In my book, Zombie Economics, I started the account of macroeconomics with the observation
Macroeconomics began with Keynes. Before Keynes wrote The General Theory of Employment, Interest, and Money, economic theory consisted almost entirely of what is now called microeconomics. The difference between the two is commonly put by saying that microeconomics is concerned with individual markets and macroeconomics with the economy as a whole, but that formulation implicitly assumes a view of the world that is at least partly Keynesian.I went on to observe how the pre-Keynesian approach had been revived by the “New Classical” school, and how the apparent convergence with “New Keynesian” economics had been shown to be illusory after the failure of Dynamic Stochastic General Equilibrium models to deal with the 2008 financial crisis and the subsquent, still continuing, depression.
Long before Keynes, neoclassical economists had both a theory of how prices are determined in individual markets so as to match supply and demand (“partial equilibrium theory”) and a theory of how all the prices in the economy are jointly determined to produce a “general equilibrium” in which there are no unsold goods or unemployed workers.
With all of this, though, I still never thought of academic macro, in either saltwater or freshwater form, as being a simple reversion to the pre-Keynesian notion of general equilibrium, with no concern about aggregate demand or unemployment, even in the short run. It turns out that, at least for a large segment of the profession, this is quite wrong. I’ve just received a book entitled Big ideas in Macroeconomics: A nontechnical view by Kartik Athreya, an economist at the Richmond Federal Reserve who made a splash a few years back with a piece entitled Economics is Hard. Don’t Let Bloggers Tell You Otherwise, which, unsurprisingly, did not endear him to bloggers. As a critic of mainstream macro, I’m briefly mentioned, and I just got a review copy.
The new book is an attempt to simplify things, and indeed it has proved enlightening to me and also to Herb Gintis who contributes a blurb on the back, commending it as an accessible and accurate description of the dominant way of thinking about macroeconomics.
The easiest way to see why the book is so striking is to list some topics that do not appear in the index (and are not discussed, or only mentioned in passing, in the text). These include: unemployment, inflation, recession, depression, business cycle, Phillips curve, NAIRU, Taylor Rule, money, monetary policy and fiscal policy.
By contrast, the book includes a lengthy treatment of such topics as Bayes-Nash equilibrium in game theory, intertemporal optimization of consumption and the theory of mechanism design.
If you think that this sounds like Hamlet not merely without the Prince, but without anyone in Elsinore, from King Hamlet’s Ghost to Fortinbras, that’s because you are expecting the wrong play.
In Athreya’s world, and that of a large part of the academic macroeconomics profession, macroeconomics does indeed begin with Walras, and the first modern development in the field was the formalization of Walras’ model by the economic theorists Arrow, Debreu and MacKenzie in the 1950s. The big subsequent development is the integration of growth theory into the static ADM framework to generate the modern dynamic stochastic general equilibrium (DSGE) models. Keynes’ 1936 ‘essay’ is treated as a curiosity, too vague and wordy to permit any real analysis.
This has the odd effect that many of the leading Keynesians of the postwar era (including Samuelson, Solow and the unjustly neglected Australian economist Trevor Swan) are given respectful cites for their work on growth theory, even as (what they would have regarded as) their macroeconomic work is dismissed as being too silly even to be refuted. Even Milton Friedman is treated similarly, with his intertemporal consumption model being praised, while his adaptive expectations model of inflation is ignored. Real macro (that is, Walrasian GE applied to issues like the business cycle) begins, in this analysis, with Robert Lucas in the late 1970s.
All this gives me a bit more insight into the apparent convergence in macroeconomics in the early years of this century, and its breakdown in 2008. The New Keynesians understood themselves as having met their New Classical colleagues halfway, with DSGE models which were Keynesian in character, at least in the short run, while meeting the demands for rigorous microeconomic foundations. Meanwhile, the New Classical school were quietly snickering whenever Keynes’ name was mentioned, but were prepared to concede the possible existence of largely unspecified market “imperfections”, whose only role in practice was to justify a policy of inflation targeting.
The crisis that erupted in 2008 destroyed this spurious consensus. On any kind of Keynesian view, New or Old, the combination of high unemployment and zero interest rates implied that the economy had been driven into a Keynesian liquidity trap, with a need for fiscal stimulus on a massive scale. By contrast, for the New Classicals, a disaster of this kind could only be the result of government failure (or, in places where they still mattered, the pernicious actions of trade unions). Since this was implausible, New Classical economists have generally preferred to reassert dogma without too much attention to facts.
Broadly speaking, as far as academic macroeconomics is concerned, DSGE has won the day, not so much by force of argument as by maintaining control of the criteria for publication of journal articles in the field: it’s OK to assume full employment, and ignore inflation, but not to omit rigorous microfoundations for your model. On the other hand, with the collapse of the intellectual case for austerity (though not its political dominance), the terms of public debate are set almost entirely by New Old Keynesians like Krugman and DeLong (that’s true, even if you don’t believe, as I do, that the outcome of that debate has been a knockout win for the Keynesian side).
The result is that there is almost zero intersection between Big Ideas in Macroeconomics and what I would think of as macroeconomics. It’s not so much that I think Athreya is wrong is that we are talking past each other. As Charles Goodhart said of DSGE, Athreya’s version of macro excludes everything in which I am interested.