Grad School Days, 3/19
Remembering the impish Rudi Dornbusch and one of his students, Eeyore
One of the books on financial history that influenced me was co-authored by a guy who was in graduate school with me way back when. Thinking about that book as it pertains to our seminar on financial institutions got me to musing about his dissertation adviser at MIT, Rudiger Dornbusch.
I started graduate course work at MIT in the fall of 1976 and wrapped up my dissertation 3-1/2 years later. Rudi’s course in international monetary theory was the last course I took there.
Rudi’s star took off in 1976, when he published a paper on exchange-rate behavior. Five years earlier, President Richard Nixon had suddenly ended the Bretton-Woods regime of pegged exchange rates, so flexible exchange rates were a new phenomenon in practice.
Rudi’s paper was highly influential for two reasons. One was that it incorporated the hypothesis of “rational expectations,” which was then taking the economics profession by storm. The other reason was that exchange rates as set by the market were proving to be highly volatile, something which had not been foreseen by Milton Friedman and others who had advocated for floating rates. Rudi’s mathematical model entailed a prediction that in response to events that disturbed the equilibrium relationship between two currencies, the process of adjustment would have the exchange rate jump past its new equilibrium value before gradually converging back to it. This “Dornbusch overshooting model” was roughly consistent with exchange-rate volatility, although a skeptic could question whether it truly accounted for that volatility.
Along with Stanley Fischer, Rudi stood astride the field of macroeconomics at MIT and, indeed, in the profession at large. One or both of them supervised the leading students in the field, who went on to dominate prestigious academic positions and top policy jobs both in the United States and overseas. These acolytes in turn went on to train the next generation of graduate students. You could trace so many macroeconomists back to Fischer that I refer to him as “the Genghis Khan of macroeconomics.”
Stan and Rudi struck me as having very different personalities. With his British (actually, Rhodesian) accent, Stan was the courtly gentleman. Although he made himself approachable to graduate students, his relationships with them were always formal and correct.
Rudi did not wait for students to approach him. He approached them. He was the impish fraternity brother, teasing, mocking, and instigating. When Rudi took up jogging, he convinced about half a dozen grad students to join him on runs.
In our program, there was a dark-haired, attractive woman from a prominent Latin American family who was interested in international monetary economics. She had dark glasses, which she liked to play with. I might glance over and see her mouth puckered around one of the stems. Or she would push the stem down her blouse and hang the glasses from the button near the bottom of her cleavage. Eventually, Rudi took up with her in lieu of his wife.
I myself stayed out of the orbit of Dornbusch and Fischer. My intellectual style clashed with theirs, and with MIT’s in general. At the time, I did not have enough confidence to believe that my way of approaching economics was at least as legitimate as theirs.
This was also a period in my life in which, for reasons having nothing to do with the study of economics, I was at the hedge-finance phase in what I call my personal Minsky cycle. My overall mood was one of detachment and lack of commitment. I was low-key about everything, passionate about nothing.
Paul and Ken, two students who had been undergraduates at Yale, started at MIT two years before I did, but finished only slightly before me. Their dissertations were both in international economics.
Each of them took a year away from MIT shortly after they completed their coursework. Paul was soothing his sensitive ego, which had been bruised at MIT, probably by Rudi. I was never comfortable around Paul, so I do not know the full story. He went on to earn a Nobel Prize and then become a well-known New York Times columnist.
Ken, on the other hand, took time off to pursue what for him was an important life goal, earning the title of Grandmaster at chess. I got to know him somewhat better. He was the one who suggested that I try Israeli dancing.
At dancing, I met Jackie (now my wife), and she also got to know Ken. She dubbed him “Eeyore,” because of his memorably pessimistic pronouncements, enunciated slowly in his deep voice. When I signed up to take my general exams early, he said “You’ve probably doubled your chances of failing, but increased your expected utility.” Another one of his pronouncements was that as we moved past grad school age, “It’s all down hill from here.” When the national debt increased, he would estimate how much his share had risen.
Today, Ken Rogoff’s main claim to fame is This Time is Different, the book that he co-authored with Carmen Reinhart. Their theme, that financial crises recur throughout history, resonated very well when the book was published, shortly after the financial crisis of 2008. Eeyore’s moment had arrived.
