Econ 488: The Advanced Macro Adventure!

I have a HUGE issue with the comparison of macro and micro economics to macro and micro biology. The purpose of a metaphor is to explain something complex in terms of something simple so that your readers can associate the concepts. Metaphors should simplify the paper, not convolute it. While the idea is very interesting, it is inappropriate for these reasons.

That being said, I understood from the paper that macroeconomic fluctuations are real despite errors in deriving their micro foundations. I’m kind of confused what else to take from it, as it read more like a history-reporting paper than an analysis paper to me; furthermore, the train of thought was hard to follow as the paper seemed to be very unfocused. The section criticizing price indices could develop into a paper in and of itself. While “synthetic” aggregates are imperfect, and as such should have their shortcomings brought to light to avoid their leading to faulty conclusions.

I apologize, but I really don’t know what more to say on the matter. Please inform Hoover of these criticisms, Dr. Greenlaw – I think he’s on to something, but it needs focus.

I don’t know why, but for some reason I’ve been really sensitive to when writers are using passive voice. This article was FULL of it, making it sound very obscured. Second, I think that some of the assumptions that these writers make are the result of being surrounded by like-minded people. Researchers who cloister themselves  in academia and have no social interaction outside of it have a skewed perception of how the world operates. In particular, at one point in the article they said that since an article was published, it can be considered part of agents’ consciousness. They do a very good job of categorizing key variables to form comprehensive equations – specifically  where they state that the state of the economy can be measured by policy variables, decision variables, and random shocks. While I disagree with the assumptions that they make in order to generate these points, they make their general principle easier to conceptualize. Perhaps with more realistic assumptions, this technique would be more valuable.

The conclusions Kydland and Prescott draw are similar to the reading we have done in
Comparative this semester. They state at the end that constitutional rules should be made costly in order to ensure political stability. This is what Ostrom states in her book – however, she does allow operational rules to be altered more readily. With political stability, individuals will be more likely to adopt strategies in response to a change in the environment (which in this case could be a metaphor for a “technological” shock). Had I read this article without any prior notion of what RBC theory indicated and assumed, I think I would have found the conclusions realistic. I do feel that they oversimplify, but I wonder: if this had been my only exposure to RBC, would I have supported its general ideas?

I’m trying very hard to be open-minded about reading from schools of thought that I disagree with. That is why I’m not tearing this article to shreds. While I find a lot of it BS, I think the end product is on the right track.

Blinder, Alan S. 1994. “On sticky prices: academic theories meet the real world.” In Monetary Policy, ed. N. Gregory Mankiw, 117-154.  Chicago, IL: University of Chicago Press.

Blinder is a bit of a smartass. I don’t mean that as an insult in the slightest, but rather it made his article interesting to read. Here’s a fun quote, while I’m on the topic: “Yes, Virginia, there is an auction-market sector. But it is pretty small.” What is that supposed to mean? I want to move to a less rural state so people don’t automatically assume that I live on the border of WV. I was reading this article in Google Books, and the last part of it wasn’t included in the preview… including the conclusions. Here’s what I have from what I did manage to pillage from the internet:

In this article, Blinder presents empirical research on pricing behaviors of firms. Using the slave-labor that is graduate students, he embarked on a mission to survey 200+ firms on what they take into consideration when to deciding whether or not to adjust their prices to changes in demand or costs, in addition to how often they actually change their prices on behalf of these factors. The majority of firms are willing to adjust their prices 2-3 times per year. Surprisingly, firms respond equally as rapidly to increases and decreases in costs and demand, adjusting their prices on average within 3 months of the shock. The less statistically significant of these is the response to decreases in costs, since most firms are unlikely to be fortunate enough to have decreased costs.

The second part of Blinder’s research deals with testing whether or not specific theories on the behavior of the firm enter into firms’ thought process when deciding whether or not to change their prices. To do this, the researchers paraphrase the general idea of the theories and ask their subjects, on a scale of 1-4, how important the implications of that theory are in their decision making. He decided which theories to use based on their popularity at conferences and within economic literature.

The most important theory relates to oligopolies, where firms are reluctant to be the first to change their prices, and will therefore wait for other firms to change theirs first to avoid losses. Firms are less likely to raise their prices until costs rise, meaning they maximize the returns from an outward shift in demand as much as possible before the rising price of inputs forces them to raise their prices to maintain their profit maximization. The third most important, which is rather frightening to me,  is that firms are more likely to adjust delivery lags, service or product quality in response to a shock. This is where you get things like Toyota using low quality bolts in its cars to cut costs and avoid raising prices (I heard that rumor from a Toyota owner and a car-fiend who apparently has no qualms with lying to me… so I’m not sure of its veracity and don’t have enough interest to find out).

