A Conversation with Greg Mankiw: Financial Crisis, Recessions and Communicating Economics

I'm Malaiam.
Welcome back to Think Like an Economist. Over the next
several episodes, we're going to talk to some leading economists
to hear how they think about and use economics. Today,
we've invited Greg mank You to join us in a
conversation about his work, his time in government, and his
advice on how you can use economics to make better decisions.
Welcome to this episode of Think Like an Economist with me,
Betsy Stevenson, and.
I'm Justin Wolfs.
We're here to bring you the supertools of economics to
help you transform your life and say the world ever
more clearly.
Today we're joined by Greg man You. He's perfect for
this show because in recent episodes we've been talking about
macroeconomics and Greg is the guy who taught me macroeconomics
at Harvard.
Me too.
And Greg isn't just a mentor and a friend and
a co author of mine, he's also one of the
world's leading economists. Welcome to Think Like an Economist.
Greg, It's nice to be with you.
Look, there's so much we can talk about, but what
I really want to begin with is your big contribution.
When I told people I was talking to Greg mank
here they said, oh, you mean one of the leading
lights of the new Canesian revolution. For our listeners, for
whom this might sound a bit like code, what is
the new canes In revolution?
That's a great question.
John Miner Kaines was this great economist which did it
most important work in the nineteen thirties. Gave us a
framework for understanding depressions and recessions, and his book called
the General Theory of Employment Interest in Money quickly became
very controversial in economics, and it remains so to this day.
It became very popular in the thirties and forties, and
then it came under attack in the seventies, with people
told the new classical economists started attacking some of the premises.
Of Kanes in economics.
And that's roughly when I entered the economics scene as
a student in the seventies eighties, and so my early
work was trying to put Canesine economics on a more
solid theoretical foundation.
And so the big Caynesine insight was that demand is
a really big driver of business cycles. What is it
The new classicals disagreed with there.
You're absolutely right that John Vatter Kaines thought that aggurgate demand,
the demand for goods and services, was the key driver
to understand business cycles, and recessions and depressions were periods
of insufficient demand for goods and services and the air
for conception demand for labor. To get that story to work,
you need some wage or price stickiness somewhere in the system.
Under classical theory, prices would quickly adjust to any level
of demand and restore full employment. And that rapidity of
adjustment that undermined basic canes and conclusions. Now, the old
Kynesians didn't mind assuming slow adjustment of wages and prices
because that's the way the world looked to them, but
that came under significant attack by the new classicals. And
so one thing the new Keenans wanted to do, and
this is some of my earlier research, was trying to
help explain why it is that wages and prices were
just slowly over time rather than instantaneously to restore full employment.
So don't cut means suspense great? Why do prices adjust slowly?
I mean, if demand falls off of my goods, why
don't I just cut my prices right away and bring
demand back.
Well, that's a good question. I don't think we have
a definitive answer. There's a lot of possible explanations out there.
Some of them involve the costs of price adjustment. I
did a paper early in my career called small menu
Costs in Large Business Cycles that suggest that relatively small
costs of price adjustment, which which are something is called
menu costs, can actually help explain fairly large deviations of
output from full employment. Now that's still a controversial thesis.
There's other ideas out there. Some people think that wages
are not determined by supplying demand, but are determined by
norms in the workplace that might adjust slowly over time.
So I think there's a lot of different perspectives out there,
but I think there's a consensus that sticky wages and
prices do kind of make sense as a way of
understanding the business cycle.
If you think about where we are today, where do
you think views are on knees Senism are new Knesianism?
Do we believe that prices are sticky? How important is
demand for recessions?
I think the consensus today is that Kinges was right.
When I was in grad school, I think there was
a movement away from Kings and the tithe it has turned,
I mean, in part due to my generation's work on
sticky prices, but in part because the alternatives, the sort
of new classical alternatives sometimes called the real business cycles,
turned out not to look very attractive. And so economics
is always a matter of competing theories, and you know,
you can't beat a theory without a theory. So as
kind of started looking at alternative theories of the business cycle,
I think the kynes In approach has become sort of
the consensus view these days.
