Introduction The Story of Macroeconomics. September 2011

Transcription

1 Introduction The Story of Macroeconomics September 2011

2 Keynes General Theory (1936) regards volatile expectations as the main source of economic fluctuations. animal spirits (shifts in expectations) econ fluctuations In the SR, the effective demand (agg. Demand) determines output. the multiplier process: shocks shifts in output Market forces cannot automatically cure recessions. Active use of fiscal policy is essential to return the economy to high employment.

3 The Neoclassical Synthesis IS-LM model SR, sticky prices Theories of consumption (e.g., Modigliani, Friedman), investment, and money demand (Tobin) Growth theory (Solow 1956) Macroeconometric models IS-LM + Phillips curve Solow: Macroeconomics is finished.

4 Keynesians versus Monetarists: Monetary versus fiscal policy Friedman and Schwartz (1963) A Monetary History of the United States, Monetary policy was very powerful and it could explain most of the fluctuations in output, e.g., Great Depression.

5 Keynesians versus Monetarists: The Phillips curve Friedman (1968) and Phelps (1968): no LR trade-off between inflation and unemployment high past inflation would raise expected inflation, and that if unemployment were kept below its natural rate then the Phillips curve would shift upward over time, generating higher and higher inflation. expectation-augmented Phillips curve

6 Keynesians versus Monetarists: The role of policy Friedman argued for the use of simple rules, such as steady money growth. The available evidence casts doubts on the possibility of producing any fine adjustments in economic activity by fine adjustments in monetary policy at least in the present state of knowledge. There are thus serious limitations to the possibility of a discretionary monetary policy and much danger that such a policy may make matters worse than better.

7 Counter-revolution in the Economics profession The stagflation of the 1970s proved Friedman and Phelps to be completely correct. In less than a decade the economics profession shifted to the expectations-augmented Phillips curve that we use today.

8 Implications of Rational Expectations: The Lucas critique The Keynesian models did not pay enough attention to expectations, they failed to recognize that systematic changes in economic policy would change the parameters of the consumption and investment functions as well as the location of the Phillips curve. Thus macroeconomic models that took the estimated relations between economic variables as they held in the past, under past policies, as building blocks would blow up in the face of policy makers.

9 Implications of Rational Expectations RE and Phillips curve If the wage setters had RE, the adjustment of output to its natural level was likely to be much faster. Only unanticipated changes in money supply should affect output. Optimal control versus game theory If people and firms had RE, the right way was to think of policy as game between policy makers and the economy.

10 Results of RE revolution More focus on structural modeling of the economy (microfoundation based on the first principles) rather than estimating reduced-formed equations. taking expectations seriously Money neutral yes no Markets clear yes classical (RBC) new classical (imperfect info) no real rigidity new Keynesian nominal rigidity

11 Real business cycle models (RBC) Assume that output is always at its natural level. All fluctuations in output are movements of the natural level of output. random fluctuations in productivity main source of econ fluctuations. Criticisms of RBC Money wages are sticky. Intertemporal substitution is too weak to account for large fluctuations in labor supply and employment with small real wage changes. Technology shocks are not capable of creating the swings in productivity indicated by growth accounting.

12 New Keynesian Imperfections in different markets e.g. credit markets the role of nominal rigidities in propagating shocks to the economy Some cyclical unemployment due to failure of prices and wages to fall when demand falls.

13 Unification again since the 1990s RBC + New Keynesian insight dynamic stochastic general equilibrium models Business cycles may be caused by real shocks but nominal rigidity leads to inefficiency. Opens up critical role for monetary policy in economic stabilization.

14 New Monetarists Microfoundations matter: analyses of macro and monetary economics, including policy discussions, require adherence to a sound and internally consistent economic theory. Money matters: use models that are explicit about the frictions that give rise to a role for money. Financial intermediation matters. Modeling frictions: needs appropriate levels of abstraction and tractability (e.g. OLG and search models). To have a framework making use of similar assumptions and technical devices, that can be applied to a variety of issues.