Macro stability is a critical part of the social compact. Our capacity to understand, and design policies to beneficially influence, the behavior of employment, output, wage income, profits, and inflation is entrusted to macroeconomists. It is a responsibility for which modern theorists have become surprisingly negligent, colluding to ignore essential parts of the overall evidence-consistent narrative. In what follows, that neglect is corrected by extending rational exchange from the marketplace to the workplace, surely an intuitive innovation. Generalizing exchange in coherent macro modeling uniquely motivates both meaningful wage rigidity (MWR) and the mass involuntary job loss (IJL) that results from adverse disturbances in nominal demand. Stabilization relevance is greatly 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 optimizing, price-mediated exchange organized by continuous general equilibrium. Most in the profession is justifiably pleased with their coherent methodology. Clarity and persuasive power are significant virtues, as is the capacity to systematically interpret empirical evidence, to distinguish among competing theories, and to predict important economic phenomena. Macroeconomists, however, should be less pleased that their 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 the 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 professional careers. The massive policy response to the sharp rise in involuntary job and income loss was 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 used to halt and reverse the contraction in total spending that began in earnest during the second half of 2008. Fed policymakers accepted, with little debate, that reductions in nominal demand necessarily translate into lost jobs, output, wage income, and profit, implying the existence of meaningful wage rigidity that cannot be coherently accommodated in modern market-centric macroeconomics.
Early Keynesians, who simply assumed a keystone role for meaningful wage rigidity (MWR), would have been comfortable with stabilization policymaking in 2008-09; 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 mainstream macro academy and today has little place in consensus thinking. From Woodford (2009, p.268) writing in the depth of the Great Recession “… 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 NK market frictions. Both should eschew replicating the Early-Keynesian reliance on model-inconsistent free parameters.
Given that history, it is not surprising that 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 confusion about the propriety of the modern use of Keynesian free parameters to suppress wage recontracting, the 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 during the post-2007 instability and subsequent sluggish recovery, is not acceptable.
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