And so one of the interesting evolutions I've said in
your own work, Greg is almost increasing behavioral economics. The
young Greg mank was a new knes In because of
a fairly sophisticated theory about menu costs, and then more
recently you and Riccata Race tooked instead about attention.
I'm not a behavioral economists, but I've been heavily influenced
by the behavioral economists in my department, in particular David Labsen,
who's my slightly younger colleague who's done a lot of work.
In behavioral economics.
And I saw David Labsen give a talk about an
attention in particular here's something about consumers. And then I
started thinking about the same sort of inattention could perhaps
explain that the sluggishness of price adjustment. The firms aren't
monitoring the macroeconomy in the same way they're monitoring their
own particular market. So, if you're a small business here
spent a lot of time focused on the details of
your business. The overall macroeconomy, it's gone off monetary policy
and so on, something that may not enter into your
decision making. As a result, people may be relatively slow
to adjust their price setting to change in overall aggregate demand.
And you're right, the idea really comes from the behavioral economists,
and then we try to understand how that could help
explain the dynamics of prices and inflation over time.
And it's also a distinctively macroeconomic idea in the sense
that both sticky prices or sticky information individuals may not
be paying attention. That doesn't seem like a big deal,
but if a whole lot of us don't do it
at the same time, that can add up to macroeconomic consequences.
Oh, that's absolutely right, And there's a lot of sort
of synergies between how much detention people pay. So I meane,
if you're not paying attention, you're not going to change
your price. Well not so you're going to change my
price if you're my competitor, and therefore I'm not going
to pay much attention either.
So to me, it's pre.
Compelling that most people aren't focused on the Federal Reserve.
Most people pay don't even know the Federal Reserve is.
So it's not surprising that the overall economists low to
respond to changes and see monetary policy or other forces
that influence overall aggregate demand.
So, to characterize this big debate, the new classical saw
the economy as a well oiled machine, and a well
oiled machine goes back to equilibrium and full employment very quickly.
And you and many of your collaborators were finding a
lot of sand in the gears that were slowing things
down and that eventually causes unemployment.
That's exactly right.
We were trying to explain of the frictions that make
the economy work less than perfectly. Listen ideally, as it
would be a fully classical world.
I can't remember a talk you gave at a conference
almost a decade ago. You were talking about each generation
of macroeconomists trying to push the ball of knowledge up
the hill, and then some big catastrophe would come along
that would slip the ball back to the bottom, so
the new generation had something to study, something to do.
It's a really graphic metaphor. But we did have this
huge financial crisis in two thousand and eight, which I
think really shook our understanding of how the macroeconomy works.
The pandemic based recession is its own beast, which I
think there we all have even a maybe do have
a better understanding of exactly what happened.
But what did we.
Learn from the financial crisis and where do you see
that ball of macro knowledge today?
I think we've understood from financial crisis that financial institutions
needs to play a larger role in how macroeconomists see things.
I mean, in the past, courses in financial institutions were
like separate courses if people want to become bankers, and
they were so very distinct from macroeconomics. What we learned
in two thousand and eight was that when those financial
institutions screw up, that can have broader macroeconomic gramifications. I
think of sort of the financial institutions. It's kind of
like the stage hands at the back of the theater
when you're watching a play. Normally, when you're watching a play,
you don't really think about the stage hands. People are
operating the lights, closing the curtain and so on. But
if it's time I've go on strike, you realize, oh
my gosh, the play can't go on without them. And
that's kind of what have the financial stitutions. Normally they
kind of work well. Macro economists can think about macroacanomic
advocates like GDP and interest rates, and we don't need
to think about the details of capital requirements and banks.
Then once in a while they screw up, which they
did in two thousand and eight, and it has broad ramifications.
We need to think about it. You know, when I
teach mac economics and.
I spend much more time discussing financial institutions that I
did in the past, I'm a little confused.
He you, Greg, I thought the Great Depression had a
lot to do with a financial crisis. Did economists just
forget about that?
In part, we do forget things. I think you're right.
Certainly issues that rose in the nineteen thirties faded from time,
not only the financial crisis in the thirties, but also
things like the zero lower bound on interest rates. So
my guess is, when you guys were in my class,
I didn't spend much time thinking about the zero low
around the interustrates, and probably none of my colleagues teaching
this macroeconomic sequence did either.
