Great Recession and Macroeconomic Theory: A Useless Crisis?

ABSTRACT

The global financial crisis of 2007–08 and the subsequent Great Recession have pushed many economists to acknowledge a fundamental limit in the theoretical models elaborated after the monetarist counter-revolution: these models disregard the financial system. The years following the Great Recession have thus been marked by the development of what can be called the ‘Financial Frictions Approach’, a theoretical approach based on the addition of the financial system to the New Keynesian DSGE model. The results of this line of research are beginning to appear also in macroeconomics textbooks. Significant examples are the publication of the seventh edition of Blanchard’s textbook, and the publication of the third edition of the textbook co-authored by Blanchard, Amighini and Giavazzi. The objective of this work is twofold: (i) to show that the new model presented by Blanchard, Amighini and Giavazzi, which reflects the results of the ‘Financial Frictions Approach’, does not allow to elaborate a coherent explanation of the Great Recession and (ii) to present the pillars of an alternative theoretical model based on the lessons of Keynes, Schumpeter and Minsky.     

A ‘Big Think’ Approach to Government Debt: Promoting Significant Learning in Introductory Macroeconomics

Drawing on Dee Fink's theory of significant learning, the authors present a ‘big think’ learning module to supplement fiscal policy discussions in introductory macroeconomics courses. Students are asked to consider a salient, contentious question that can be addressed in meaningful ways based on principles-level concepts and models, namely: ‘In your judgment, does the recent steep rise in the US debt-to-GDP ratio pose a serious threat to the US economy? Why or why not?’ To enhance students' willingness and ability to engage this big think question, the module provides open-ended preparatory exercises amenable to courses taught from heterodox or mainstream perspectives. Unlike standard textbook treatments which inadvertently thwart exploratory thinking and provide little support for analyzing case-specific burdens and benefits of government borrowing, the big think unit motivates students to think logically and creatively about the debt–GDP relationship in the current US context.     

On Microfoundations and Keynes’ Economics

Most mainstream economists regard the principles of ‘rational choice’ theory as the only foundation of economics and insist that macroeconomics be based on those principles. These include certainty or certainty-equivalence, which followers of Keynes reject. Macrofoundations of microeconomics are often proposed instead. We argue that the issue is more complex and explain why it is unlikely that a logically watertight fit between the two levels of analysis will ever be achieved. The complex interactions within and between the two levels suggest that it is unhelpful to assign foundational status to either level. We examine Keynes’ General Theory is examined as an example and compromises are found to fit the two together. It is argued that compromise is inevitable and that good theorising entails defending the compromises made.     

Is ‘new’ behavioral economics ‘mainstream’?

When comparing ‘new’ and ‘old’ behavioral economics (BE), many argue that ‘new’ BE has close ties with what is often called ‘mainstream’ economics. The aim of this paper is to reframe the ‘old’ vs. ‘new’ BE debate and investigate the nature of the relationship between psychologists, behavioral economists, and ‘mainstream’ economists. This will lead us to develop the concept of ‘space of interaction’, building on Galison’s metaphor of ‘trading zones’, to emphasize the role of outsiders, strategic thinking, and negotiation in ‘new’ BE. By discussing some often implicit arguments in an otherwise disconnected literature, we seek to bring new arguments to the discussions through a careful study of those relationships in the history of ‘new’ BE and its more recent developments. Leaving aside the orthodox/heterodox contrast and comparative approaches, we hope to provide a different account of the changes in ‘new’ BE and its relationship with the ‘mainstream’.     

‘JUMPS’ IN MACROECONOMIC MODELS: AN EXAMPLE WHEN EIGENVALUES ARE COMPLEX‐VALUED*

The dynamic properties of continuous‐time macroeconomic models are typically characterised by having a combination of stable and unstable eigenvalues. In a seminal paper, Blanchard and Kahn showed that, for linear models, in order to ensure a unique solution, the number of discontinuous or ‘jump’ variables must equal the number of unstable eigenvalues in the economy. Assuming no zero eigenvalues and that all eigenvalues are distinct, this also means that the number of predetermined variables, otherwise referred to as continuous or non‐ ‘jump’ variables, must equal the number of stable eigenvalues. In this paper, we investigate the application of the Blanchard and Kahn results and establish that these results also carry through for linear dynamical systems where some of the eigenvalues are complex‐valued. An example with just one complex conjugate pair of stable eigenvalues is presented. The Appendix contains a general n‐dimensional model.     

