Conundrum Macroeconomics

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The term I came up with is “conundrum economics”. The heretofore nameless phenomenon refers to analysis with models that lack the capacity to accommodate, at least coherently, the existence of the activity being studied. The urge to name that curious practice became acute with the juxtaposition of the macro thinking that dominates modern graduate-school curriculums and the devastating 2008-09 episode of extreme macro instability. The Great Recession is understood to have been the most perilous edge-of-depression market breakdown since the 1930s.

A deeply troubling conundrum of the friction-augmented general-market-equilibrium (FGME) model class, aka dynamic stochastic general equilibrium (DSGE), is its inability to accommodate the six million involuntarily lost jobs that occurred during the 2008-09 crisis. Barro formulated his famous critique of arbitrarily suppressing wage recontracting lest we forget Lucas’s message that the nonexistence of forced job loss is a requirement of market-centric general equilibrium. After huge New Keynesian investment of time and resources, mainstream theorists have discovered no market super friction able to overturn the rational decision rule requiring an employee to choose a wage cut, rather than job loss, if the reduced wage does not violate his or her opportunity costs. Consensus theory becomes a conundrum exercise whenever tasked to explain contraction phases of business cycles, which always feature involuntary job loss and consequent unemployment.

Conundrum macroeconomics is best understood as the result of the century-long conflict between two model-building methodologies. One side has usefully emphasized analytic rigor, coherently modeling aggregate behavior guided by optimizing market exchange organized around general equilibrium. The other has stressed, also usefully, stabilization relevancy, positing irrational wage rigidity in order to link spending disturbances and job- and output-instability and thereby justifying discretionary management of nominal demand. The arguments of each side are largely valid, a tricky situation that motivated a prolonged macro civil war. If the two approaches remain unreconciled, the pendulum of theoretic dominance will continue to swing between the opposing camps, indicating that the promise of macroeconomics will remain unfulfilled.

The GEM Project is full of good news on dealing with the longstanding conundrum. Most fundamentally, it demonstrates that there is no inherent conflict between the analytic rigor of rational exchange organized by dynamic general decision-rule equilibrium and the stabilization relevancy provided by meaningful wage rigidity. Reconciliation is made possible by the generalization of optimizing exchange from the marketplace to workplaces restricted by costly, asymmetric employer-employee information and routinized jobs. Arbitrarily restricting price-mediated transactions to the marketplace turns out to be the principal reason why, at least since the Second Industrial Revolution, rational-behavior macro models have not been up to the task of elucidating recurring, costly instability in highly specialized economies.

The truncated scope of rational exchange has, for some time, been poisoning the macro well. Beyond the failure to come close to adequately explicating the 2007-09 (or any other) recession, it is alarming that obvious shortcomings of modern macro thinking have been generating deep dissatisfaction among the coming generations of economists. The bleak message of David Colander’s (2005, p.180) survey of and interviews with graduate students at seven top-ranked North American economics programs is that new customers are rejecting the product: “In the interviews, macro received highly negative marks across schools. A typical comment was the following: ‘The general perspective of the micro students is that the macro courses are pretty worthless, and we do not see why we have to do it, because we don’t see what is taught as a plausible description of the economy. It’s not that macroeconomic questions are inherently uninteresting; it is just that the models presented in the courses are not up to the job of explaining what is happening. There’s just a lot of math, and we can’t see the purpose of it.’” Another student was more succinct: “Macro sucks.” (Colander (2007), p.174) Nothing has changed. The central message of the GEM Project remains: The costs of counterfactually restricting macro theory to a single (market) venue of exchange are broadly debilitating.

Blog Type: New Keynesians

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