Macroeconomic Problems, Microeconomic Solutions

1
Macroeconomic Problems, Microeconomic Solutions

• Peter J. Boettke
• Econ 881/Spring 2005
• February 28

2
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

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Macroeconomic Problems

• Errors of Over optimism
• Produce products which nobody wants
• Errors of Over pessimism
• Dont product products which people want

? 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.
4
What is the solution to these problems?

• Classical
• Market discipline
• Keynesian
• Government correctives
• Fiscal policy
• Mix of fiscal and monetary policy
• After Keynes
• Market equilibrium

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Fiscal Policy Versus Monetary Policy as a
Corrective
Crowding out makes fiscal policy ineffective
Liquidity trap makes monetary policy ineffective
r
r
LM
IS
IS
LM
Y
Y
Keynesian World View
Monetarist World View
6
Neo-Keynesian Synthesis
r
LM
Goods Market equilibrium Money Market
equilibrium
r
IS
Y
Y
7
What is Wrong With this Picture?

• Unconnected to the Choices of Individuals
• Labor Market
• Money Illusion
• Capital Market
• Fiscal Illusion
• Autonomous Investment
• Capital Goods Market
• Time and the Process of Production
• Complementarity and Substitutability in the chain
  of production

8
Labor Market Response

• Workers do not persistently suffer from money
  illusion

W/P
W/P0
W/P1
N
N0
N1
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Short Run Phillips Curve
I
Long Run at Natural Rate
Short Run Trade Off as Workers Suffer Money
Illusion
U
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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

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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

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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

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The Classic Austrian Theory of the Cycle
Higher Order Goods
r
So
S1
r
D
Q
Q
S/C
Lower Order Goods
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Main Tenets of the ABTC

• Non-neutrality of Money
• Injection effects through Relative price
  adjustments
• Capital Structure
• Heterogeneous and multi-specific goods
• Capital maintenance and entrepreneurial decision
  making
• Intertemporal Coordination and Monetary mechanism
• Interest rates as signals between present and
  future
• Complimentarity of Capital and Labor
• Employment of scarce resources

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Critique of ABCT

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