Lucas's slides tell a nice story, and the general idea is to draw a parallel between the Great Depression and the recent recession. This is not a talk based on original research, but draws ideas mainly from the work of others. Lucas's account of the Great Depression follows Friedman and Schwartz's Monetary History and Cole and Ohanian (see this Wall Street Journal article for a summary of their research). Basically, the Fed did not act appropriately to offset the monetary contraction culminating in the massive banking failures and panics of 1933, and the recovery was prolonged by various New Deal policies.
Lucas's narrative for the recent recession in part follows Gary Gorton (see this interview for example). In contrast to the Great Depression, there was no disruption in payments, but in Gorton's view there was something akin to a bank run phenomenon in the shadow banking sector. But, in Lucas's view, the Fed did the right thing in this instance, acting to mitigate the effects of the financial panic.
I could find plenty of reasons to quarrel with Lucas's story. The Friedman-Schwartz quantity-theory-of-money narrative misses the the effects of lost intermediation services; Gary Gorton's Diamond-Dybvig shadow-bank-run story may not hold water; Cole and Ohanian downplay financial factors to a fault; etc.
However, what Krugman and friends focus on is summarized in Lucas's conclusion:
Lucas sees this as another parallel to the Great Depression. The Fed has now done all it can, so what is impeding the recovery? Possibly, just as in the Great Depression (according to the Cole-Ohanian narrative), it's the government again.
• Throughout this talk, I have defined recession as deviation from a 3% growth trend.
• Implicit assumption is that economy will get back to old trend line–only question is how long it will take.
• Is this really the case?
• Know that European economies have larger government role and 20-30% lower income level than US.
• Is it possible that by imitating European policies on labor markets, welfare, and taxes U.S. has chosen a new, lower GDP trend?
• If so, it may be that the weak recovery we have had so far is all the recovery we will get.
Now it's clear, at least to me, that Lucas is just throwing out an idea for discussion. Lucas is a scientist, of course, and he's not going to commit himself to some view without solid research to back it up. That's why he uses words like "is it possible..." If I were looking for a reason for the sluggishness in the current recovery, blaming the US government would not be the first thing that would come to mind, but it is not silly for Lucas to be asking the question. In any case, Lucas's talk is at least thought-provoking, and frames the issues in a nice way.
Now, here's what Krugman has to say about it:
there’s a good reason Lucas won’t even consider the obvious explanation in terms of a shortfall in demand. More than 30 years ago, in a burst of radically premature triumphalism, Lucas and his colleagues declared the “Death of Keynesian economics”. As cited by Greg Mankiw (pdf), Lucas wrote that Keynesian theorizing was so passe that people would giggle and whisper if it came up in seminars.Now, as if this was not already abundantly obvious, Krugman is seriously confused.
Since then, as is obvious to everyone but the hermetic inhabitants of the freshwater world, the attempt to explain business cycles in terms of rational expectations and frictionless markets has failed; and Keynesian economics continues to be very useful. But to concede that, to even consider the possibility that we’re in a demand-shortfall slump of the kind Keynes diagnosed, would be an incredible comedown for Lucas.
So he can’t and won’t consider the possibility.
The Mankiw paper that Krugman links to is this one. This is an interesting piece of intellectual history, as that paper looks like a precursor to Ball and Mankiw's Sticky Price Manifesto. Actually, Lucas's comments on the Ball-Mankiw paper are excellent reading in this context, and apply directly to how Krugman thinks about the world. Here are some of the more juicy passages:
The cost of the ideological approach adopted by Ball and Mankiw is that one loses contact with the progressive, cumulative science aspect of macroeconomics. In order to recognize the existence and possibility of research progress, one needs to recognize deficiencies in traditional views, to acknowledge the existence of unresolved questions on which intelligent people can differ. For the ideological traditionalist, this acknowledgement is too risky. Better to deny the possibility of real progress, to treat new ideas as useful only in refuting new heresies, in getting us back where we were before the heretics threatened to spoil everything. There is a tradition that must be defended against heresy, but within that tradition there is no development, only unchanging truth.And,
A few years ago, one of my sons used the Samuelson-Nordhaus textbook in a college economics course. When I visited him, I looked at the endpaper of the book to see if actual GNP was getting any closer to potential GNP than it had been in the edition I had used many years earlier. But the old chart was gone, and in its place was a kind of genealogy of economic thought, with boxes for Smith and Ricardo at the top, and a complicated picture of boxes connected by lines, descending down to the present day. At the bottom were three boxes: On the left, a box labelled “Communist China”; in the center, and slightly larger than the rest, a box labelled “Mainstream Keynesianism.” The last box, on the right, was labelled “Chicago monetarism.”In Lucas's commentary you can pretty much substitute "Krugman" for "Ball and Mankiw" and it makes perfect sense.
