When I tell people that macroeconomic analysis has been triumphantly successful in recent years, I tend to get strange looks. After all, wasn’t everyone predicting lots of inflation? Didn’t policymakers get it all wrong? Haven’t the academic economists been squabbling nonstop?

Well, as a card-carrying economist I disavow any responsibility for Rick Santelli and Larry Kudlow; I similarly declare that Paul Ryan and Olli Rehn aren’t my fault. As for the economists’ disputes, well, let me get to that in a bit.

I stand by my claim, however. The basic macroeconomic framework that we all should have turned to, the framework that is still there in most textbooks, performed spectacularly well: it made strong predictions that people who didn’t know that framework found completely implausible, and those predictions were vindicated. And the framework in question – basically John Hicks’s interpretation of John Maynard Keynes – was very much the natural way to think about the issues facing advanced countries after 2008.

So let me talk about where Hicksian analysis comes from.

What many macroeconomists don’t realize, I believe, is that Hicks on Keynes actually grows directly from Hicks’s own work on microeconomics — not mainly macroeconomics — embodied in his book Value and Capital. V&C was a seminal work on the economics of general equilibrium – that is, getting past one-market-at-a-time supply and demand to the interactions among markets. Hicks didn’t invent general equilibrium, of course, but he sought to turn it into a useful tool of analysis.

What’s the minimum interesting general equilibrium problem? The answer is, an economy with three goods, which means that there are two relative prices. You can think of such an economy as having three markets, but because of adding up you only need to look at two – if any two are in equilibrium, so is the third.

Geometrically, you can represent equilibrium in a three-good economy in a space defined by the two relative prices. Say that there are three goods, X, Y, and Z. Choose Z as the numeraire – the good in which prices are measured. Then we have the price of X on one axis, the price of Y on the other. There will be many combinations of those two prices at which the market for X clears, defining one schedule in this space; you can similarly define a schedule representing prices at which the market for Y clears, and yet again for Z. Where all three lines cross (remember the adding up) is the equilibrium for the economy as a whole.

What does this have to do with macroeconomics? Well, as Hicks realized, a minimal model of macro issues involves three markets: the markets for goods, bonds, and money (or, better, monetary base). If we assume that all three are gross substitutes – the most natural though not inevitable assumption – we get Figure 1:

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We can make this more familiar by putting the interest rate – which moves inversely to the price of bonds – on the axis, which flips the figure upside down, and by removing one of the markets; what we get is Figure 2, which is basically IS-LM:

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Wait, you say, isn’t IS-LM usually presented as a model of output, not the price level? Yes – but you can get there by invoking sticky prices and/or wages, so that there’s an upward-sloping aggregate supply curve, without changing the figure. In practice we think that AS is very, very flat in the short run, so that you do better by just putting GDP on the axis, but this is good enough for my purposes now.

A different kind of objection involves what, exactly, is going on behind these curves. On one side, can we just assume sticky prices without deriving them from first principles? Actually, yes – the evidence is overwhelming. Meanwhile, the demand for goods involves intertemporal decisions, driven by expectations about the future, so don’t we need to specify all of that explicitly? Well, no – of course we want to understand such things as well as we can, but is it really unreasonable to assume that lower interest rates mean higher demand under pretty much any detailed story?

A foolish insistence on microfoundations at all times and no matter what the issue is the hobgoblin of little minds.

So what is the payoff to this application of miniature general-equilibrium theorizing to macro? Even in normal times, this approach, Mickey Mouse as it looks, offers a big step up in sophistication from a lot of what you hear – including what you hear from economists who are all teched up but have no idea how to apply their equations to anything real. In particular, a lot of what you hear about macro issues is monocausal: money drives the price level, borrowing drives interest rates. What we already have here is an understanding that there isn’t that kind of clean separation, that money can affect interest rates and spending affect output.

But the really big payoff, as Hicks realized all the way back in 1937, is that this framework tells you what happens when interest rates get close to zero. We’re all doing a lot of head-scratching lately about negative rates, but still, it’s clear that there’s something like a floor, so that the picture looks something like Figure 3:

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And that in turn says that once you hit that flat section – once you are in a liquidity trap – the rules change. Even huge increases in the monetary base won’t be inflationary – they shift MM to the right, but it makes no difference. Large budget deficits, which shift GG, won’t raise rates. However, changes in spending, positive or negative – e.g., harsh austerity — will have an unusually large effect on output, because they can’t be offset by changes in interest rates.

All of this was predicted in advance by those of us who understood and appreciated Hicksian analysis. And so it turned out. I call this a huge success story – one of the best examples in the history of economics of getting things right in an unprecedented environment.

The sad thing, of course, is that this incredibly successful analysis didn’t have much favorable impact on actual policy. Mainly that’s because the Very Serious People are too serious to play around with little models; they prefer to rely on their sense of what markets demand, which they continue to consider infallible despite having been wrong about everything. But it also didn’t help that so many economists also rejected what should have been obvious.

Why? Many never learned simple macro models – if it doesn’t involve microfoundations and rational expectations, preferably with difficult math, it must be nonsense. (Curiously, economists in that camp have also proved extremely prone to basic errors of logic, probably because they have never learned to work through simple stories.) Others, for what looks like political reasons, seemed determined to come up with some reason, any reason, to be against expansionary monetary and fiscal policy.

But that’s their problem. From where I sit, the past six years have been hugely reassuring from an intellectual point of view. The basic model works; we really do know what we’re talking about.