All of a sudden, it's come back in a big way.
You didn't.
Can I ask you to explain to our listeners what
is the zero lower bound? Because it really matters?
Oh?
Yes, the zero low bound really does matter. It's the
idea that interest rates can't go below zero and maybe
then go a little bit below zero, because they happened
some European countries.
They can't go much below zero.
Sometimes people call it the effective lower bound, so it's
around zero, and usually interest rates are well above zero,
so the fact that it can't go much below zero
is not much of a constraint on policy. DeFore we
can kind of ignore it. But in the nineteen thirties,
innstraints at zero, and they have recently in two thousand
and eight. What we need to focus on what's most
important sort of fluctuates over time depending on what the particular.
Issues of the day are and Betsy posed the question,
what have we learned from the financial crisis? Well, we
then had after that once in a century shock, we
just had another once in a century shock ten years later.
What have we learned from the economics of the pandemic.
Well, I think unusual events are not as unusual as
we think. The way statusasion would put you know, the
distributions have fat tails, meaning that you know, stream events
are much more likely than you would normally think they are.
I think that's an important thing for people to remember
that the world is vastly more uncertain, and when some
terrible unusual thing happens, there'll be some people saying, oh, yeah,
I've been thinking about that.
I was warning it that to be more likely now.
Even the pandemic Bill.
Gates, for example, has been talking about pandemic risk for years.
And I'm sure there's other things that we're not thinking
about now. You know, what's the possibility and asteris in
to come and land in the middle of Manhattan. You know,
nobody's thinking about that now, but it could happen. So
there's all sorts of a sort of very usual events
that will hit us in the future, and we will
be surprised at them because they'll be unique in their nature.
It's like this pandemic is it's very much different from
other business cycles in two thousand and eight, was different
from other business cycles. This famous quote actually from Robert
Lucas many years ago, the famous new classical economists, So
that all business cycles are alike, this was the quote.
I think one thing we've learned is that they're not right.
Exactly desire.
Yeah, I think we've every business cycle so has unique features,
and then we have to come to grips with it.
Like this pandemic business cycle. It's the first business like
I know of that's being effectively driven by microbiology. Right
from the beginning, I kind of knew that the end
was going to be determined not by macro policy. It's
been determined by the how the microbiologists big progress against
the virus, whether it's testing or vaccines or something, but
something to have the microbiology to get her economy.
Going again, even in the labor space.
There.
It's our first service sector led recession, and it's not
clear to me that a service sector lead recession is
going to end or have a transition that looks the
same as a goods producing sector lead recession because it's
different kinds of jobs with different kinds of skills, And
I don't think we've really fully started to grapple with
what that's going to mean for workers in the next
year or two as we try to get them back
into their jobs.
You know, I think that's exactly right. It's a very
different kind of recession from the labor market perspective. Another
way which different from the labor market perspective is the
huge rise of unemployment is basically driven by temporary layoffs.
So permitive job losses has crap up a little bit,
but they hasn't crept up a lot. Permit job losses
have not reached the level they did in the two
thousand and eight recession. It is potentially hopeful if people
think they have jobs waiting for them at they're right,
and that means we could.
Perhaps recover quickly.
So Greg, you said, the big lesson from the pandemic
is distributions have fat tails, or to put it more graphically,
for our listeners, they should expect to be surprised. One
of the things we like to do on this podcast
these hope our listeners take these big macroeconomic ideas and
think about how they apply to their own lives. So
if distributions have fact tales, how should we make different
decisions in.
Our everyday lives?
Knowing that, I think.
Be prepared for a lot of uncertainty. One thing you
can do with that is precautionary saving. Put more money
aside for when these extreme events happen. We have a
financial wherewith all to handle them. The others to be
incredibly well diversified. We know very little about actually how
to invest as economists, but the one thing we absolutely
do know is that diversification is the only free launch
out there. I encourage everybody who's investing their own money
to be maximally diversified. That means across many different stocks,
across many different countries, across many different asset classes. Is
you never really know which particular asset class is going
to pay off. I know there are people out there
who sort of make big bets on a small number
of things. I think those people are either much much
smider than I am, we're much much more foolish than
I am.
