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Macroeconomics made easy?

February 10th, 2014

In my book, Zombie Economics, I started the account of macroeconomics with the observation

Macroeconomics began with Keynes. Before Keynes wrote The General Theory of Employment, Interest, and Money, economic theory consisted almost entirely of what is now called microeconomics. The difference between the two is commonly put by saying that microeconomics is concerned with individual markets and macroeconomics with the economy as a whole, but that formulation implicitly assumes a view of the world that is at least partly Keynesian.

Long before Keynes, neoclassical economists had both a theory of how prices are determined in individual markets so as to match supply and demand (“partial equilibrium theory”) and a theory of how all the prices in the economy are jointly determined to produce a “general equilibrium” in which there are no unsold goods or unemployed workers.

I went on to observe how the pre-Keynesian approach had been revived by the “New Classical” school, and how the apparent convergence with “New Keynesian” economics had been shown to be illusory after the failure of Dynamic Stochastic General Equilibrium models to deal with the 2008 financial crisis and the subsquent, still continuing, depression.

With all of this, though, I still never thought of academic macro, in either saltwater or freshwater form, as being a simple reversion to the pre-Keynesian notion of general equilibrium, with no concern about aggregate demand or unemployment, even in the short run. It turns out that, at least for a large segment of the profession, this is quite wrong. I’ve just received a book entitled Big ideas in Macroeconomics: A nontechnical view by Kartik Athreya, an economist at the Richmond Federal Reserve who made a splash a few years back with a piece entitled Economics is Hard. Don’t Let Bloggers Tell You Otherwise, which, unsurprisingly, did not endear him to bloggers. As a critic of mainstream macro, I’m briefly mentioned, and I just got a review copy.

The new book is an attempt to simplify things, and indeed it has proved enlightening to me and also to Herb Gintis who contributes a blurb on the back, commending it as an accessible and accurate description of the dominant way of thinking about macroeconomics.

The easiest way to see why the book is so striking is to list some topics that do not appear in the index (and are not discussed, or only mentioned in passing, in the text). These include: unemployment, inflation, recession, depression, business cycle, Phillips curve, NAIRU, Taylor Rule, money, monetary policy and fiscal policy.

By contrast, the book includes a lengthy treatment of such topics as Bayes-Nash equilibrium in game theory, intertemporal optimization of consumption and the theory of mechanism design.

If you think that this sounds like Hamlet not merely without the Prince, but without anyone in Elsinore, from King Hamlet’s Ghost to Fortinbras, that’s because you are expecting the wrong play.

In Athreya’s world, and that of a large part of the academic macroeconomics profession, macroeconomics does indeed begin with Walras, and the first modern development in the field was the formalization of Walras’ model by the economic theorists Arrow, Debreu and MacKenzie in the 1950s. The big subsequent development is the integration of growth theory into the static ADM framework to generate the modern dynamic stochastic general equilibrium (DSGE) models. Keynes’ 1936 ‘essay’ is treated as a curiosity, too vague and wordy to permit any real analysis.

This has the odd effect that many of the leading Keynesians of the postwar era (including Samuelson, Solow and the unjustly neglected Australian economist Trevor Swan) are given respectful cites for their work on growth theory, even as (what they would have regarded as) their macroeconomic work is dismissed as being too silly even to be refuted. Even Milton Friedman is treated similarly, with his intertemporal consumption model being praised, while his adaptive expectations model of inflation is ignored. Real macro (that is, Walrasian GE applied to issues like the business cycle) begins, in this analysis, with Robert Lucas in the late 1970s.

All this gives me a bit more insight into the apparent convergence in macroeconomics in the early years of this century, and its breakdown in 2008. The New Keynesians understood themselves as having met their New Classical colleagues halfway, with DSGE models which were Keynesian in character, at least in the short run, while meeting the demands for rigorous microeconomic foundations. Meanwhile, the New Classical school were quietly snickering whenever Keynes’ name was mentioned, but were prepared to concede the possible existence of largely unspecified market “imperfections”, whose only role in practice was to justify a policy of inflation targeting.

The crisis that erupted in 2008 destroyed this spurious consensus. On any kind of Keynesian view, New or Old, the combination of high unemployment and zero interest rates implied that the economy had been driven into a Keynesian liquidity trap, with a need for fiscal stimulus on a massive scale. By contrast, for the New Classicals, a disaster of this kind could only be the result of government failure (or, in places where they still mattered, the pernicious actions of trade unions). Since this was implausible, New Classical economists have generally preferred to reassert dogma without too much attention to facts.

Broadly speaking, as far as academic macroeconomics is concerned, DSGE has won the day, not so much by force of argument as by maintaining control of the criteria for publication of journal articles in the field: it’s OK to assume full employment, and ignore inflation, but not to omit rigorous microfoundations for your model. On the other hand, with the collapse of the intellectual case for austerity (though not its political dominance), the terms of public debate are set almost entirely by New Old Keynesians like Krugman and DeLong (that’s true, even if you don’t believe, as I do, that the outcome of that debate has been a knockout win for the Keynesian side).

The result is that there is almost zero intersection between Big Ideas in Macroeconomics and what I would think of as macroeconomics. It’s not so much that I think Athreya is wrong is that we are talking past each other. As Charles Goodhart said of DSGE, Athreya’s version of macro excludes everything in which I am interested.

  1. Jim Rose
    February 10th, 2014 at 21:17 | #1

    Macroeconomics began with Keynes. Before Keynes wrote The General Theory of Employment, Interest, and Money, economic theory consisted almost entirely of what is now called microeconomics.

