History of Modern Macroeconomics Lecture 3.4. The Empirical Microfoundations of Macroeconomics (1945-1970) Kevin D. Hoover Department of Economics Department of Philosophy Center for the History of Political Economy Duke University

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History of Modern MacroeconomicsLecture 3.4. The
Empirical Microfoundations of Macroeconomics
(1945-1970) Kevin D. HooverDepartment of
EconomicsDepartment of PhilosophyCenter for the
History of Political EconomyDuke University
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Two Macroeconomic Traditions of the 1930s 1

• Frisch/Tinbergen
• micro/macro distinction
• macro dominates micro
• problem of aggregation ignored
• supported econometrics
• engineering attitude
• socialist/central planner

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Two Macroeconomic Traditions of the 1930s 2

• Keynes
• micro/macro distinction (not in those words)
• micro at root macro emergent
• problem of aggregation does not arise
• hostile to econometrics
• medical attitude
• AsideIf economists could manage to get
  themselves thought of as humble, competent people
  on a level with dentists, that would be
  splendid. John Maynard Keynes (1931)
• liberal/saving markets from their own
  fallabilities

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Wartime Planning and Controls
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Wartime Planners
Milton Friedman (1912-2006)
John Kenneth Galbraith (1908-2006)
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Economists and the War

• The other thing that was so important in the
  fifties and sixties was operations research.
  The World War II generation brought a whole bunch
  of smart guys, like Abraham Wald and Friedman,. .
  . I mean everybody into Washington to work on the
  war effort, and economists thought of all kinds
  of great stuff . . . I guess thats what we
  always claim. We invented the convoy system . .
  . we basically won the war singlehandedly.
• Robert E. Lucas, Jr.

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Keynes Mostly Lost. What Survived

• Consilience of Keyness ontology with the
  national income and product accounts
• Interventionist attitude
• Neoclassical synthesis
• Already in Keynes classical is special case of
  the general theory
• Picked up by Klein (The Keynesian Revolution)
• Samuelson implicit in 1st edition of Economics
  (1948) term coined in 3rd edition (1955)

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The New Empirical Macroeconomics

• Walrasian
• general equilibrium
• individual optimization (microfoundations)
• IS-LM Keynesian
• Aggregation
• practice demands
• must be eliminable in theory
• work towards maximum disaggregation

Lawrence Klein (1920- )
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IS-LM-AS Sets the Agenda for Macroeconmetric
Models
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Hydraulic Keynesianism The Phillips Machine or
Moniac
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Phillips Machine Schematic
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Phillips Machine Details
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Phillips Machine in Punch
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IS-LM-AS Sets the Agenda for Macroeconmetric
Models
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Microfoundations Transactions Demand for Money
(Baumol) 1
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Microfoundations Transactions Demand for Money
(Baumol) 2
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Microfoundations Transactions Demand for Money
(Baumol) 3

• Implications
• Income-elasticity of money demand ½
• Interest-elasticity of money demand ½
• Compare to the Traditional Quantity Equation
• Income-elasticity of money demand 1
• Interest-elasticity of money demand
  undetermined (possibly zero)

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Microfoundations of the Various Keynesian
Functions

• Transaction Demand for Money Baumol (1952)
• Speculative Demand for Money Tobin (1958)
• Consumption Function Duesenberry (1949)
  Modigliani and Brumberg (1952) Friedman (1945
  1955)
• Investment Jorgensen (1966)
• Production Function (Franklin Fisher 1969)
• Labor Supply Lucas and Rapping (1969)

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Kleins Modeling Agenda

• In contrast with the parsimonious view of
  natural simplicity, I believe that economic life
  is enormously complicated and that the successful
  model will try to build in as much of the
  complicated interrelationships as possible. That
  is why I want to work with large econometric
  models and a great deal of computer power.
  Instead of the rule of parsimony, I prefer the
  following rule the largest possible system that
  can be managed and that can explain the main
  economic magnitudes as well as the parsimonious
  system is the better system to develop and use.
  Klein 1992

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An Opposing Current

• the focus should be on the analysis of parts of
  the economy in the hope that we can find bits of
  order here and there and gradually combine these
  bits into a systematic picture of the whole
  1951
• A hypothesis is important if it explains much
  by little, that is, if it abstracts the common
  and crucial elements from the mass of complex and
  detailed circumstances surrounding the phenomena
  to be explained and permits valid predictions on
  the basis of them alone. Friedman 1953, p. 14
• We curtsy to Marshall, but we walk with Walras
  1949

Milton Friedman (1912-2006)
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Genealogy of Kleins Macroeconometric Models
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Complexity of Kleins Models
Model Number of Equations
Klein Model I (1950) 6
Klein Model II (1950) 3
Klein Model III (1950) 12
Klein-Goldberger (1955) 25
Brookings-early (1959) about 200
Brookings-late (1972) about 400
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Brookings Model (1965)
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Phillips Machine Schematic
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The IS-LM Core of a Large-scale Macroeconometric
Model

• Source Green et al. The IS-LM Cores of Three
  Econometric Models, in Lawrence Klein (editor)
  Comparative Performance of U.S. Econometric
  Models, p. 104.

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Computing Power as a Limitation on Economic
Modeling
Before World War II
After World War II
Burroughs Adding Machines in Veterans Bureau
Computing Section
Eniac The First American Digital Computer
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• Thanks
• ??
• The End