Times change. Accordingly, to Ball and Mankiw, Chicago monetarism (or at least Milton Friedman) now shares the middle, mainstream box, and there is a new group for the right-hand box, to be paired with the Chinese communists. But the tradition of argument by innuendo, of caricaturing one’s unnamed opponents, of using them as foils to dramatize one’s own position, continues on. I am sorry to see it perpetuated by Ball and Mankiw, and I hope they will put it behind them and return to the research contributions we know they are capable of making.
Delong's response was more amusing. He said he wished Lucas would "take Milton Friedman seriously." All of those slides look liked a pretty strong endorsement of the Friedman-Schwartz interpretation of the Great Depression! I have to wonder if he even read the slides or just saw the name Lucas and went into insta-mock mode.ReplyDelete
The difference in humility is pretty staggering though. Lucas tone is almost conjectural, whereas Krugman is so confident and authoritative - despite the fact nobody really has a strong grasp on what's going on. I don't personally agree with Lucas' analysis, but I don't know what's the point of attacking the man for just speculating on possible reasons why the recovery is weak - especially since his reasoning isn't completely insane. It's not as though Krugman has a better theory, outside of just complaining that aggregate demand isn't big enough - whatever that means.
Lots of words here, but no, the notion that Obama socialism is the reason for the slow recovery really does deserve ridicule, regardless of your opinion on the personalities of the people arguing pro or con.ReplyDelete
"Lots of words here, but no, the notion that Obama socialism is the reason for the slow recovery really does deserve ridicule, regardless of your opinion on the personalities of the people arguing pro or con."ReplyDelete
Of course, anonymous poster knows everything, much more than Lucas. The arrogance of such people is astounding. Fortunately, no one will ever hear or care what this guy says.
Ctrl+F Obama. Weird, it didn't turn up with anything.ReplyDelete
The only thing we have here is the dredges of the left wing blogosphere latching on to a single bullet point at the end of a 40 page powerpoint presentation. It has followed the usual pattern- the greater the degree of separation from Krugman the more awful and vapid the criticisms have become. At the tail end of the lot and the furthest removed you've got poor little Matt Yglesias, who in the fashion typical of his "low quality high quantity" blog format vomited out this monstrosity:
I have a feeling that Lucas wasn't actually trying to accuse the man he voted for of raising the red flag of communism above Washington, but hey that's just me.
Kartik got Yglesias right -- he is a boob with no business commenting on economics. Shame that nitwit is perceived as an economist.ReplyDelete
Matt, if you read this, I AM trying to be rude. You're a joke and you should know it.
Lucas' critique of the intellectual style that he ascribes to Ball and Mankiw is part of my own critique of Lucas and his movement:ReplyDelete
It is a bit rich, for example, to hear a Rational Expectations guy talk about "science", when so many lab experiments have shown that RE only occasionally applies.
And I do NOT buy the notion that Lucas is "throwing some ideas out there for discussion" in his recent lecture. The notion that the long duration of this recession is due to Obama's policies is absurd on its face (given the fact that most of them are just partial returns to policies that prevailed for most of the postwar period). Why doesn't Lucas instead suggest that the recession is caused by aliens controlling our brains from space or Communists fluoridating our water?
