To fix or to rebuild?
There are plenty of obscure economists who have come up with ways to fix macroeconomics. I think of them like the early 2000s emo bands of Economics. It’s our job to listen to them before they air on the radio. It’s our job to take their theories and pick them apart. What exactly are they fixing? What does the model specifically address?
Is there even a model that fully encapsulates all macroeconomic phenomena?
Can we do that?
I don’t want to say no. But the question is: how do we get there?
I think the biggest mystery is unemployment. I’m still trying to figure it all out. You’re going to have to convince me that involuntary unemployment truly exists. I’m coming up with an argument that it might not. Give me some time. Let me figure it out.
DSGE models: attempt to explain aggregate economic phenomena (growth, business cycles, effects of monetary and fiscal policy)
Dynamic (studies how the economy changes over time), stochastic (takes shocks like price changes, technology changes into affect)
• Institutional framework
• Rational expectations
Schools of thought that use DSGE models:
• Real business cycle
• New Keynesian
Schools of thought:
• Economy’s performance is determined by changes in the money supply
• Economic well being can be adjusted by changes in the money supply
Important things to monetarists:
• Long run neutrality and short run money non-neutrality
o Money is neutral in the long run if the supply and demand choices of people reflects only concern for the underlying quantities of goods and services that are consumed or produced
o Short run money non-neutrality means that changes in money supply take place very gradually (RBC economists don’t think this exists)
• Distinction between real and nominal interest rates
o Real interest rates take expected inflation into account, as rational people would do as they make trade offs between the present and the future.
• M1 and M2
• No permanent tradeoff between unemployment and inflation
• Monetary policy is more potent than fiscal policy when it comes to stabilizing the economy
Not widely practiced today.
• Focused on the effects of aggregate demand on output and inflation
• Stressed the importance of fiscal policy, and the powerlessness of monetary policy (not actually a thing anymore)
• Changes in aggregate demand have their greatest effect on real output and unemployment, not on prices. (Phillip’s curve)
Things important to Keynesians:
• Sticky prices and wages
• Increases in government spending causes an increase in output
• Prices, and especially wages, respond slowly to changes in supply and demand, resulting in periodic shortages and surpluses, especially of labor.
When I think about what model best describes the macro economy, I can’t help but veer towards the classical aggregate supply and demand model. Its simplicity in structure allows it to be versatile when held up against the theories of the economists of the Monetarist and Austrian schools. It holds firm against the theory that supply creates its own demand, thus concluding that aggregate supply will always equal aggregate demand. It also confirms the idea that saving equals investment. The model itself is affected by a wide range of factors, including aggregate price, input costs, investments, exchange rates, distribution of income, and my personal favorite: changes in monetary and fiscal policy. With a demand curve that encapsulates all of the components of GDP and a long run supply curve in which no input prices are assumed to be constant, which is applicable to reality. Although no model is perfect, this one is a relatively good at describing the macro economy.