The least influential theories were beliefs that customers judged quality based on price, lags based on bureaucratic influences, and firms’ greater likelihood of adjusting their inventory stocks than their prices. That last one was from Blinder’s 1982 paper, so it must have been rather disappointing to discover that it had minimal significance in the real world. The remainder of the paper has to do with how Blinder manipulated his data in regression analysis. Instead of wading through his thought process, I decided to jump to the conclusion and work my way back… only to discover that Google Books had hidden the conclusion from me. Which made me angry.

I’ll probably revise this later. I’m saying that now because I don’t really want you to remember it. Let’s face it: I’ve said that exact same thing for nearly every post I’ve done. So there it is. Out of the way, and sure to be remembered because of this unnecessary rant.

I’ve read one and a half of the New Keynesian articles in the Reader thus far, but I fully intend to read all of them… I should considering I have to write about the theory. Regardless, Here:

Mankiw, N. Gregory. 1992. “The reincarnation of Keynesian economics.” European Economic Review 36 (April): 559-65.

This very brief, casually written article describes some of the skepticisms that make New Keynesianism so new and fancy. New Keynesians are allowed to maintain ties to Keynes’ theories while scrutinizing them as they do not consider his work to be flawless. New Keynesians do not consider the General Theory to be an economic bible of sorts, but rather a stepping stone that ought to be considered in later theory. It is to be used in conjunction with more classical approaches. NK theorists do not have a consensus on how effective either fiscal or monetary policy are, but they address evidence that fiscal policy is not as overwhelmingly influential as Keynes suggested it was. Given that the General Theory was in response to the Great Depression. Therefore, the specific economic conditions which inspired it make it exceptionally dated in this regard. NKs also consider monetary policy to have a relatively greater impact on the economy. There is not necessarily a trade off between unemployment and inflation in the long run, and in fact most NKs lean toward a LR natural rate hypothesis. However, there may be such a trade off in the short run, just to screw with policy makers. NK theorists are also skeptical about the benefits of discretionary policy, believing it to be an explanation of high inflation rates (ten times what they were when Keynes was around).

I find it hard to analyze this article, since it’s more or less a list of things New Keynesians don’t do. It makes just about as much sense as analyzing a list of groceries that an individual has decided specifically not to buy. The overall impression that I get from them is that in the long run, policy is more or less ineffective and can only be used to mediate crises in the short run. Mankiw doesn’t say this, but it seems that stabilizing peoples’ long run expectations appears to be the prescription of NK theorists. I suppose that may lead to more stability in the short run, since individuals can focus more on mediating short run fluctuations in the economy without worrying about what’s going to happen ten years down the road.

Snowdon, Brian and Howard Vane. 1995. “New Keynesian economics today: The empire strikes back.” American Economist 39 (Spring): 48-65.

Old-school Keynesians brought the “visible hand” that is government into the picture of macroeconomic theory. If that were an actual picture, it would be like taking a utilitarian-looking shadowbox of a factory machine with gears and all that jazz and splattering it with grime and grease paint and permanent ink. Classicals argued that the invisible hand performed magic and equilibrated the economy; Keynesians argued that markets do not self-equilibrate, and therefore the government can be used for that purpose. New Keynesians focus more on assumptions related to overall efficiency as opposed to equilibration. New classicals and cyclists argue that consumers adjust the quantities of items they purchase depending on prices, NK theorists argue that firms adjust their behavior on behalf of demand shocks. New Keynesians also assume imperfect competition and information with variable transaction costs, creating inflexibility in the form of nominal wages and prices and real variables (not specified in this article).

From this point onward, the authors interview Mankiw on his views. While interesting and different from other things I’ve read of his, I don’t feel like writing about them (mostly because I haven’t entirely finished reading that part). The term “Monopolistically competitive” came up in the reading. Any ideas about what that means? Maybe? As of now, my general impression of how NK theorists have impacted macro theory as a whole mirrors how I view Keynes as having effected classical theory. cyclists were trying to make everything seem nice and rational with their silly assumptions… And then the New Keynesians crashed their party with reality (kind of like the way Green Peace throws blood on peoples’ furs, I should imagine).

I’m done.

