Saltwater and freshwater economics
In economics, the freshwater school (or sometimes sweetwater school) comprises macroeconomists who, in the early 1970s, challenged the prevailing consensus in macroeconomics research. A key element of their approach was that macroeconomics had to be dynamic, quantitative, and based on how individuals and institutions interact in markets and on how they make decisions under uncertainty.
Many of the proponents of this radically new approach to macroeconomics were associated with Carnegie Mellon University, the University of Chicago, the University of Rochester and the University of Minnesota. They were referred to as the "freshwater school" since Pittsburgh, Chicago, Rochester, and Minneapolis are located nearer to the Great Lakes.
The established consensus was primarily defended by economists at the universities and other institutions located near the east and west coast of the United States, such as Berkeley, Harvard, University of Pennsylvania, Princeton, Columbia, and Yale. They were therefore often referred to as the saltwater schools.
The terms 'freshwater' and 'saltwater' were first used in reference to economists by Robert E. Hall in 1976, to contrast the views of these two groups on macroeconomic research. More than anything else it was a methodological disagreement about to what extent researchers should employ the theory of economic decision making and how individuals and firms interact in markets when striving to account for aggregate ("macroeconomic") phenomena.
The saltwater–freshwater dichotomy is a thing of the past. In his overview article from 2006, Greg Mankiw writes:
An old adage holds that science progresses funeral by funeral. Today, with the benefits of longer life expectancy, it would be more accurate (if less vivid) to say that science progresses retirement by retirement. In macroeconomics, as the older generation of protagonists has retired or neared retirement, it has been replaced by a younger generation of macroeconomists who have adopted a culture of greater civility. At the same time, a new consensus has emerged about the best way to understand economic fluctuations. [...] Like the neoclassical-Keynesian synthesis of an earlier generation, the new synthesis attempts to merge the strengths of the competing approaches that preceded it.
According to saltwater economic theory, the government has an important 'discretionary' role to play in order to actively stabilize the economy over the business cycle.
Researchers associated with "the freshwater school" found that government economic policies are of utmost importance for both the economy's abilities to respond to shocks and for its long-term potential to provide welfare to its citizens. These economic policies are the rules and structure of the economy. They might be how markets are regulated, what government insurance programs are provided, the tax system, and the degree of redistribution, etc. Most researchers that have been associated with "the freshwater school" have, however, found it hard to identify mechanisms through which it is possible for governments to actively stabilize the economy through discretionary changes in aggregate public spending.
Internal model consistency ("rational expectations")
Economists usually disagree on how to model the preferences of decision makers in a model-consistent fashion (so-called "rational expectations"):
In general, "saltwater economists" insist less on internal model consistency than freshwater economists. Typically, they find "examples of irrational behavior interesting and important." Like behavioral psychologists, they tend to be interested in situations where individuals and groups behave in a seemingly boundedly rational way.
Freshwater economists have in general been interested in accounting for the behaviour of large groups of people interacting in markets, and believe that understanding market failures requires framing problems that way.
"Saltwater Keynesian economists" argue that business cycles represent market failures, and should be counteracted through discretionary changes in aggregate public spending and the short-term nominal interest rate.
"Freshwater economists" often reject the effectiveness of discretionary changes in aggregate public spending as a means to efficiently stabilize business cycles. Economists loosely associated with "the freshwater school" have found that market failures might be important both as a cause of and as amplification and propagation of business cycles. However, it does not follow from these findings that governments can effectively mitigate business cycles fluctuations through discretionary changes in aggregate public spending or the short-term nominal interest rate. Instead they find, in general, that government policies would be more effective if they concentrate on structural reforms that target identified, important market failures. These economists also emphasize that the government budget constraint is the unavoidable accounting identity and connection between deficits, debt, and inflation.
In 2009 Paul Krugman commented that "since then [forty years ago] macroeconomics has divided into two great factions: “saltwater” economists (mainly in coastal U.S. universities), who have a more or less Keynesian vision of what recessions are all about; and “freshwater” economists (mainly at inland schools), who consider that vision nonsense". However, Krugman noted that the difference had become mainly theoretical during The Great Moderation, but that the financial crisis cast the dichotomy in a new, harder light.
In a blog post in December 2012, Krugman continues his discussion: "So yes, the equations in one of Mike Woodford’s papers look a lot like the equations coming out of Chicago or Minneapolis. And a few years ago it was possible to delude oneself into believing that this represented a true convergence of thought. But recent events have proved that it just wasn’t true. Stephen Williamson tersely comments in a reply: [When] Krugman can't figure out what is going on in his own department (the Department of Economics at Princeton University), do you think you can trust him to take the pulse of the profession?"
- Bounded rationality
- Efficient-market hypothesis
- Rational expectations
- Real business cycle theory
- Ricardian equivalence
- Gordon, Robert J. (2003), Productivity Growth, Inflation, and Unemployment, Cambridge University Press, pp. 226–227, doi:10.2277/0521800080, ISBN 0-521-53142-X
- Kilborn, Peter T. (1988-07-23), "'Fresh Water' Economists Gain", The New York Times, retrieved 009-11-27
- Warsh, David (2006), Knowledge and the Wealth of Nations, W. W. Norton & Company, pp. 105, 270–272, ISBN 0-393-05996-0
- Mankiw, Greg (2006), "The Macroeconomist as Scientist and Engineer", Journal of Economic Perspectives 20 (4): 29–46, doi:10.1257/jep.20.4.29
- Warsh, David (1988-09-04), "The Third Coast", The Boston Globe, retrieved 2009-11-27
- Arnold Kling. (2002). Sweetwater vs. Saltwater.
- Thomas F. Cooley. (2009-09-08). Animal Planet Vs. Economic Reasoning .
- Krugman, Paul (2009-09-02), "How Did Economists Get It So Wrong?", The New York Times, retrieved 2009-11-27
- Williamson, Stephen, The Confused and the Confusing
- The State of Economics:The other-worldly philosophers in The Economist.com.
- Background on "fresh water" and "salt water" macroeconomics, by Robert Waldmann