Co-authored with Akerlof, this is perhaps the most relevant paper Yellen wrote for understanding what she’s likely to do at the Fed, not least because it’s so recent. The paper is a critique of an argument made by Robert Lucas, the Nobel laureate who turned macroeconomics on its head with his mid-1970s critique of Keynesianism. Lucas was not only skeptical of the prescriptions traditional Keynesians proposed for combating economic downturns, such as fiscal stimulus. He also thought that they would be pointless even if they worked. The idea is that downturns are followed by upswings of equal size, and so the ebbs and flows of the business cycle sum to zero in the long run. If that’s true, Lucas theorized, then the net cost of recessions and booms is zero, and so policies to stabilize the economy and end recessions are unnecessary.
Akerlof and Yellen think this gets it all wrong. For one thing, being unemployed during a downturn is worse than being unemployed during a boom. “Weeks of unemployment are likely to be more onerous in a trough than in a boom,” they write. “Employment is correspondingly more beneficial in a bust than in a boom. Estimates of the welfare losses from the business cycle due to this latter effect alone are an order of magnitude greater than Lucas’s estimate.”
What’s more, Lucas’s central assumption, that booms and busts cancel each other out with or without stabilization policies, is wrong. Akerlof and Yellen quote a paper by their Berkeley colleague Brad DeLong and Summers to this effect: “…successful macroeconomic policies fill in troughs without shaving off peaks.” If that’s true, then stabilization can make income higher and unemployment lower if you look at both recessions and downturns. If that’s true, it’s hard to argue it’s not worth it. Stabilization by Yellen and her husband, George Akerlof
