What Did Tyler Cowen Say and Mean In His Original Post?

Generally speaking, neo-classical economists found out about Mason's post from Marginal Revolution's Tyler Cowen. It's a quick post:

The new macroeconomic thinking, some of it is good, note that about half of it runs counter to long established empirical truths that never have been overturned (as always, so much faith in that Lucas supply curve!).

I think I've done a pretty good job of pointing out that some of Mason's points are good, and that some of this other points (and I love this subtle slam) — runs counter to long established empirical truths that have never been overturned — are coming from left field.

But what did he mean by "so much faith in the Lucas supply curve"?

******************************

There are some really deep theoretical holes in macroeconomics. In short, it's hard to come up with a theory of why open market operations would influence the economy at all. And, the Keynesian assertion that monetary policy could shift the aggregate demand had little in the way of foundations for the first 35 years economists were teaching it.

At the time Lucas was working on this in the early 1970's, the focus of macroeconomics was shifting from fiscal to monetary policy. So most of his work is about the latter, although it extends to the former.

Lucas was the first one to show how rational, optimizing, people could respond to policy in a way that created a correlation between monetary policy and output that was structural and causal.

The core problem is that rational, optimizing, people should be able to figure out that monetary policy is ... scammy. It's just hard to come up with a way in which 1) agents who were comfortable with their portfolio could 2) be made offers through open market operations that they will turn down until one that is too good to be true comes along, and 3) and change their real behavior as a result of their particular portfolio shuffle ... especially since the portfolio of the whole country would remain unchanged.

Lucas solved this by showing that if agents formed expectations of policy, and then were met with a somewhat different policy, that the unexpected portion of policy might produce effects. Those effects include something like the Phillips Curve, and a correlation between lowering interest rates and the output going up.

There are 3 big problems with this. 

• If it's only the unexpected part of policy that works, how do you form a policy at all with the goal of the most important part being unexpected? 
• The empirical evidence showed that these effects just weren't that big.
• The correlation of aggregate demand policy with output rising is only a correlation. Most of aggregate demand policy is expected, and therefore not-causal. The causal part comes from the fraction of aggregate demand policy that was unexpected.

Cowen's point is that Mason is celebrating the "Biden stimulus package" because it contains mostly expected stuff, with a some unexpected stuff thrown in, that the evidence tends to show won't do much. Mason is either thinking that Lucas was wrong (a rare thing), that a lot more of the ARPA was unexpected than seems so, or that somehow unexpected policy has recently gotten much more powerful. These seem fanciful.