Lucas makes me more mad than any other economist ever (with the possible exception of Prescott), since he is regarded by many as THE greatest living genius in macroeconomics. That just makes me (irrationally) angry!! When I was a physicist there was NOT ONE famous practitioner of my field whom I could point to and say "This guy did crap science" - even string theorists, who get made fun of a lot, have made a lot of really original and beautiful math. No reasonable person on Earth would ever call Ed Witten or Lenny Susskind a hack!! But here's Bob Lucas proposing that our recession, which looks just like the same recession Sweden or Japan had after their financial crises, is being caused by Barack Obama?!!!
Matt Y., along with the likes of Ezra Klein and David Leonhardt, are masters of 'wonky' pseudo-seriousness. Yes, Kartik was 100% on target.ReplyDelete
You didn't understand his talk. What he's saying is no more absurd than someone arguing that the prolonged recovery is the result of the government NOT spending. That's why he's saying it. He wants to make you mad. Stop blogging and go write your thesis.
Lucas's lecture does not seem to be just a provocative exercise aimed at making Keynesians and Democrats mad. There is a strand of thought that persistent output disasters can be traced back to mismanagement. This is summarized in Kehoe and Prescott's book on "The Great Depression of the XXth Century". It includes chapters on the Great Depression in various countries, crises in Latin America, Japan in the 90's, Finland etc. There is a research agenda here and Lucas is subscribing to it. So I guess it is worth having a serious discussion about whether or not this makes sense (specially given the huge policy implications).ReplyDelete
Personally, what makes me uncomfortable is that if you pick a long enough period in a country you will be able to find a bunch of policies that look counter-productive. From that perspective, I find Yglesias's comments germaine. If you want to suggest that welfare state-like policies account for the drop in US GDP now, you need to explain why they didn't in the 60's and 70's, when they were arguably much larger and more distortionary. Perhaps there is something about the combination of financial disaster and bad policies, who knows? But no one has really talked about that.
"If you want to suggest that welfare state-like policies account for the drop in US GDP now, you need to explain why they didn't in the 60's and 70's, when they were arguably much larger and more distortionary. "ReplyDelete
This passage reminded me of Thomas Sargent's interview in The Region where he discussed his research on persistent high European unemployment. He blamed European welfare state for it; he was criticized by those who said that made no sense since Europe's unemployment was lower than US prior to the 1970s shocks. Sargent/Ljunquist responded that it was the interaction of those shocks with the European labor institutions that explained the puzzle.
Good. Yes, the idea is very much in the spirit of Kehoe and Prescott's book, though Lucas is also a quantity theorist and subscribes to Friedman/Schwartz. The piece in Lucas's talk on the latter part of the Great Depression essentially comes from Cole-Ohanian, pp. 21-58. In terms of the current issues, Prescott says similar things. As far as I know Prescott's ideas are not written down, though they seem to relate to his work with Ellen McGrattan on unmeasured investment. Prescott is not talking off the top of his head, and appears to have thought through the quantitative issues. You may not subscribe to the conclusions, but if you talked to Prescott you would know where the ideas come from and could at least understand what he is getting at. I think you can learn something from the Kehoe/Prescott book, but generally those people don't give monetary and financial factors a chance. In the current context, and in the Great Depression, I think that matters in a big way. Lucas seems to think that, once you correct for the effects of a financial-crisis-type shock with monetary policy, that you are essentially back in the world of the neoclassical growth model, which I don't think is right. The slow recovery may be due to lingering financial factors and/or the dynamics of the housing market. Whether that's inefficient or not, I don't know, but I don't think it has anything to do with sticky wages and prices.
Stop blogging and go write your thesis.ReplyDelete
Noah sure is convinced he knows a lot of things he clearly doesn't.ReplyDelete
"And I do NOT buy the notion that Lucas is "throwing some ideas out there for discussion" in his recent lecture."ReplyDelete
Nobody cares what you buy.
Anon 9:10: "Kartik got Yglesias right -- he is a boob with no business commenting on economics. Shame that nitwit is perceived as an economist."ReplyDelete
Who thinks that Matt Yglesias is an economist?
