As regular readers of this blog will know, macroeconomics isn’t my thing. Although unimpressed by the state of knowledge in macro, I’m even less impressed by my own expertise in it, and so avoid commenting on it.
Still, I try to keep up with the debates, and was reading the recent posts by Simon Wren-Lewis and follow-up by Paul Krugman on exactly this question of the state of macroeconomics and the various divisions. Broadly speaking, the former argues that looking to base macroeconomics on micro-foundations is an essential research strategy, while the latter says that insisting on microfoundations (“the insistence that everything involve intertemporal optimization”) excludes useful approaches to thinking about economic policy on the grounds that they are ‘ad hoc’.
With great diffidence, it seems to me that what you might or might not build micro-foundations for matters more. Whenever I think about the macroeconomy I turn back to a small book I read as an undergraduate, rarely cited these days, Edmond Malinvaud’s Theory of Unemployment Reconsidered.
Theory of Unemployment Reconsidered: Lectures
He begins by pointing out that the classical theory of unemployment (and its descendants) make the mistake of looking at each market as a partial equilibrium – so the labour market would clear, and unemployment would fall, if only the real wage fell. For macroeconomics, though, general equilibrium analysis is needed. That was the important step contributed by Keynes in The General Theory. Rationing in the labour market is closely linked to rationing in the goods market.
Malinvaud goes on to describe different ‘regimes’, depending on whether rationing prevails on the buy-side or sell-side of the labour and goods market at any moment – he labels them classical unemployment, Keynesian unemployment and repressed inflation. One would now surely add financial markets too, and a ‘debt hangover’, credit rationed state of the world. Policy prescriptions vary a good deal depending on which regime applies.
That’s as far as I’m going, the conclusion that the connections between markets can tip the economy into different rationed equilibria. When those connections and dynamics are clear, we could worry about how well microfounded the model is. Malinvaud also echoes another of my views: “The level of aggregation may hide some important complications.” Yup. This boils down to saying macroeconomics is fiendishly complicated, and after this brief excursion, I’m going back to avoiding it.