Rational Behavior Macroeconomics

Print/Save PDF

A powerful feature of generalized-exchange labor pricing is its roots in rational behavior organized by general decision-rule equilibrium. In the 1990s New Neoclassical Synthesis (NNS), mainstream New Keynesians (NK) committed to that venerable standard. Indeed, if faced with a choice between rationality and evidence consistency, any NNS jump ball goes to the former.  I admit to being uncomfortable with that always being the correct choice, but a long career making sense out of difficult, high stakes macro problems has persuaded me that close, not perfunctory, attention should be paid to rational behavior. Substituting assumptions of convenience misleads, typically badly. At a minimum, relying on such guesswork must be carefully justified.

But in practice such care borders on nonexistent. A recurrent lament of the GEM Blog is the casual mainstream NK scrapping of rationality, particularly in labor pricing, that robs macro modeling of powerful guidance. The use of rationality to motivate behavior is among the most useful innovations in the development of economics. If carefully pursued, rational self-interest has a record of opening up analyses to important, often unanticipated, results. Think about it. Why shouldn’t modern modeling of mass involuntary job loss aspire to Edmond Malinvaud’s (1977) high standards: “…the characteristics of great theoretical achievements [are] clear foundations, consistency with many observed facts, unification of theories which previously appeared as fundamentally distinct.”

NK research that relies on convenient wage-rigidity assumptions illustrates a consequential puzzle in mainstream macroeconomics. Rigorous rational-behavior labor-price inflexibility, consistent with the evidence, has already been modeled in the GEM Project (this website and elsewhere). NK theorists could incorporate  results of that existing work into their research at little cost. In so doing, they would acknowledge that the key to useful wage modeling after the Second Industrial Revolution is the intuitive addition of a second venue of rational exchange to textbook market-centric modeling. The new venue is comprised of firms in which workplace employer-employee information is inherently asymmetric. Such workplaces comprise a substantial share of the total labor force in any modern, highly specialized economy, making the confinement of labor pricing wholly to the marketplace deeply problematic. The exclusion of millions of workers in large, highly specialized firms from market-centric analysis is a problem that macro theorists ignore at their own peril.

Paying attention to the fact of information-challenged workplaces would immediately upgrade NK research to the elite status of macro models rooted in neoclassical tenets of optimization and equilibrium. Not even cranky Real Business Cycle theorists, always conscious of the terms of the New Neoclassical Synthesis, could not properly object.

Consider the case for and against the more general use of the powerful results of the workplace-marketplace synthesis. The general argument for usage is its consistency with Malinvaud’s great theoretical achievements noted above. The two-venue model grounds wage setting in optimization and general decision-rule equilibrium, protecting the theory from being misled by convenient, evidence-inconsistent labor pricing. It provides a rich, realistic environment for productive analysis. The  cornucopia of new, rational-behavior facts to be built upon features downward nominal wage rigidity over stationary business cycles, chronic wage rent, the existence of involuntary job loss in the millions in response to adverse demand disturbances, the critical distinction between stationary and nonstationary total-spending contractions, the existence of both temporary layoffs and permanent job downsizing, the exclusive location of rational wage rigidities and involuntary job loss in highly specialized firms restricted by information-challenged workplaces, and the existence of large human-resources departments that design intra-firm exchange mechanisms and set a substantial share of wages in modern economies.

The generalization of rational exchange from the marketplace to workplaces restricted by information asymmetries critically accommodates extreme  instability that transforms garden-variety recessions into depression. The 1930s depression, the 1970s stagflation, the 1990s virtuous cycle, the 2000s Great Recession, its subsequent slow recovery, and the 2020s abrupt contraction and rapid recovery from the mass COVID shutdown are provided more evidence-consistent explanation than provided by market-centric NK theory. The information-challenged workplace is informed by the nonconvex workplace-exchange relation. The WER (rooted in optimization and equilibrium)  is the long missing analytic tool that enables the rational-behavior modeling of mass involuntary job loss.   

What argues against the use of the intuitive workplace generalization of rational exchange? Little objection has been raised about the  intra-firm model itself. NK theorists familiar with the generalized-exchange theory accept that it is not wrong. Instead, critics argue that it is insufficiently useful to justify the cost of introducing the second (workplace) venue. That cost especially includes investment in human capital needed to understand what actually goes on inside large, highly specialized establishments, virgin territory for most – but not all – theorists. Herbert Simon and his colleagues in their close study of rational behavior occurring inside large, complex organizations have alerted economists to the inherent differences from goings-on in the marketplace. Despite the substantial share of total employment and wage income that occurs in firms with human-resource departments, leading NK theorists still insist on assigning little significance to the necessity of the workplace venue in order to accommodate the substantial modern incidence of asymmetric employer-employee workplace information. That assessment must be a conundrum for economists who teach as doctrine Akerlof’s market for lemons.

Blog Type: New Keynesians  

Write a Comment

Your email address will not be published.