If Yglesias is an economist, can I be an astronaut? Or a king?
Noah: "It is a bit rich, for example, to hear a Rational Expectations guy talk about "science", when so many lab experiments have shown that RE only occasionally applies."
Boy, I hope that someone tells Bob Lucas about these experiments. How embarrassing for him.
I know nothing at all about Matt Yglesias, so I consulted Wikipedia, my source for all information. He has a degree in philosophy, which apparently qualifies him to pass judgment on Lucas. Go figure.ReplyDelete
Stephen, Noah is in the cohort that's going to rebuild economics in reaction to the current crisis, while you and yours blather on, like the right-wingers who f*cked up the Great Depression. But they at least had the excuse of honest ignorance; you guys have to deliberately destroy painfully acquired knowledge.ReplyDelete
But don't worry, you can spend the rest of your life sucking down a tenured paycheck while whining about people getting money from the government.
I would say 'stop blogging and go do some economics', except that blogging is much less destructive.
"Stop blogging and go write your thesis."ReplyDelete
Okay, I've gotta say this made me laugh pretty hard.
Stephen, when you say Prescott's ideas are probably based on his "Unmeasured Investment..." work with McGratten what exactly do you mean? I've read the paper, IIRC it basically just reconciles the neoclassical growth model's inaccurate assumptions about the 90s with the data from the 90s. I can't really see the connection between that and his ideas about the recent recession.ReplyDelete
Robert Barro’s ‘New Classical and Keynesians, or the Good Guys and the Bad Guys’ in Swiss Journal of Economics and Statistics 1989 is another excellent paper on New Keynesian economics failure as a progressive research programme.ReplyDelete
Barro said that instead of providing new theoretical results and hypotheses for empirical testing, the objective often seems to be to provide respectability for the basic viewpoint and policy prescriptions that characterised the old Keynesian models. It may well be more rewarding to look instead for new theoretical insights, empirical hypotheses, and policy implications.
Barro also criticizes new classical macro and RBC in that essay
On RBC economists, their downplaying of monetary and financial factors illustrates the criticisms that Marshall and Boulding made of mathematics and quantitative economics restricting analysts to what was mathematically tractable and measureable rather than what was truly important.
I follow RBC economists such as Ohanian, Rogerson and Prescott closely and respect their arguments that supply shocks are very important.
They and similar others are doing some of the best work around because they are providing new theoretical results and hypotheses for testing.
Barry: "...like the right-wingers who f*cked up the Great Depression."ReplyDelete
Wow. Bold claim. I'm sure that we can think of some things that the Hoover Administration and Congressional Republicans did wrong. Of course, the top 2 on that list would be convincing industry not to cut real wages (read Cole and Ohanian) and passing Smoot-Hawley, which are not usually associated with right-wing thinking.
But then the Dems had an absolutely iron grip on government from 1933 to 1947, controlling the Presidency and both houses of congress. (They also controlled the House in 1931-1932.)
And yet the Great Depression lasted until 1939. Wow, those evil right-wingers must have been super-talented to keep the economy in a Great Depression for 6 years (!) after they were totally out of power.
It can't have been price fixing and cartelization by the Roosevelt Admin, can it?
Barry: "But they at least had the excuse of honest ignorance; you guys have to deliberately destroy painfully acquired knowledge."ReplyDelete
I didn't want to spill the beans but my conscience is bothering me too much.
I know Steve Williamson personally and he is actually a cartoon villain with a handlebar mustache, tying fair young maidens to railroad tracks and polishing his bust of Mussolini.
Although Steve teaches at Wash U, he lives in a secret volcano fortress near St. Louis, where he plots with his nefarious economist friends to crush the working man (and woman) and suck the marrow from his (and her) bones.
I think that his latest idea involves using a giant laser to destroy the moon.
Well done, Barry, you are exactly right, sir.