Thanks for sharing moments of your MIT years. Let me add some observations on the economists you mention. I'm older than you and all those economists. I knew Stan and Rudi in the late 1980s, and Rudi's second wife in the mid 1990s. I moved to DC when the LA debt crisis became a shock to the U.S. and European banking systems and the Bretton Woods institutions were asked to deal with it. It was in 1985 and soon I met Rudi who had entered into action trying to help the Brazilian government (I knew him because he had visited Chile for conferences and meetings with his former MIT students and soon we had opposing views of Chile’s economy between 1975 and the debt crisis which had started in June 1982). Rudi wanted to become the new LA’s Money Doctor (a reference to the advisory work of Princeton professor Edwin W. Kemmerer in the 1920s and 30s). It was a terrible time for the Brazilian government and to all other LA governments that needed urgently an extraordinary fiscal adjustment (only in Chile, the debt crisis had been the result of heavy private borrowing before interest rates jumped from 5% to 20% and the floating interest rates paid on the stock of foreign debt). Rudi was a great fighter against what he called populism but he lost —no LA country attempted a serious fiscal adjustment in the 1980s.
Stan moved to the WB in 1988 and soon had to learn to dance with a huge bureaucracy. I still remember his first participation in a loan committee. Indeed, it was a large loan that promised to support the fiscal adjustment of a large country (also heavily indebted but not a LA one). It was a close call given the country’s record but nothing compared with the fake support promised to Argentina later that year. By then, Stan had learned to dance. I’m not familiar with Stan’s participation in the IMF’s lending support to Argentina in the late 1990s but my impression is that his dancing with the Bretton Woods bureaucracy aged badly (remember that that experience ended with the famous “corralito” of December 2001). Then he spent some time far away from a bureaucracy and got ready to move to Israel, perhaps his greatest non-academic success.
They were not the only well-known academic economists moving to the U.S. government or the Bretton Woods institutions in the 1980s and 1990s. It looked like they knew something that non-academic economists, like myself, failed to understand. I assumed then they were moving out because of the great obstacles to make progress within orthodox macroeconomics and develop alternative theories. In the past 20 years, there has been little progress: we learned how flawed that macroeconomics is (I think the grotesque celebration of Piketty’s work on capital is a clear example of that failure) and there is nothing else to rely on. Most macroeconomists continue using the orthodox, “accounting” framework, expanded in several ways from the simple model of the early 1960. In turn, non-orthodox macroeconomists are still “warming-up”.
Although I participated with Rudi’s second wife in a large, expensive study of China’s state enterprises, I was already too old to play along the game of knowing what they have to do. In the early 1990s, I advised the WB and government donors on reforming Africa’s foreign aid but nothing happened as discussed years later by Bill Easterly in his book “The Elusive Quest for Growth…”. I didn’t dance with the donors’ bureaucracy but learned a few thing that helped me a lot while working in Beijing for 3 years. I tried but failed to teach those lessons to Rudi’s wife so I was not surprised that the study was ignored despite its huge cost. In particular, you have to spend a lot of time looking for the right people to help —never assume that because you can deliver a lot of other people’s money to someone else that money would be enough incentive for them to do as you want. In LA, I had been always advising people who had great projects or huge debts but when I moved to DC in 1985, I started to help government politicians and officers whose personal projects I was not supposed to help. That study turned out to be a personal project for too many people on both sides of the table.
In the 1990s, I used to be an avid reader of PK’s serious analysis but I stopped reading it when it took me too much time to figure out how serious his analysis was. Also, since I was involved in several financial and fiscal crisis, I’m familiar with the KR&CR’s book but I think it’s just a collection of poor data. They built their narrative on data over centuries when we can hardly built a good narrative of recent crises on reliable and relevant data. Also, they tried to find similarities across crises but you have to look at the differences too. If the purpose of the analysis is to build a general theory of financial crises, then focus on the similarities. But if the purpose is also to understand what government interventions are needed to end the crises, then focus on how a government should take account of the circumstances of the crisis is dealing with. Let us say that there are no two crises alike.
Arnold's reminiscence posts are fun.