So there are a fewty lot there who can do
that would beat the.
Market, you know, Warren Buffet's probably one of them. But
for most people, they're probably not as smart as they think,
especially about.
Predicting the future.
Therefore, the price is better off being as diversified as
they can be.
So when you think about where we are with macroeconomics today,
a natural question is where we are with macroeconomic policy.
And you have advised President Bush as the chair of
the Council of Economic Advisors, You've given a lot of
policy advice over your career. Do you think we're in
a good place to give that kind of advice today?
And what did you learn from your experience in giving
advice to policymakers.
You're actually the one Robert Lucas quote that I completely
agree with, the one whose essays he said, as an
advice giving profession, we're way over our heads, and.
I kind of agree with that.
I think it's very hard to give a macro economic
advice because there's so much we don't know. So, for example,
de to gdpvations are arising and very high. How high
can they go before we run into problems? I don't
think we have good answers to that question. Well, what
conditions path or rise before inflation becomes a problem. I
think again, different macroeconomists have different opinions about that. So
I think there's lots of macroeconomic things we don't know
the answer to. I think a large dose of humility
is probably called for.
Do you think we do a good job at communicating
our humility.
I think some people aren't as humble as they should be,
and they do a pretty good job of communicating their
lack of humility.
I think we should be more humble.
The problem is, humble doesn't sell well.
You know, if you want to.
Write op eds, it's much easier to have a strong
opinion and argue strongly for it, then say, well, it
could be this, it could be that. Who knows, We're
not really sure. Here's my best guess. That doesn't sell
well and up ed pat. So the popular debate tends
to focus on economists that.
Are insufficiently humble.
I try nothing fall into that trap, but I'm sure
I do too when I write off.
Ends, I'm struck that humility is so important. I agree
with you. Do we educate young economists in humility?
Probably not what we probably don't. It's maybe perhaps a
more of a personal characteristic that can be best taught
not explicitly, but implicitly by example. The economist side I
admire tend to be more humble. I was a student
of Stanley Fisher's. He's my PhD dissertation advisor, and I
think stan was a great career as professor and as
an economic policy maker, being vice chair of the FED
most recently. He was very good at flying economic knowledge
but also not overstating what he knew.
So, Greg, I love this point about humility, but also
about how it does itself.
So I didn't tell you.
In my experience, I actually only got yield at once
by the President's chief of staff, and it was because
it was the only time I said, well, on the
one hand, and on the other hand, he was like,
you need to tell us what to do, and I
was like what.
So there is this.
Balance right between humility. Like I wanted to say, I
didn't have certainty, and I also tempered my advice. But
at the same time, I do see a lot of
economists get into trouble for falling into the trap I
fell into, which is refusing to fall down on one side.
So I was just wondering if you must have wrestled
with this.
Yeah, when I was working for George Bush, I never
felt like I couldn't express uncertainty. I was part of
an economic team that worked together really well. So you know,
I was working with Steve Friedman, who was head of
a National Economic Council, and John Snow who Secretary of Treasury.
We all got along really well.
We often saw things really well, so with them I
could sort of say, oh, I'm uncertain. We'd eventually come
up with a consensus recommendation and that would go to
the president. So I never felt like I was ever
in a position to have to suppress what I thought.
And indeed, you know, one of the things, but only
somewhat related to what you asked, which is what happens
if you're working for a president and you happened to
agree with the president, you happen to think it's wrong.
In take the other position.
Whenever I would get a question for a reporter, what
I would always say is the president thinks that, and
then I express the president view and I just wouldn't
tell them my view. And interestingly, the reporters never really
followed up with a question because they didn't honestly care
about my view. They don't care about the president's view.
So that brings us to this idea of just communicating
to that broader public. And I followed that rule as well,
which is, you know, you're representing the decisions of the president.
And I saw economists not having as much sway and
policymaking as maybe they even should have, Which is why
I think like this thing about humility is a little complex.
Right.
We see a lot of arrogant economists. That stereotype is
for real. But then I'd like to see economists have
even sort of more sway in terms of helping people
understand how incentive shaped the behavior.
Going make them agree more.
The problem is is that in that policy context, for
the person who acts as if they have complete certainty
the message you're going to cross better, I think that's unhealthy.
