Reckless New Keynesians

Print/Save PDF

The GEM Project focuses on evidence-consistent rational wage rigidity and its role in macroeconomic analysis. That research has demonstrated that, in highly specialized economies, WR manifests itself in two ways: downward nominal wage rigidity and pure wage rent. DWR is defined by its capacity to rationally suppress labor-price recontracting, which in stabilization analysis is a super-power. PWR is even more consequential, defined as rational labor payment chronically in excess of market opportunity cost to a substantial share of the total work force.

Downward wage rigidity is more familiar to macroeconomists. Early Keynesians unsuccessfully put DWR microfoundations at the top of their research agenda. It is good news that the GEM Project added PWR to the EK quest and then solved the enduring wage-rigidity puzzle. The task was not easy. It necessitated constructing a workplace venue of rational exchange restricted by costly, asymmetric on-the-job information and routinized jobs. Once cojoined with mainstream market-centric analysis,  the second venue uses optimizing employer-employee interaction organized by continuous general decision-rule equilibrium to motivate both DWR and PWR.

The Project’s achievement, however, came at an awkward time. Since seizing the macro mainstream in the late 20th century, New Keynesians have reworked the EK research agenda and made welcome progress toward realigning model-building with optimization and equilibrium, the fundamental tenets of economic theory. Headway, however, has been uneven. Most notably, discouraged by the stubborn difficulty of the problem NK theorists effectively abandoned research on wage-rigidity microfoundations, quietly accepting the practical adequacy of irrational assumptions about nonmarket labor-pricing. The dominating make-do example today is Guillermo Calvo’s randomly rotating, arbitrarily fixed wage. Mainstream NK macroeconomists use that irrational short-cut to provide some empirical relevance to their consensus friction-augmented general-market-equilibrium (FGME) modeling.

Early Keynesians also assumed irrational wage rigidity to provide their models with stabilization relevance. The two schools, however, differ in a consequential way. EK modelers emphasized that their work was provisional, awaiting guidance from future research that figures out how to microfound DWR. By contrast, NK theorists (as noted above) have implicitly concluded that rational-behavior wage rigidity is not especially important. Moreover, frustrated by their inability to square their FGME modeling with mass involuntary job loss and other critical macro facts, they have become increasingly aggressive in defending the mainstream status of market-centric thinking, culminating in the tacit NK agreement that (even in the absence of rational DWR) their market-centric, continuous-equilibrium model class is today fundamentally settled theory. There is no need to continue debating macro foundations. More to the point, there is no need to endure the disruption that would result from introducing the workplace venue of rational exchange. Most NK theorists appear satisfied that their FGME model class is just about as good as it can get.

The idea, as I understand it, is to simply ignore dissatisfaction with the inability of mainstream general market equilibrium to explain troublesome instability facts. It takes chutzpah to ignore critics when they include important policymakers. One of the most significant stabilization authorities during the Great Recession illustrates that discontent. Jean-Claude Trichet was Governor of the European Central Bank when he complained that mainstream macro models provided authorities little guidance on how to respond to the macro turmoil in Europe that closely followed the 2008-09 extreme instability in the United States. From Trichet (2010): “When the crisis came, the serious limitations of existing economic and financial models immediately became apparent. Macro models failed to predict the crisis and seemed incapable of explaining what was happening to the economy in a convincing manner. As a policymaker during the crisis, I found the available models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools.” The even more crucial policymaker felt much the same way. Ben Bernanke. during the design and execution of the Fed’s successful strategy to prevent the 2008 crisis from morphing into a 21st-century depression, curtly dismissed mainstream macro theory.

The reckless push to have FGME broadly recognized as settled theory has had consequences. Most relevant here it has suppressed macro research on rational nonmarket exchange. Model-building that explains what goes on inside firms as well as gathering/interpretating nonmarket evidence has indeed been long dormant. But, while relevant research has become increasingly dated, that does not mean it is no longer useful. Indeed, the GEM Project has demonstrated that by the turn of the century the nonmarket fact-finding literature was sufficiently robust to fully support the workplace-marketplace synthesis today.

The readily apparent power and empirical relevance of the workplace venue provides watertight motivation to establish an intrafirm beachhead in dominant market-centric macroeconomics. The GEM Project delivers a generalized-exchange theory that satisfies Edmond Malinvaud’s (1977) high model-building standards: “…the characteristics of great theoretical achievements [are] clear foundations, consistency with many observed facts, unification of theories which previously appeared as fundamentally distinct.” The boldness of my “great theoretical achievement” claim should pique interest, if only to satisfy the urge to debunk.

Pulling it all together, the GEM Project produces the first continuous-equilibrium, rational-behavior macroeconomics that is consistent with the broad range of instability evidence. Those facts notably include the ever-problematic involuntary job loss that occurs in the millions in each and every recession but is, out of necessity, marginalized in modern market-centric macro research. Won’t scholars, serious about stabilization and frustrated by the recklessness of insisting that FGME modeling is settled theory, want to look at the generalization of rational exchange?

Blog Type: New Keynesians

Write a Comment

Your email address will not be published.