Last week’s post summarized Michael Woodford’s five key elements of the 21st-century consensus among macro theorists. He celebrates the general acceptance of the friction-augmented general-market-equilibrium (FGME) framework in modern analysis: “… the study of business fluctuations is no longer driven by the kind of disagreements about the foundations of macroeconomic analysis that characterized the decades following World War II.” The post dismantled that claim, focusing on debilitating shortcomings of consensus theory in economies that are dependent on workplaces restricted by costly asymmetric employer-employee information. It laid bare the folly of Woodford’s choice to ignore the neoclassical maxim that market-centric modeling must not be relied upon in the context of unbalanced information.
Does Woodford worry, at least in private, about the damage caused by pushing aside that sensible maxim? Isn’t it obvious that dogmatic commitment to market-centric modeling badly constricts theorists’ capacity to account for consequential intra-firm features of modern economies? Ignored or misrepresented phenomena in Woodford’s world include involuntary job loss, persistent cyclical joblessness, continuous-equilibrium unemployment, the nature of good and bad jobs, the distribution of firm revenues among factors of production, the existence and role of pure profit, the determinants of capital spending, the determinants of household consumption (ignoring the GEM revival of the insightful 1971 analysis of Barro & Grossman), job tenure, worker reference standards, wage givebacks, firm downsizing, Harris-Todaro rational job transfer, the centrality of nominal-demand management in stabilization policymaking, the relative importance of the Federal Reserve’s real-side objective, the existence and importance of large human-resource departments in firms that account for a substantial share of total employment, the criticality of Herbert Simon’s maxim that profit-seeking management must invest in convincing employees to adopt the firm’s objectives as their own, management recognition of the importance of equitable treatment in employee satisfaction, and the endogeneity of effective worker supervision. That’s a lot of damage.
This week looks at what, in the same piece, Woodford identifies as the most significant remaining disagreement among macroeconomists: “… important differences in methodological orientation remain among macroeconomists. Probably the most obvious divisions concern the importance attached, by different researchers, to work aspiring to “pure science” relative to work intended to address applied problems. This leads to differing evaluations of the degree of progress recently achieved in the field, which might suggest to outside observers that the foundations of the subject remain fundamentally contested, even though, as I have argued above, there are not really alternative approaches to the resolution of macroeconomic issues any longer.
“One hears expressions of skepticism about the degree of progress in macroeconomics from both sides of this debate, from those who complain that macroeconomics is not concerned enough with scientific rigor and from those who complain that the field has been exclusively concerned with it. Some protest that the current generation of empirical DSGE models, mentioned above as illustrations of the new synthesis in methodology, have not been validated with sufficiently rigorous methods to be used in policy analysis (e.g., Chari, Kehoe, and… McGrattan, 2008). Proponents of this view do not typically assert that some other available model would be more reliable for that purpose. Instead, they argue that scholars with intellectual integrity have no business commenting on policy issues.” Tension between the math and policy wonks is the biggest methodological problem in a macro academy that cannot accommodate layoffs? LOL. Involuntary job loss is surely the most important property of macro instability, yet mainstream New Keynesians have invested inordinate effort convincing themselves to make do instead with voluntary unemployment. What we have is a con that macro theorists are playing on themselves. Keynes must be rotating in his grave.
Given the importance in public and private policymaking of understanding how the economy actually works, the state of modern macroeconomics is tragic. There is no better word. Mainstream thinking has badly regressed in its explanation stabilization over the past half-century. Today, the best advice to policymakers is to ignore the guidance of Woodford and other leading macro theorists. Indeed, that is what the world’s two major central banks were doing in their battle to tame the 2007-09 Great Recession. (It is particularly embarrassing that Woodford’s article was published in early 2009.) Top policymakers in both institutions were bitter about the sorry irrelevance of “converged” macroeconomics in their time of need. What twisted incentives does it take to ignore a world in crisis in order to keep praising a model that is clueless about what is actually going on? For starters, mainstream theorists could acknowledge that the six million lost jobs, accumulating when Woodford was extolling the power of voluntary unemployment to usefully explain what happens in recession, were in fact involuntary. The two concepts differ fundamentally.
The saving grace is the solution to the mainstream mess is not difficult. The macro academy must admit that market-centricity used to model economies in which a great deal of total employment and production occurs in workplaces restricted by unbalanced information is not adequate. We all, at least deep down, know that. It easily follows that useful analysis requires the generalization of optimizing exchange from the marketplace to information-challenged workplaces. Macro theory quickly becomes practical rather than dangerous. Perhaps Woodford could help by revising his assessment of the central the central tension in the profession today from rigor versus practicality to willful ignorance versus usefulness. Wouldn’t it be good to stop doing damage?
Blog Type: New Keynesians Chicago, Illinois