Mark Thoma has a long post on the end of the Fresh Water Salt Water truce. He quotes at length from Olivier Blanchard’s declaration of peace in our time. In particular from Blanchard
the old fresh water/salt water distinction has become largely irrelevant: While research on the topic started with new-Keynesians, recent research has been largely triggered by an article by Golosov and Lucas (2007), itself building on earlier work on aggregation of state-dependent rules by Caplin and by Caballero, among others.
I’d call Caplin and Caballero definitely salt water, so the proof that the war is over is the paper by Golosov and Lucas.
Obviously Blanchard knows a lot more than I do about the current state of macro research. However, I can’t help but notice that he names only one paper by Fresh water economists which accepts nominal rigities (OK one of the economists is Lucas so it counts more than double but still one article is one article).
Blanchard is likely to see convergence basically to New Keynesian general equilibrium models (like say Blanchard and Kiyotaki which isn’t exactly new is it). He, like Mankiw, is a new Keynesian who loves math and favors the rational expectations hypothesis. That is, he will be reconciled with Prescott long before, say, Larry Summers or Brad DeLong.
I’m not surprised by the recent contributions of fresh water economists to the policy debate. For one thing, many fresh water economists have extreme policy views. The school is partly based on preferring mathematical elegance to assumptions which most people find plausible, but it is also partly based on the idea that the market is wonderful and public intervetion in the market is always bad. Thus a nice model of nominal rigidities is OK, but a conclusion that, therefore countercyclical macro policy is good is not.
Note Lucas decided that the business cycle is of trivial importance so reducing its amplitude would provide trivial benefits *before* he accepted a model with nominal rigidities. Back when he considered the business cycle the key issue in Macro, he argued that active policy could only increase its amplitude.
Now that we seem to be in a recession which sure doesn’t seem trivial, he suddenly argues that macro stabilization policy can’t work, although it can given nominal rigidities as in his paper with Golosov.
Is there any work from Lucas at all that doesn’t fall under the heading of lets do math, the harder the better, so long as we don’t conclude that it is possible for public intervention to improve on laissez faire ?