If you change a few words, Barry's comment would be identical to the ones I get from Ron Paul's supporters (though those people can be more threatening). By the way, my early inference about Noah was that he is a first or second-year PhD student at Michigan but, and he can correct me if I'm wrong, the scuttlebut is that he is more advanced than that, and perhaps distractable. If Noah wants to "rebuild economics" instead of whining about why we can't be more like physicists, he should do some productive research. As Barry recognizes, I am an old guy and can afford to do this. I have fun doing it, but it's unclear whether blog activity can or will advance the science. This could just be another branch of the entertainment industry.ReplyDelete
Barry is an idiot. I don't think anything else needs to said about him.ReplyDelete
I support Chris-the-regression-runner for astronaut, but not king. Gotta have standards to be king, ya know.ReplyDelete
What is disturbing is that this Noah is simply a whiner who has produced nothing and is creating negative externalities to the advancement of the science by stinking up the debate forum. This is not the behavior one would expect from a serious economist. I wonder why any department would be interested in hiring such a malcontent.ReplyDelete
I think Noah will have a tough time on the market -- people will remember him as the know-it-all whiner and nobody will be interested in hiring him. Word to the wise, dear Noah.ReplyDelete
Lucas does not mention Obama specifically when he ascertains blame for the stalled recovery (even though it is clear that he refers to Obama).ReplyDelete
Prescott is on the same mission but is bolder. He does not use 'is it possible' and other terms to cover his behind. He lays the blame squarely at Obama's feet.
In a presentation from June 2009 he is 'forecasting a lost decade of growth for the U.S' because of 'Proposed increase in tax rates'. He claims that proposed (as opposed to actual) increases in taxes are so bad that they caused the recession and have stalled the recovery. Under the heading 'Expactations matter' Prescott says that 'Things were going well for the U.S. economy until the fourth quarter of 2008' but then there was some 'Some depression of economy between Obama election and his taking office'. This was not because of anything the then current administration did, but rather because 'People expected...worse policies' such as
'Pro tax increase, Pro White House managing the economy, Pro bailout of businesses, Pro cartelization' when Obama took office.
So Prescott says the same thing as Lucas: Expectations of 'bad policies' when Obama took office are the source of the calamity we are in. And just as for Lucas, Prescott has no evidence at all to back up this claim. But according to Williamson this is the pinnacle of modern economic science.
I'm with you until that last sentence. Everyone knows that Ed has some views that are out at the extremes. There is a set of skills that you have to acquire in listening to Ed and extracting what is useful. Maybe someone will write a book about it some day. In any case, under some of the politically-driven talk is a guy who is a serious scientist and has advanced economics in important ways.ReplyDelete
I apologize if my last sentence is incorrect.ReplyDelete
My basic point is that there is no difference between Lucas and Prescott in this particular case. Both are 'out at the extremes' in their presentations in that their conclusions about the lack of recovery are built on anti-Obama sentiment rather than on a serious attempt to use economic science, either theoretical or empirical, to advance the debate.
^As opposed to Krugman, who says "aggregate demand deficiency" as if that statement has any meaning whatsoever.ReplyDelete
Yes, exactly. What Lucas and Prescott are saying is precise enough that you could actually write down the model and determine what you need to know to evaluate it, then go on to quantify the effect. When Krugman says "aggregate demand deficiency," that has no content. All he's saying is "output is below trend," which is self-evident.ReplyDelete
"What Lucas and Prescott are saying is precise enough that you could actually write down the model and determine what you need to know to evaluate it, then go on to quantify the effect."ReplyDelete
I dispute that. The concept of an aggregate production function seems as vacuous as aggregate demand. An economy is a complex network of firms. I think the work of Gabaix and Acemoglu/Ozdaglarz, building on the early ideas of Long/Plosser might eventually lead to something where we can do serious quantitative macro, but Lucas/Prescott is as much of a deadend as Krugman/deLong.
How did the inferior work of Prescott come to win out over Long/Plosser?
