Finally, many outsiders and some insiders have concluded from the crisis that economic theory in general is bunk, that we should take guidance from people immersed in the real world – say, business leaders — and/or concentrate on empirical results and skip the models. In reality, however, advice from business leaders has generally been worse than useless this past decade, while the voices in the air heard by madmen in authority have, as usual, given very bad advice. And while empirical evidence is important and we need more of it, the data almost never speak for themselves – a point amply illustrated by recent monetary events.

So let me talk about three things:

The unsung success of macroeconomics

The excessive prestige of microeconomics

The limits of empiricism, vital though it is

The clean little secret of macroeconomics

There’s a story about quantum physics – not sure where I read it – about the rivalry between the physicists Julian Schwinger and Richard Feynman. Schwinger was first to work out how to do quantum electrodynamics, but his methods were incredibly difficult and cumbersome. Feynman hit upon a much simpler approach – his famous diagrams – which turned out to be equivalent, but vastly easier to use.

Schwinger, as I remember the story, was never seen to use a Feynman diagram. But he had a locked room in his house, and the rumor was that that room was where he kept the Feynman diagrams he used in secret.

Modern macroeconomics is a bit like that, if you can imagine Schwinger in control of all the journals and in a position to prevent anyone from publishing the simpler version. What’s the equivalent of Feynman diagrams? Something like IS-LM, which is the simplest model you can write down of how interest rates and output are jointly determined, and is how most practicing macroeconomists actually think about short-run economic fluctuations. It’s also how they talk about macroeconomics to each other. But it’s not what they put in their papers, because the journals demand that your model have “microfoundations.”

Now, the thing about IS-LM-type analysis is that using it isn’t that big a deal in normal times, but it makes some very strong predictions – predictions very much at odds with many peoples’ priors — about abnormal times. Specifically, this kind of analysis says that when there is a really big adverse shock to demand – say, from the collapse of a major housing bubble – there’s a regime change, and neither monetary nor fiscal policy have the same effects they do in normal times.