What’s Essential in Macro Theory

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I admire Jean-Pascal Bénassy’s text Macroeconomic Theory (2011). But its New Keynesian roots cause him to get some significant things wrong. A troubling example is his identification of a “particularly important issue, that of government policy effectiveness. It is shown notably that hypotheses on information and expectations formulation are absolutely central in assessing whether government can actually control the evolution of employment and output.” (p.25)

Bénassy’s confident conclusion about expectations and information is the generally accepted assessment that has directed cutting-edge research for more than three decades. The GEM Project concurs with parts of it, especially the crucial roles of confidence (a kind of expectations) in stabilization authorities’ capacity to deliver on their real-side (high trend employment) objective and of imperfect information in large, highly specialized workplaces. However, his assertion of centrality for expectations formation is little more than a  misleading artifact of market-centric general-equilibrium restrictions imposed on the scope of rational price-mediated exchange. The artifact has diverted a great deal of the rigorous thinking about stabilization-relevant macroeconomics into blind alleys and is central to any adequate explanation of the paucity of useful stabilization theorems produced by the current generation of mainstream macro theorists.

In generalized-exchange modeling, meaningful wage rigidity uniquely microfounds the causal link from nominal demand disturbances to recognizably sized, same-direction changes in employment, output, and profits. The MWR channel is what is ‘absolutely central’ to macro-model stabilization-policy effectiveness, remaining robust even in the implausible perfect foresight circumstances of the Rational-Expectations Hypothesis. Exchange generalization from the marketplace to bureaucratic workplaces posits expectations that efficiently use available information, including all that is known about the behavior and plans of government authorities. Once the arbitrary, debilitating marketplace-only constraint on rational exchange is eliminated, the most consequential restriction on information is its asymmetric, costly nature in large, specialized workplaces, a limitation that is sufficiently accepted by practitioners to be axiomatic.

No reasonable debate rooted in the formulation of expectations or the nature of information attends the derivation, from model primitives, of the generalized-exchange capacity to microfound government stabilization effectiveness. (Chapters 2 and 3 in the Website’s E-book) Market failure, consistent with continuous decision-rule-equilibrium, is shown to result from the MWR interaction with nominal demand disturbances. Broad failure, characterized by substantial involuntary job, output, and income loss, is best understood as a meta-class externality. Within Pigou’s powerful externalities framework, the private costs associated with continuous, general decision-rule equilibrium are intermittently and at times substantially below the social cost of recessions or depressions. There can be no plausible opposition to such externalities mandating government intervention. Pigou went even further, asserting that economists have a moral responsibility to identify adverse externalities and design government interventions that ameliorate their effects.

To mainstream macro theorists, generalized exchange is an unfamiliar exercise, requiring significant human-capital retooling in order to accommodate what occurs in the specialized workplace. However, its unique capacity to properly answer big questions makes it well worth the effort. Microfounded MWR is ‘absolutely central’ to stabilization-relevant coherent macro modeling. Market-centric general-equilibrium modeling, despite interesting work on information and expectations formulation, is inherently not up to the task.

Blog Type: Wonkish San Miguel de Allende, Mexico

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