Great want to what's the secret source? Our listeners have
just learned some economics and they want to be persuasive.
How do they do it well?
I think it's helpful to keep your audience in mind.
So when I write op eds, I usually try to
write in a way that's gonna, if not persuade someone
who disagrees with me, at least give them pause and
make them a little less certain so I'm never writing
an outbed to try to basically solidify the base of
people who have already agree with me. That's not interesting
way to write that bed. So I try to think of, Okay,
who's a reasonable person who doesn't agree with me? What
arguments might they find sympathetic? Can you put those terms?
So thinking about your audience all the time when you're writing,
I think it's tremendously important.
Actually, I have a slight advantage.
I'm sort of my contict is sort of center right,
and I'm go university that center left, soba seely's surrounded
by people who disagree with me. That's a great advantage
because you know how the people don't agree with you think,
and trying to get inside somebody else's mind is often
very difficult. I teaches a s freshman seminar and I
once had a student who was from Santa Monica, very liberal,
very far to the left. At the end of the seminar,
he said his favorite book we read was Milton Freedman's
Capitalism the Freedom And I said, well.
Why was that your favorite book?
And he said, well, I don't agree with it at all,
but these are the arguments I have to figure out
how to argue against. And I thought that was a
very insightful insight because understanding people you disagree with is
much harder, and something's more important than understanding people you
agree with.
One of my favorite things about being in a seminar
room with you agree is we'll be in a room
and there'll be many great economists arguing very technical fine
points of a particular seminar paper or a projection or
a forecast, and inevitably, when you put your hand up
and interject, you'll use what looks to me like economics
one I one so little lessons we've been talking about
on this podcast, that you have a deep understanding of
the fundamentals and you'll reinsert them back into the conversation.
Where does that come from?
Well, you know, my favorite courses when I took economics
as a student was the introductory micro and macro courses.
I feel like I learned so much there, and I
felt looking back my own education, I felt like all
the more advanced courses were just reiterating the same idea
as I learned in basic economics and adding more math
and more rigor more precision. But basically all the core
economics is really there in the first year economics, so
I think everything can be couched in those terms. I
also always when IVER see an economic idea, I always
want to put it in the big picture, like how
is this going to fit in for the big pictures?
Unless interest in the details, which I'm assuming the author's
getting right. More so Soolkia, why should I care about this?
And I think too many economic papers are written in
a way that the author assumes that everybody cares about
the subject as much as he does or she does,
and often the audience doesn't. And so trying to bring
everything back to one oh one is a way of saying, OK,
why is this important? And if you can't put it
on one or two, it may not be important.
Let's switch gears a little bit. You know, a lot
of our listeners are from all over the globe, and
an increasing part of the globe is China, And so
I was wondering, where do you see globalization going? Maybe
thinking a little bit about China's impact on the world,
But we're at a time where it does seem like
a lot of countries are trying to retreat from globalization,
and so I'm wondering where you think it's going.
Globalization has kind a hard few years, and people on
both the right and the left. I don't mean the
sort of center right set off. I mean the far
right and far left have been very skeptical about globalization
and that so it includes like Donald Trump and the
far right and Bernie Sanders and the far left. And
you see right now this is there's really not a
consensus to sort of push forward in a way that
was true in the past. So I think of sort
of moderates and people like you know, George Bush, both
George Bush's who pushed for more global free trade, and
Bill Clinton who signed father side naftental law, and Barack
Obama who negotiated TPP which unfortunately did not get passed
into the law. So that all consensus and it's between
the center left and center right, and that's now been
sort of hijacked, and now it's the populist extremes that
have sort of taken hold in the popular imagination and
where it's sort of in an anti globalization phase. I
personally think it's very unfortunate because I atually think actually
globalization is good for humanity. And why I think of globalization,
I'm thinking about both trade and goods and movement of
people through immigration. I think they're both sort of basically
very positive forces for the human race worldwide, and so
I think it's very unfortunate that we've gone into this
slightly xenophobic phase. I don't know how it's gonna all
end up, but at this point I'm nervous. I still
sort of preach the virtues of trade. It's certainly true
that trade creates winners and losers. It's never been true
that when we open up to trade absolutely everybody.
