Macroeconomic stability is a cornerstone of the modern social compact. Our capacity to under-stand, 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 provides a remedy for 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 (decision-rule) equilibrium enables the microfounding of downward wage rigidity (DWR), pure wage rent (PWR), and involuntary job loss. IJL is manifest in both temporary layoffs and permanent job downsizing that result from adverse disturbances in nominal demand. Absent DWR, PWR, and IJL macro theory that is both stabilization relevant and rigorous, i.e. rooted in optimization and equilibrium, is not feasible.
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 optimizing, price-mediated exchange organized by general decision-rule equilibrium. Most economists are justifiably pleased with their 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, has for decades been 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 and fiscal 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 DWR, which is defined below and does not coherently exist in today’s consensus macroeconomics.
By contrast, Early Keynesians (EK) who simply assumed a keystone role for nominal wage rigidity (NWR) 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 rigorous 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 accepted the necessity of coherent dynamic stochastic general-market-equilibrium (DSGE) microfoundations in modeling, while New Classical/RBC theorists accepted the use of rational market frictions. Both promised to eschew replicating the Early-Keynesian reliance on model-inconsistent free parameters.
A huge stumbling block proved to be the inherent absence of super friction that rationally suppresses wage recontracting. Consequently, 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. The 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.
The GEM Project research agenda has two overriding objectives. First is to properly microfound nominal wage rigidities. Rational NWR was, of course, the elusive holy grail of Early Keynesian labor research; and, despite modern inattention, it remains crucially important. For the first time in the history of economic theory, both DWR and PWR have been made consistent with optimizing behavior organized by continuous general decision-rule equilibrium and, consequently, with rigorous macro theory. Inclusion of GEM research in mainstream debate and dissemination provides consensus thinking a path to stabilization-policy relevance as well as an enriched understanding of economic growth. It is a big deal
Second, the book systematically works through implications of rational PWR in a range of applications of macro theory. The far-reaching exercise further demonstrates the criticality of wage rigidity in the understanding of highly specialized economies featuring workplaces that are inherently restricted by costly, asymmetric information.
Blog Type: New Keynesians Saint Joseph, Michigan