Engagement with the Mainstream in the Future of Post Keynesian Economics

This paper examines the reasons for the difficulties Post Keynesian economics has had in supplanting mainstream neoclassical theory and for its resulting marginalization. Three explanations are given: intellectual, sociological and political, where the latter two are largely responsible for the current relationship of Post Keynesian economics to the mainstream. The paper also reviews various strategies for improving the future of Post Keynesian economics, including a focus on methodological issues by maintaining an ‘open systems’ approach; a strategy of ‘embattled survival’; the development of a positive alternative to mainstream economics; a strategy of ‘constructive engagement’ with the mainstream; and a dialogue with policymakers. While the global financial crisis has increased the potential for constructive engagement with the mainstream, significant barriers remain to the effectiveness of this approach. The crisis has, however, enhanced the possibility of engaging directly with policymakers and gaining a greater role in management education.     

The Economics of Regulating Cross-border Finance: Two New Views

For much of the 20th century the dominant view in macroeconomics was that cross-border finance needed to be regulated in order to balance the ‘impossible trinity’ first sketched by John Maynard Keynes in his two books on monetary theory. The dominant view in development economics during the same period was that cross-border capital flows need to be regulated for similar reasons but also to mobilize domestic resources for economic development. The view that capital mobility was something to be constrained fell out of favor in mainstream economics by the 1980s and 1990s. The experience of numerous financial crises in the past 20 years has spawned new economic theories that reintroduce the notion that cross-border finance can cause financial instability. One strand of new theory in this realm picks up from Ragnar Nurkse, Hyman Minsky, and others, and has become popular in many emerging market capitals and in the United Nations system. Another strand of new theory comes from modern welfare economics and is gaining ground in mainstream economics, central banks, and the Bretton Woods institutions. This paper examines these new breakthroughs and traces them to their origins in economic thought. Coupled with new econometric evidence on the efficacy of capital account regulation, the regulation of capital flows is justified now more than ever.     

Evolutionary macroeconomics: a research agenda

In this article, the goal is to offer a new research agenda for evolutionary macroeconomics. The article commences with a broad review of the main ideas in the history of thought concerning the determinants of economic growth and an introduction to the evolutionary perspective. This is followed by a selective review of recent evolutionary approaches to macroeconomics. These approaches are found to be somewhat disconnected. It is argued that the ‘micro-meso-macro’ approach to economic evolution is capable of resolving this problem by offering an analytical framework in which macroeconomics can be built upon ‘meso-foundations’, not micro-foundations, as asserted in the mainstream. It is also stressed that the economic system and its components are complex adaptive systems and that this complexity must not be assumed away through the imposition of simplistic assumptions made for analytical convenience. It is explained that complex economic systems are, at base, energetic in character but differ from biological complex systems in the way that they collect, store and apply knowledge. It is argued that a focus upon stocks and flows of energy and knowledge in complex economic systems can yield an appropriate analytical framework for macroeconomics. It is explained how such a framework can be connected with key insights of both Schumpeter and Keynes that have been eliminated in modern macroeconomics. A macroeconomic framework that cannot be operationalized empirically is of limited usefulness so, in the last part of the article, an appropriate methodology for evolutionary macroeconomics is discussed.     

Capital mobility and the effectiveness of fiscal policy in open economies

This paper uses a dynamic general equilibrium two-country optimizing ‘new-open economy macroeconomics’ model to analyze the consequences of international capital mobility for the effectiveness of fiscal policy. Conventional wisdom suggests that higher capital mobility diminishes the effectiveness of fiscal policy. The model laid out in this paper provides an example that a higher degree of capital mobility can also increase the effectiveness of fiscal policy. This tends to be the case if the stance of monetary policy can be described by means of a simple monetary policy rule.     

Is neo-Walrasian macroeconom(etr)ics a dead end? An assessment of recent criticisms of DSGE models

After the 2008 “new Great Crisis,” it is widely recognized that mainstream macroeconom(etr)ics—the last result of Lucas’s anti-Keynesian revolution of the 1980s, which tried to give macroeconomics sound neo‐Walrasian microeconomic bases —has failed to anticipate and then appraise the crisis. Has this crisis revealed a failure of this macroeconom(etr)ics as a scientific theory? Mainstream macroeconomists defend their models on the basis of their alleged superiority in terms of clarity and coherence. The thesis of this article is that this claim about superiority is false. The study argues that the reasons for the failure of mainstream macroeconom(etr)ics—in particular its poor predictive performance and interpretative weakness—reside in the implications of the neo-Walrasian legacy and the problems connected with the implementation of that program.     