    In 1937, Haberler had spent the two previous years researching competing theories of the causes and consequences of business cycles and then published Prosperity and Depression: A Theoretical Analysis of Cyclical Movements.

    Paul A. Samuelson hailed this book as “the definitive study of business cycles, both pre- and post-Keynesian” while Schumpeter referred to it as a “masterly presentation of the modern material” Read more at http://www.fee.org/the_freeman/detail/gottfried-haberler-a-centenary-appreciation#ixzz2susUhHTf

    the Athreya book sounds boring.

    who assumes full employment in real business cycle theory? much of richard rogerson’s career has been about labour supply and unemployment. Kydland and prescott’s work on time inconsistency is on the unemployment/inflation trade-off.

  2. Rodney
    February 10th, 2014 at 22:36 | #2

    I’m surprised you didn’t make the stronger statement that Athreya’s version of macro excludes everything of importance in the real world. (But then I’m not an economist.)

  3. Ikonoclast
    February 11th, 2014 at 07:26 | #3

    I would have thought that the Classical Political Economy of Adam Smith contained some macroeconomic elements. (Though it is a long time since I read The Wealth of Nations). I am fairly certain a considerable part of Marx’s analysis could be termed macroeconomics. Nevertheless, I agree Keynes is very important and is again shown to be relevant.

    In attempting to go from the lower to the higher, going from the “mechanical-mathematical” to the “organic-sociological” one might move from a consideration of microeconomics to macroeconomics to political economy. But this cannot be a simple mechanical or logical progression where one can deduce all the higher behaviours and phenomena from the lower. The higher behaviours and phenomena cannot be deduced in most cases. They must be empirically observed. Is not the attempt to deduce all economics from microeconomics both reductionist and a denial of the reality of emergent phenomena (which is perhaps the same thing)?

    Rather than trying to reduce political economy to mathematical microeconomics (surely a discredited project) would it not be better to apply reductionism (to the extent that it could reveal laws useful to political economy) to the thermoeconomics or biophysical economics project? In that case the laws of physics become the ally of the economist.

    It becomes fairly easy then to deduce some fundamental laws of economics by relating them to the Laws of Thermodynamics. For example, no economic production can occur without the use of exergy (energy available for useful work) and without a net increase in entropy in the biosphere. It is not easy to brush aside the insights that come from this. If the economy attempts to grow indefinitely then energy supply (or materials supply) will limit economic activity. Waste accumulation will become another limit. In other words, we would jettison the fallacy that the economy is free-standing from the natural world and unbound by basic natural laws.

    Most mainstream economists still pay no real attention to natural limits. Some pay lip-service and then go straight back to doing economics as if the natural world did not matter. This is the paradigm of our society which is now about to suffer a paradigm shock where all such illusions are shattered.

  4. Jim Rose
    February 11th, 2014 at 07:51 | #4

    Rodney :
    I’m surprised you didn’t make the stronger statement that Athreya’s version of macro excludes everything of importance in the real world. (But then I’m not an economist.)

    I am sorry but you are referring to keynesian macroeconomics.

    It is old Keynesian macroeconomics that ignores the real world in which incentives matter, people adjust, learn and anticipate within a policy regime, and they are subject to budget constraints including limited information and uncertainty.

  5. Uncle Milton
    February 11th, 2014 at 08:44 | #5

    The irony is that this guy works at a Federal Reserve Bank. While he is working on Bayes-Nash equilibria, most of his colleagues will be using the tools of macroeconomics circa 1974 to analyse unemployment, inflation, monetary policy etc so they can advise the President of the Richmond Fed on whether he should be arguing that interest rates should go up down, or the stay the same at the next Board of governors meeting.

    What would Kartik Athreya have to say if his boss asked him what should happen to interest rates month. He would have no way of thinking about it. It would be like asking someone what lies beyond the end of the universe.

    He can’t be very happy working at a place whose very existence is devoted to doing macroeconomics he doesn’t believe should exist.

  6. Ikonoclast
    February 11th, 2014 at 10:43 | #6

    It is so typical of bourgeois economics to want to argue about academic minutiae and irrelevant trivia and to entirely miss the main phenomena. Indeed this kind of ideological denial and obfuscation is part and parcel of the system’s attempt to perpetuate and grow forever in a finite environment. The irony is almost beyond belief. At the very moment we are about to hit the wall, the system and its dupes believe more heavily than ever in capitalist ideology and the lack of physical limits.

    “Today’s global ecological crisis is principally a product of the logic of capital, which treats the environment as an “externality” that does not enter directly into its system of valuation. Consequently, the global economy is increasingly on a collision course with the biosphere. An ecological collapse of life as we know it induced by present-day “business as usual” (that is, capitalism) is a threat that is increasingly imminent, inevitable if the world doesn’t change course, and irreversible. It represents a historic problem for which capitalism itself has no possible answer.” – Green Left Weekly.

  7. Independent Thinker
    February 13th, 2014 at 13:12 | #7

    Interesting to see a whole lot of discussion without knowing the facts.

    May be you should guys read this blog to get another perspective

  8. Independent Thinker
    February 13th, 2014 at 13:13 | #8

    ooops forgot link

  9. Jim Rose
    February 14th, 2014 at 18:11 | #9

    see http://ideas.repec.org/p/nwu/cmsems/453.html for the original title of the prescott and kydland paper Time to build and aggregate fluctuations which was Time to Build and the Persistence of Unemployment

  10. Miss Harvard
    February 15th, 2014 at 15:51 | #10

    I see Stephen Williamson cleans your clock again on his website.

    http://newmonetarism.blogspot.com/2014/02/macroeconomics-in-blogosphere.html

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