How do you wins?
There's always going to be some people adversely affected. But
I think on net trade is positive sum and if
we have the right social safety net to help the
people who do get hurt, then it's overall a positive.
Force for society.
So then let me ask you to put your communicator
hat on. How would you make the case for globalization?
It's clear in favor. It's clear a lot of people
haven't heard those arguments or they haven't landed. So what's
great man Ky's case.
Well, when I.
Teach basic economics, I make comparative advantage, which is the
Ucardo's theory of why trade can make both beat trading
parties better off. They make that a very center of
the course. It's not something that I lead to the
end of the course. That's sort of an extra topic.
I think is really central to economics. He's the basic
theory of comparative advantage explains not only why we treat.
It for the countries, so why we treat it for
the people.
It's why we know we don't grow our own food
and make our own clothes, right we treat among people
within a country. It's really based on the same force
as this trade among countries. There's a great book for
the general public, or the Myth of the Rational Voter,
by Brian Kaplan in Brian Kaplan in this book goes
through a variety of biases that uninformed people that economics
tend to have. And one of them is an anti
market bias, a bit more skeptical about markets allocations than
a commissar. And the other is an anti foreign bias.
They tend to be skeptical about foreigners. I think both
of those bias are true, and I think both the
biases are very unfortunate. The anti foreign bias, let me
put my amateur sociology hat for a minute. The anti
feim bias I think comes from the deep evolution of
human kind. If you think of a man evolved in
the savannah somewhere, if you saw a bunch of people
they didn't recognize coming over the horizon, they probably weren't
coming over to engage in mutually advantageous gains from trade.
They were probably coming over the border to steal your
food or something.
So we didn't evolve in an environment where trade of
strangers could be mutually beneficial, but in a world system
that has the rule of law.
It can be a win.
Whim, Greg, I was just going to say, I've been
thinking a lot about anti foreign bias and in some
way a different, much more narrow sense, which is just
my eight year old is talking a lot about how
kids treat other kids that they think are different. I
think Justin said to our son yesterday, nothing important in
the world has ever been invented by someone who wasn't
seen as different.
But there's David Ricardo in the background, which is we
learn more and do better and trade more with people
who are more different than us.
Absolutely no, that's exactly right.
So so the idea that we all want to trade
with Canada crazy. These very so treating with China, which
is fastly different from us. The developing world like a
lot of Americas, sou Southern Africa, and that's a real
where the games for created really are.
All right, this is the fun bit, Greig. We've called
our podcast Think Like an Economist, because we think that
learning how to think like an economist really helps you
see the world more clearly. And I get to say
that because I was a student of yours who learned
to think like an economist from you.
So can you tell us just a little bit about
what it really means to you to think like an economist?
I think it's very hard to say what thinking like
an economist is. Economists have a lot of small models
of the economy that are basically the logical representations of
how we think people interact, and we try to do
it in a mathematical way, in a way that sort
of puts emotion and irrational thoughts and some subjective thoughts
to a side. We try to think as objective as
we can about human interactions. It means developing theories. It
means looking at evidence and that the theories evolve in
response to that evidence.
And for those of our listeners who need persuading. Why
do you think it's valuable to think like an economist.
Well, I always think of economics from the stand point
of public policy because I think as a voter, I
can think better about what the good policies and bad policies.
But even if you don't think about I'm interested in
public policy. I think you be honest in little economics.
You can make better decisions in your own life. The
idea of some costs is being irrelevant. Once you sort
of recognize that, you say a Hi, you know, I've
maybe made some of irrational choices in my own life.
I should be ignoring some costs.
If you understand a little bit of finance, the idea
of diversification holding the market portfolio makes sense to a
non economist holding index funds that holds all the stocks
regards with it's a good company or bad companies, it
seems kind of crazy. Want you understand a little bit
of finance, You understand, Hey, that's kind of a smart
thing to do. So I think it does help in
personal decision making as well as thinking broadly about public policy.
Terrific, Greg, Thank you so much for talking with us
today on think like an economist. I think you brought
a lot of really important insights for our listeners.
It's been a great pleasure.
Thank you Justin and Vetsi, and thanks for early you've
done to teach you by the best mind