Macroeconomic Problems, Microeconomic Solutions

Peter J. Boettke Econ 881/Spring 2005 February 28

Main Points to Stress

Macroeconomic problems are coordination problems

Production plans must mesh with consumption demands

Capital and Labor

Incentives must be aligned and capabilities must be exploited

Incentive problems are knowledge problems and knowledge problems are incentive problems

Changing circumstances result in disturbances, but the crucial question is one of adjustment

Feedback and learning through time

Macroeconomic Problems

Errors of Over optimism

Produce products which nobody wants

Dont product products which people want

Errors of Over pessimism

Capital goods are allocated incorrectly; capital investments are inappropriate; labor is misallocated; and as a result the economy underperformed from the point of view of realizing the mutual gains from exchange, employing resources efficiently, and satisfying the demands of consumer sovereignty.

What is the solution to these problems?

Classical

Market discipline
Government correctives

Keynesian

Fiscal policy Mix of fiscal and monetary policy

After Keynes

Market equilibrium

Fiscal Policy Versus Monetary Policy as a Corrective

r

IS

Liquidity trap makes monetary policy ineffective LM

r LM

Crowding out makes fiscal policy ineffective IS

Keynesian World View

Monetarist World View

Neo-Keynesian Synthesis
r LM Goods Market equilibrium; Money Market equilibrium

IS

Y Y

What is Wrong With this Picture?

Unconnected to the Choices of Individuals

Labor Market

Money Illusion

Capital Market

Fiscal Illusion Autonomous Investment

Time and the Process of Production Complementarity and Substitutability in the chain of production

Capital Goods Market

Labor Market Response

Workers do not persistently suffer from money illusion

W/P W/P0 W/P1

N N0 N1

Short Run Phillips Curve

I Long Run at Natural Rate

Short Run Trade Off as Workers Suffer Money Illusion U

Lucas Critique of Keynesian System

Adaptive Expectations Rational Expectations

Bayesian Learning

Expectations on underlying distribution

Methodological Rule --- economist cannot assume a level of knowledge greater than the participants in the economy

Equilibrium Theory of the Business Cycle

Monetary Neutrality and Market clearing

Noise and disturbances to the system (signal extraction)

Invariance proposition

Upshot of Lucas Critique

Short Run and Long Run Phillips Curve are the same Microfoundations of Macroeconomics provides coherence to the discipline General Competitive Equilibrium

Optimizing behavior Continuous Market Clearing

Is New Classical Economics Austrian Economics?

Microfoundations

Aggregate economics unconnected to choice

Compositive Method, 233-234

Rationality

Hypothesis or axiom

Choice under uncertainty

Expectations and the Equilibrium Construct

Logical coherence

Process theory and adjustment, 236, fn. 25

The Classic Austrian Theory of the Cycle

r So S1 Higher Order Goods

D Q Q S/C Lower Order Goods

Main Tenets of the ABTC

Non-neutrality of Money

Injection effects through Relative price adjustments

Heterogeneous and multi-specific goods

Capital Structure

Capital maintenance and entrepreneurial decision making

Intertemporal Coordination and Monetary mechanism

Interest rates as signals between present and future Employment of scarce resources

Complimentarity of Capital and Labor

Critique of ABCT

Theory

Bias error and bias toward particularly costly errors Incoherence of grafting a disequilibrium story on an equilibrium theory
Co-movement of investment and consumption Limited applicability of interest rate mechanism as trigger

Empirical