machine: Schematic Econ 314S History of Modern Macroeconomics Fall 2017

26. Singapore Econ 314S History of Modern Macroeconomics Fall 2017

27. Japanese World Economic Model The EPA World Economic Model An Overview, February 1986, World Economic Model Group Econ 314S History of Modern Macroeconomics Fall 2017

28. The IS-LM Core of a Large-scale Macroeconometric Model Source: Green et al. “The IS-LM Cores of Three Econometric Models,” in Lawrence Klein (editor) Comparative Performance of U.S. Econometric Models, p. 104. Econ 314S History of Modern Macroeconomics Fall 2017

29. Computing Power as a Limitation on Economic Modeling Before World War II After World War II Burroughs Adding Machines in Veterans Bureau Computing Section Eniac: The First American Digital Computer Econ 314S History of Modern Macroeconomics Fall 2017

30. The March of Progress – 1 Punch Cards IBM 360 Mainframe Computer (c. 1964) IBM Card-punch Machine Econ 314S History of Modern Macroeconomics Fall 2017

31. The March of Progress – 2 My first computer – IBM PC (1985) My current Macbook Pro (2013) Cray XK6 Supercomputer (2011) Econ 314S History of Modern Macroeconomics Fall 2017

32. Commercialization • Data Resources International (DRI) • founded 1969 • largest non-governmental distributor of economic data • DRI also built the largest macroeconometric model of the era • purchased by McGraw-Hill for for over $100 million. • ultimately bought out its main competitors: WEFA and Chase Econometrics to form Global Insight Otto Eckstein (1927-1984): first econometrics millionaire Econ 314S History of Modern Macroeconomics Fall 2017

33. Thanks  The End Econ 314S History of Modern Macroeconomics Fall 2017