Modern Macroeconomics

I wrote this comment  in response to a question here about modern macroeconomics, where someone asked if “Seriously??”, many basic macroeconomic models ignore inequality:

Seriously! But with a couple of caveats.

First, there are a number of other important questions that can be partially (and usefully) answered while ignoring the unequal distribution of wealth within an economy, and focusing instead on the behavior of averages. In comparing GDP across countries, these models predict that places with higher investment in physical and human capital will have higher GDP; these basic models do a fairly good job of describing GDP–even though they ignore important inequality within these countries.  That’s an old example, but there are many others within macro that don’t have an obvious need to include inequality in order to get at many aspects of their respective problems.

And second, a number of models do incorporate inequality in a variety of ways. Many New Keynesian models (like those used by Christina Romer, Ben Bernanke, Greg Mankiw, and other current/recent government economist bigwigs) have initial equality, but have inequality after the fact: some portion of people end up unemployed (usually at random) and worse off than they could be, and that sort of thing. These unemployed people are worse off than they otherwise would be, and these models frequently imply that the government has a role in helping them (cf the stimulus!)….

But the salient point stands: most basic macroeconomic models don’t really address inequality systematically. It is usually an outcome of the model (eg some people end up unemployed) or a direct result of special assumptions. For instance, in one model, one group (savers) values future consumption more than another group, so they tend to save more on average, while the group that doesn’t value future consumption as heavily (ie, they are more impatient) tends to borrow more. When combined in equilibrium, unsurprisingly the “borrowers” usually borrow as much as they can and end up living paycheck to paycheck, so to speak.

But again, that really isn’t the point of the model–blaming it for not treating inequality more accurately is like blaming an AIDS treatment for not preventing cancer.  The paper actually proposes a scenario in which a small negative shock in the credit market as a much larger negative impact on the overall economy–like what happened when Lehman Brothers failed. And the model follows through on that, quite successfully. It’s just not meant to be a realistic or interesting treatment of inequality.

So, is this bad? In these days of the 99%, there seems to be an implicit understanding that inequality and the current economic climate (of stagnant wage growth and high unemployment) are causally linked, and the current basic macroeconomic models don’t leave much room for a political economy channel by which the rich can tilt the playing field their direction. Whether this is, in fact, happening is a matter of debate–the recent book The Great Stagnation argues that both are a result of a common cause. Whatever the truth, macroeconomics has (thankfully) responded well to past inconsistencies by developing new methods and ideas that allow us to come ever-closer to a coherent understanding of the economy. With any luck (and if I have anything to say about it!), the response to the current crisis will be no less fruitful.

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One thought on “Modern Macroeconomics

  1. The way I see it is that traditional economists “don’t deal with inequality” is a long gripe coming from the Left. In a general sense it’s true. Proponents of market capitalism (whether regulated or not) accept natural unemployment–that unemployment just occurs and will always occur. That’s why they call it “natural”–to make it seem so. In an over-simplified sense, they accept this inequality in their system because it’s more efficient. Many on the Left–even if they don’t always portray it this since it’s terribly unfashionable to say it in our hyper-materialistic times–are willing to sacrifice efficiency to protect people from the market (environmental regulations if you will). A big concern then related to this issue is whether or not all regulations and “hindrances” to the market are bad overall in these terms. The height of unionization in the US was just after WWII, that is when the US seized the status of sole super-power and its economy boomed allowing working-class folks to have a good house and car for the first time.

    Out from these general concerns comes the likes of various other fields that try to study the economy–everything from psychological-based models that accept homo-economicus (yet insert some irrationality into the system) to the greatly divergent economic sociologists that want to reconceive how we think of the economy.

    Cool post. And I realize some of that above is only tangentially related to your post’s topic…. Any other thoughts?

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