Anon 8:45 "Both are 'out at the extremes' ...in that their conclusions about the lack of recovery are built on anti-Obama sentiment rather than on a serious attempt to use economic science..."ReplyDelete
According to Anon 6:22, Lucas voted for Obama, which, if true, makes him an unlikely vessel for "anti-Obama sentiment."
Of course, all economists bring preconceptions to their policy evaluation. This is true of great minds like Lucas, and much more modest talents, such as myself. It is especially true of the usual group of nasty partisan hacks with whom we are all familiar.
Confirmation bias is a big part of the problem. People ignore evidence that contradicts their views and latch on to evidence that confirms their views.
If you are invested in the idea that govt programs do not work, then the continuing economic weakness is more evidence of their failure. If you are a Keynesian -- either vulgar or New -- then the lack of economic progress is evidence that the govt did too little.
I think that the simplest explanation for Lucas' views is that they are more-or-less consistent with the last 40 years of his views on economic policy.
In other words, I think that Anon 8:45 has the causality backwards. Lucas does not oppose govt expansion because he hates Obama, he opposes Obama's govt programs because he thinks that they are bad ideas, likely to reduce growth and wealth.
What Lucas and Prescott are saying is precise enough that you could actually write down the model and determine what you need to know to evaluate it, then go on to quantify the effect.ReplyDelete
What model goes from Obama's policies to the slow pace of the recovery?
According to Williamson 'What Lucas and Prescott are saying is precise enough that you could actually write down the model and determine what you need to know to evaluate it, then go on to quantify the effect'.ReplyDelete
According to Lucas 'Most important [for the slow recovery in the Great Depression] were effects of demonization of business'. Yes, that is much more precise and amenable to rigorous economic analysis than the 'aggregate demand deficiency' arguments of Krugman and others.
This is not my field but I think that it would be straightforward to write down a model in which uncertainty about future govt regulations create uncertainty about cost structures, which delays or reduces business investment.ReplyDelete
Increased uncertainty about costs can delay investment. Can we all agree about that?
That might be what Lucas meant by the "demonization of business."
Now, what does aggregate demand deficiency mean? Do we have a model of it?
Yes, we have models by Dixit and Pindyck about the option value of waiting on investment. These could be adapted for uncertainty about taxes.ReplyDelete
And we do have models of AD deficiency, for what they are worth. For example, I would think Ray Fair's olde-worlde Keynesian model, that can be found on his website would do the trick. Its up to the user if they buy into those type of models but they exist.
fair and balanced of Austin Tx
Fair&Balanced@Austin: "And we do have models of AD deficiency, for what they are worth. For example, I would think Ray Fair's olde-worlde Keynesian model, that can be found on his website would do the trick. Its up to the user if they buy into those type of models but they exist."ReplyDelete
Well, I knew -- even with my modest macro knowledge -- that old-school Keynesian models had a concept of insufficient AD. Before I was Chris-the-regression-runner, I was Chris-the-undergrad-ISLM-wiz.
I was looking for something more recent and micro-founded. Does insufficient AD make sense in any model that people take seriously today? I think that Steve was suggesting "no," if I understood correctly.
A sticky price induced failure of market clearing would result in an output gap and you could say that's the result of deficient demand if you wanted to. But as Stephen has pointed out before the normal sticky price new keynesian model doesn't really mention "aggregate demand" at all.ReplyDelete
It is a fairly meaningless phrase in the context of modern microfounded economics. I would imagine the Post-Keynesians have some models (or are they Austrian-like in their fear of math?) that deal more explicitly with aggregate demand, but they certainly wouldn't be microfounded. Those are the guys that have mulled over the concept of "macro foundations for microeconomics". No i'm not joking.
Of course Krugman and company also come off as very critical of the concept of "microfoundations" as well. The evidence for sticky prices of the magnitude required for NK models to function is pretty weak... using actual data for price changes gives very underwhelming results. I think that's largely why he doesn't like microfoundations. Trying to explain WHY traditional Keynesian economics "worked" (ie microfoundations) was enormously difficult. The initial attempts resulted in utter failure and many of the folks that tried then jumped ship, said the whole program was rotten, and that things needed to be rebuilt from the ground up. That's how we got modern freshwater macro. The New Keynesians eventually did provide some workable microfoundations but that's still the largest weak point in NK macro.