对西方主流宏观经济学均衡假定的反思——从凯恩斯主义的投资恒等于储蓄说起

自从凯恩斯的《通论》出版以来,宏观经济学就逐渐成为一个比较系统而相对独立的学科,后人将凯恩斯的短期经济增长模型进一步长期化为外生和内生经济增长理论.纵观主流宏观经济学的理论构建,几乎都有一个共同的假设:市场能够自动实现均衡,但是,正是这个假设将西方主流宏观经济学引入了歧途.对于原凯恩斯主义、新古典综合派、新凯恩斯主义、哈罗德-多马的古典经济增长理论和索洛的新古典增长理论、新古典宏观经济学派而言,它都是一个难以回避的硬伤.     

The Economist Watcher: Economic Contributions of David Colander

ABSTRACT

This article gives an appraisal of the work of David Colander. After a brief biographical summary, we look at his work in methodology and the role that institutions and ‘vision’ play in his economic analysis. A crucial part of his work in this area is viewing not only the economy but also the economic profession as an adaptive complex system. This leads us to his major contributions to macroeconomics and economic education. We conclude with an overall assessment of his contributions to economics.     

A convenient representation for structural vector autoregressions

Latent variables are used to rewrite a wide class of structural vector autoregressive (SVAR) models. The framework is general enough to include as particular cases all just and over-identified models recently used in applied macroeconomics. The latent variables representation can conveniently be estimated with standard software packages like LISREL, EQS, LINCS and AMOS, for example. The approach is illustrated by using the models of Blanchard and Quah (1989) and Swanson and Granger (1997). First version received: October 1999/Final version accepted: August 2000     

On the effectiveness of monetary and fiscal policies in a Keynesian model

One of the central problems in macroeconomics is the comparison of the effectiveness of various monetary and fiscal policy measures for regulating output and employment. Opinions on this issue are quite varied. This paper analyses this controversy in the framework of a non-Walrasian model with price rigidities. It studies a monetary economy where money is the sole medium of exchange in the model ‘money buys goods and goods buy money; but goods do not buy goods’. The works of Benassy, Dreze, Malinvaud and Younes are utilised for constructing a model of Keynesian unemployment equilibrium.     

Hysteresis and sluggishness in Portuguese unemployment, 1977–88

The phenomenon of unemployment persistence led to the development of alternative theories of unemployment. Among these the ‘hysteresis’ concept by Blanchard and Summers (1987) received a wide interest. Based on this notion we developed a generalized model that nests Blanchards and Summers' theory. Using this framework we conducted an empirical investigation for the Portuguese labour market (1977–88). The results obtained point towards the existence of labour demand sluggishness, wage inertia and unemployment hysteresis. The model also suggests the existence of a rather inelastic labour demand curve.     

Intertemporal Choice,Saving and Investment,and Interest Rate: Contributions from a Neglected Hayekian Model

Hayek’s ‘Utility analysis and interest’ expounds a graphical model of intertemporal choice that has not received the attention it deserves. This model is important in that it can be used as a basic macroeconomic model and can therefore perform for the Austrian School the role that the Solow model plays for the standard neo-classical paradigm. This article provides an in-depth presentation of the Hayekian model, and then applies the model to key theoretical issues in macroeconomics; namely, the effects upon intertemporal equilibrium and upon the interest rate of a change in time preference, of the implementation of a technical development and of an increase in the supply of labor.     

Is physician behavior too serious a business to be left to economics? Reply to medical altruism in mainstream health economics: theoretical and political paradoxes

This short paper is a Reply to ‘Medical altruism in mainstream health economics: theoretical and political paradoxes. COMMENTS’.     

Economic emergence: An evolutionary economic perspective

The standard neoclassical approach to economic theorising excludes, by definition, economic emergence and the related phenomenon of entrepreneurship. We explore how the most economic of human behaviours, entrepreneurship, came to be largely excluded from mainstream economic theory. In contrast, we report that evolutionary economists have acknowledged the importance of understanding emergence and we explore the advances that have been made in this regard. We go on to argue that evolutionary economics can make further progress by taking a more ‘naturalistic’ approach to economic evolution. This requires that economic analysis be fully embedded in complex economic system theory and that associated understandings as to how humans react to states of uncertainty be explicitly dealt with. We argue that ‘knowledge,’ because of the existence of uncertainty is, to a large degree ‘conjectural’ and, thus, is closely linked to our emotional states. Our economic behaviour is also influenced by the reality that we, and the systems that we create, are dissipative structures. Thus, we introduce the notions of ‘energy gradients’ and ‘knowledge gradients’ as essential concepts in understanding economic emergence and resultant economic growth.