Just below I claimed that economics is a science. If that is so, we should expect to see empirical progress. Here are a few issues where I (and many others) have been swayed by the data; I will state these in the form of untrue claims which I no longer believe:
1. We can both control the price level and keep interest rates stable by targeting the monetary base. Twenty years ago I believed this, but even the Swiss have not stuck with monetary targeting. A better solution is to broadly target the price level but allow for mild inflation.
2. Minimum wage boosts will generally put many low-skilled workers out of work. I covered this one a few days ago.
3. Investment is highly elastic with respect to observed changes in real interest rates. I’ve seen a few good studies that generate significant elasticities, typically using taxes as an exogenous instrument. But more often than not you can’t get this result. Short-term cash flow is often a better predictor of business investment.
4. Free capital movements for developing countries should usher in macroeconomic stability. Ask Argentina, Thailand, and Indonesia. Sometimes this proposition will be true, it is simply not as true as we once thought. If you don’t do all your reforms to perfection, and perhaps even if you do, international capital markets may put you through the wringer. But note, I am not endorsing capital controls, which have problems as well, most of all corruption.
5. Immediate privatization is more important than establishing the rule of law. Arguably the jury is still out on this one. We haven’t observed the other sequencing in many cases (when has rule of law come first?) and thus we do not have the relevant counterfactual. But privatization alone is less effective than we used to think, pick almost any ex-Communist country as an example.
6. It is relatively easy for a disinflation to be credible, provided the government sticks to its guns. So expect some nominal wages to remain sticky and some unemployment to result. People simply won’t believe a government, can you blame them? Of course the disinflation may still be worth doing, but the costs are higher than we used to think.
7. Fairness perceptions, envy, and a stubborn attachment to the status quo have little to do with nominal wage stickiness. OK, this one remains up for grabs. But the evidence is mounting in favor of the importance of fairness perceptions; furthermore this is strongly consistent with my real world experience. We used to look more toward long-term contracts and efficiency wage theories to explain sticky wages.
8. Human beings maximize expected utility in the same way, regardless of context. But now, alas, I despair as to how general a science economics can ever become. The non-economist may not be shocked here. Still we now have a wide body of knowledge about the importance and specifics of framing effects.
All these results share some common features. All have real world policy implications. All spring from a variety of economic methods, but most prominently from direct observation and economic history, informed by fairly straightforward theories and simple approaches to data. Rarely have fancy-schmancy empirical methods, on their own, led a radical reshaping of our understanding.