Ditch microfoundations and we don't have to worry about any of that uncomfortable nonsense, we can just go back to the wonderful world of AS/AD, where we have no clue why anything is actually happening and all output gaps are obviously the result of AD deficiency and the policy implications are ludicrously simplistic.
I don't think most people really recognize how much of a massive, massive step back Krugman's ideas for macro (a subject he has never, ever made a noteworthy contribution to I might add... he was an incredible trade economist, he's never ever been a macroeconomist) would be.
LAST October, I won the Nobel Prize in economics for my work on unemployment and the labor market...In my Nobel acceptance speech in December, I discussed in detail the patterns of hiring in the American economy, and concluded that structural unemployment and issues of mismatch were not important in the slow recovery we have been experiencing, and thus not a reason to stop an accommodative monetary policyReplyDelete
So, your point is that Peter Diamond doesn't think that structural mismatch is much of a problem and so ... AD is a valid and useful concept and it must be insufficient?
Do I have right?
No, it's not necessarily related to this post which I haven't read that well. I just wanted to make sure, in general, you knew that a top expert who made a career in studying these things thinks that our unemployment today is not primarily for structural reasons.ReplyDelete
If you read his NYT piece and his Nobel lecture, you'll see that all he does is state the conclusion. There is no more content to what Diamond says there than in Krugman's blog posts. Having a Nobel prize doesn't mean you are right or insightful about everything all the time.
The concept of aggregate demand makes sense if you think that markets don't clear. In New Keynesian models certain markets don't clear because of menu costs (and for those who say these don't work, I hope you have looked at something beyond Golosov and Lucas. Nakamura and Steinsson's paper may be a good starting point (http://www.nber.org/papers/w14001) ). In these models yu can then get something very close to aggregate demand through preference shocks.ReplyDelete
In old Keynesian models market don't clear simply because they don't. The point there is that market clearing is not a natural phenomenon, but something that requires particular institutions that may or may not work well. The view there is that, specially when it comes to labor markets in turbulent times, they don't.
Another way of putting it is: market clearing wages are only one among a continuum of possible wages. If you don't have an explicit theory for why wages converge to that particular number, then you might as well assume that they don't. In the language of modern labor search models, it gets down to questions about the bargaining protocol or endogenous dynamics of match efficiency, none of which we really know all that much about.
Mankiw points out in his 1991 NBER paper that the last decade has seen New Keynesian Economics replacing plain Keynesian Economics. He emphasizes imperfect competition, menu costs, coordination failure, and efficiency wages as key ingredients in New Keynesian models.ReplyDelete
As far as I can tell, two decades later, only imperfect competition turned out to be useful.
1. A New Keynesian model has a well-defined notion of equilibrium. In a standard Woodford model, a monopolistically competitive firm sets its price in a forward-looking fashion, assuming that it will have to satisfy whatever demand arises for its output at that price, until Calvo says the firm can change its price again. Obviously it's not standard competitive equilibrium, but I don't think it's useful to say that markets are not clearing. Everyone is optimizing given the rules of the game. Of course you can question why the rules of the game make any sense.
2. Preference shocks are clearly demand shocks - literally. I don't think you would want to base a business cycle theory on those, though. Would you?
"In the language of modern labor search models, it gets down to questions about the bargaining protocol or endogenous dynamics of match efficiency, none of which we really know all that much about."
The history of the coordination failure models is interesting. These went from theoretical examples, like Bryant, Diamond, and Cooper-John, to quantitative models like Farmer-Guo that could be fit to data. Woodford had an easier time selling his sticky price models to central bankers though, in part by making the approach seem like something the Old Keynesians were familiar with.
"t's unclear whether blog activity can or will advance the science"ReplyDelete
well, i find it useful to learn more about economic theory (the comments section as much as the posts). and i hope that it exposes you to some ideas you might otherwise have missed.