It is time to wrap up, for now, the GEM Blog’s forceful argument that the development and dissemination of consensus macroeconomics has been greatly damaged by Ptolemaic intent. To reiterate, research is Ptolemaic if its central objective is the defense of mainstream analysis organized around the micro-coherent, market-centric dynamic general-equilibrium model. The approach is, by its nature, irresponsible with respect to evidence, carefully selecting and featuring facts that support mainstream thinking. Inconsistent evidence, including a great deal of what is crucial to understanding actual macrodynamics, is ignored. As a result, the modeling found in our most prestigious journals and, worse, taught to students in our most prestigious graduate schools is not relevant to understanding and managing macro instability that is rooted in market failure and can produce great welfare loss.
With the advent of generalized-exchange macroeconomics that generates micro-coherent, stabilization-relevant continuous general-equilibrium theory, it is time to start culling the macro cannon. It is time to start weeding out work that is not only stabilization-irrelevant and inconsistent with the most important evidence but also embarrassing in its obvious disregard for how modern economies actually work. Students should not be asked to take seriously the foolish, Rube-Goldberg stuff produced by Ptolemaic theorists.
My first-cut candidates for culling graduate-school reading lists are the numerous articles that substitute implausible or weak market imperfections for meaningful wage rigidity (MWR). Those are mainly search/match/bargaining (S/M/B) analyses that attempt to explain cyclical unemployment with voluntary search-match activities. Also high on the hit list are articles featuring RBC elimination of nominal-demand propagation in the supposedly policy-relevant analyses of real macro shocks.
The favorite mainstream explanation for the central, persistent employment-volatility puzzle remains the indivisible labor-supply hypothesis (Hansen (1985) and most notably Rogerson (1988)) that posits agent inability to adjust the length of his or her workday. In that approach, costs of going to work and/or supervising worker OJB impose a binary choice on households (work full-time or not at all), creating lumpiness in the optimization process. (See Chapter 6.) The model is characteristically Ptolemaic; its restrictions on the length of the workweek are weak, do not correspond with the evidence, and do not generate recognizable employment cyclicality. It fails in its objective to effectively replace the early Keynesian reliance on the assumption of wage rigidity.
His failure does not prevent Rogerson (1997, p.75) from lecturing the great early Keynesians: “The basic idea of macroeconomics at the time seemed to be that some unemployment could probably be understood in the context of the existing paradigm, but most of it could not. The key role of the language that was developed was to separate that part of unemployment that was ‘understandable’ from that part that was not. Frictional, voluntary and equilibrium unemployment were the names given to that part that was understandable using existing [textbook market-centric, general-equilibrium] theory, while involuntary, cyclical and disequilibrium unemployment were the names given to that part that was not explainable in terms of received theory.”
Rogerson, of course, was not alone. The early Keynesian refusal to assign a central stabilization role to “understandable” frictional unemployment was forcefully challenged by the emerging mainstream rejection of wage rigidity that is not derived from optimizing behavior. The New Neoclassical/RBC counter-revolution turned Keynesianism on its head by restricting analysts’ attention to labor-market phenomena that can be coherently modeled within the consensus market-centric general-equilibrium framework. Given that Pareto-efficient market-centric analysis, with its deeply embedded wage recontracting, cannot be made consistent with involuntary job loss and employment rationing, cyclical duties were forced on frictional unemployment. The voluntarily unemployed were moved, without apology or embarrassment, to the center of mainstream business-cycle analysis. The research program demands that macro theorists give up their longstanding practice of following the relevant evidence – at best a foolish strategy.
The macro canon was not always dominated by foolishness. It was not always vulnerable to being lambasted by global stabilization authorities for being useless. It did not always embarrass. For roughly half of the postwar period, mainstream thinking was dominated Early Keynesians and their assumption of nominal wage rigidity capable of suppressing labor-price recontracting. That consensus model was consistent with the critical evidence produced by macro instability and provided credible guidelines for effective policy response.
Early Keynesians lost their mainstream status because of their chronic inability to microfound meaningful wage rigidity. Leading macroeconomists concluded that micro-coherence trumped stabilization-relevance, and the literature became dominated by attempts to generate business cycles absent MWR. The canon featured doomed attempts to model employment cyclicality with the voluntarily unemployed as they search for and get matched up with job vacancies. Job separation always results from voluntary quits; involuntary job loss (both temporary layoffs and permanent downsizing) are never considered.
Here’s the twist. With the advent of generalized-exchange macroeconomics, the mainstream canon, still irrelevant and foolish, no longer has an exclusive claim of micro-coherence. The GEM Project has microfounded MWR in the context of rational exchange governed by continuous general decision-rule equilibrium, eliminating the modern canon’s justification for emphasizing voluntary unemployment. Let the reading-list culling of foolish models begin. Rogerson is not a bad place to begin.
Blog Type: New Keynesians Saint Joseph, Michigan