Macroeconomic stability is a cornerstone of the modern social compact. Our capacity to understand, and design policies to beneficially influence, the cyclical behavior of employment, output, income, and inflation is entrusted to macroeconomists. It is a responsibility for which mainstream theorists have long been surprisingly negligent, ignoring essential parts of the story. The GEM Project helps remedy that neglect by extending rational price-mediated exchange from the marketplace to workplaces restricted by costly, asymmetric information and routinized jobs. The generalization of rational exchange in general-equilibrium modeling enables the microfounding of meaningful wage rigidity (MWR), pure wage rent (PWR), and involuntary job loss (IJL) that results from adverse disturbances in nominal demand. Stabilization relevance is enhanced absent any diminution of analytic rigor.
Relevance and rigor are both worthy objectives. Stabilization-policy guidance has been sine qua non for macro modeling since its emergence as a separate branch of economics in the 1930s global depression. Meanwhile, the unique power of economic theory, with its special status supporting government, business, and investor decision-making, is inextricably rooted in the formal economic method of organizing optimizing, price-mediated exchange via continuous general rational-behavior equilibrium. Most economists are justifiably pleased with their coherent methodology. Clarity and persuasive power are significant virtues, as is the capacity to systematically interpret evidence, to distinguish among competing theories, and to anticipate important economic phenomena. Macroeconomists, however, should be less pleased that mainstream modeling, rooted in market-centric dynamic general equilibrium, is today mired in a crisis of stabilization irrelevancy unmatched since the 1930s and the ascent of Keynes.
The hard fact is that mainstream macro modeling and New Keynesian (NK) theorists who construct and maintain it did not play a significant advisory role during the 2007-09 Great Recession, which was the most challenging instability crisis of their careers. The massive policy response to the frightening jump in involuntary job and income loss was instead grounded in ad hoc Keynesianism. Especially in the United States where the macro disruption originated and was most acute, monetary tools were aggressively and creatively used to halt and reverse the contraction in total spending that began in earnest during the second half of 2008. Policymakers accepted, without debate, that reductions in nominal demand necessarily translate into lost jobs, output, wage income, and profit. That acceptance implies the existence of meaningful wage rigidity (MWR), which is defined below and does not coherently exist in today’s consensus market-centric macroeconomics.
By contrast, Early Keynesians (EK) who simply assumed a keystone role for nominal wage rigidity would have been comfortable with the 2008-09 stabilization policymaking; and that’s the rub. The Keynesian modeling constructed by the founders of macroeconomics as a separate discipline has been repudiated, in harsh and unforgiving terms, in the academy and today has little place in consensus thinking. From Woodford (2009, p.268): “… there has been considerable convergence of opinion among macroeconomists over the past 10 or 15 years…. The cessation of methodological struggle within macroeconomics is due largely to the development of a new synthesis by Marvin Goodfriend and Robert G. King, called ‘the New Neoclassical Synthesis [NNS],’ that incorporates important elements of each of the apparently irreconcilable traditions of macroeconomic thought.”
The foremost element of the synthesis is that New Keynesians accept the necessity of coherent dynamic stochastic general-market-equilibrium (DSGE) microfoundations in modeling, while New Classical/RBC theorists accept the use of SVGE-consistent market frictions. Both should eschew replicating the Early-Keynesian reliance on convenient free parameters.
Given that background, it is not surprising that many prominent scholars are reluctant to emphasize the monetary management of unemployment and instead focus on real disturbances rooted in technology, tastes, or public spending to complement their core emphasis on the control of price inflation. Related rejection of the use of Keynesian free parameters to suppress wage recontracting, the primary mechanism by which nominal wages are reduced, is also unsurprising. The analytic muddle associated with the proper design of monetary policy, a bold-relief characteristic of mainstream macro modeling that has persisted in the aftermath of the Great Recession, is not acceptable.
Blog type: New Keynesians
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