    The first several pages of this article are fragmented summaries of prior RBC research. The only parts I could recognize as being Stockman’s thoughts were lists he made of similarities and virtues of RBC theory. He was also more interested in reporting the actual numbers found by different research than explaining their significance, which just added to my general dismay and confusion. His main argument in favor of RBC theory is that it can be used to explain how shocks will impact the economy between quarters. When describing the parameters for RBC, he includes focuses on rates more than static variables, which may be more beneficial for forecasting using these models. Specifically, he discusses the discount rate (how individuals value the future), the rate of capital depreciation, substitution in consumption and leisure, etc. In reality, I think that at best these could be used to forecast only one quarter into the future as they are limited in their progression. However, if someone can figure out a way for me to substitute 150% of my time for leisure, I am all ears.

One of the more interesting points in Stockman’s extensive lit survey relate to how business cycles relate to long run growth. He believes that the LR and SR growth are interrelated. SR trends are also called nonstationary movements, around the LR (stationary) trend. Some even argue that variation in SR trends may actually be indicative of a change in LR behavior. Further research also compared seasonal fluctuations to the business cycle, finding a high correlation between them. This indicates that business cycles may not be completely random, but rather the manifestation of rational behavior given seasonal phenomena (such as consumers buying more during Christmas season).

Stockman then has an incredibly defensive section where he outlines different arguments against RBC theory. Particularly in his discussion of the incredibility of technology shocks, his most compelling argument is that he doesn’t see anyone else coming up with a better idea. The only arguments that he really seems to take seriously are those which state that monetary changes impact business cycles (which makes sense, considering he worked for the Cleveland Fed).

Ultimately, he remains ambiguous in his discussion of the role of monetary policy. While recessions may be uncomfortable, he holds that they may just be individuals and firms rationally adjusting their behavior to the optimal level. Nonetheless, he believes that monetary shocks are possible, and in those instances monetary policy may be used effectively. But since economists don’t really know how business cycles work, they shouldn’t do anything until they figure it out. Excellent.

Stockman, Alan C. 1988. “Real Business Cycle Theory: a Guide, an Evaluation, and New Directions.” Cleveland Federal Reserve Quarterly Journal.
153716

My parents want me to focus on my studies and therefore give me money to pay for groceries, rent, and medical stuff. My mom has, rather forcibly at times, expressed interest in paying for my gas, but I have refused. Therefore, gas is the only necessity that I really pay for. Earlier today, I dropped 10 extra dollars on gas, meaning my real wage has decreased. Therefore I will choose to work less in the coming weeks until my job will offer me a higher real wage… No I won’t, will I?! I’m going to work extra hard despite the havoc it will wreak on my school work.

I also made baked apples this evening.

 This article is a reasonably causal yet skeptical assessment of real business cycles. Mankiw briefly describes varying degrees to which real business cycle advocates take their theory, beginning with those who use it as an indicator for the infallibility of hardcore classical economics. These economists believe that nominal variables are completely irrelevant and have no impact on the economy whatsoever; markets will always clear due to real variables alone. Business cycles, therefore, occur as the result of fluctuations in the level of available technology and because of a change in individual production functions between leisure and goods. The leisure-goods trade off is especially problematic as the idea contrasts empirical evidence. For example, in a recession, people consume less and increase their leisure time, and the opposite occurs in a boom. If both of these are normal goods (as real business cycle theory assumes), their reactions should coincide when confronted with the same economic stimulus.  This is where technology steps in to save the day. Real business cyclists argue that recessions occur when technology becomes less productive, which decreases the marginal product of labor and therefore the real wage. As a result, people will both decrease their consumption and increase their leisure. Interesting theory, but Mankiw isn’t having it – as a Keynesian, he believes that unemployment is caused by market inefficiencies, and that individuals are not making a conscious choice to enjoy more leisure by responding to fluctuations in real variables.

More lenient cyclists* treat economic shocks as incidents that are specific to one or a few industries, as opposed to the aggregate economy. The regression of technology in one industry effects aggregate wealth, and leads to a recessing business cycle. Another explanation for this notion states that recessions are caused by adjustment within the labor market as individuals find it less rewarding to work in one industry in relation to another. A recession in this case would be the result of this adjustment in the labor market. The second interpretation works well with Keynesian theory, since the only detail that differs between the two theories is the idea of whether workers are unemployed voluntarily or involuntarily in such situations. Cyclists argue that workers are merely attempting to maximize their utility by switching to a more financially rewarding job. However, in that case recessions would be coupled with a large number of job vacancies, which they are not. Instead, high unemployment coincides with low labor demand, indicating involuntary unemployment that Keynesians believe in. Cyclists also suspect that money has no impact on the real economy, and that instead money reacts to variation in output and never vice versa.

Real Business Cycle Theory provides an interesting way of looking at the short run behavior of the aggregate economy, but severely lacks convincing empirical data. I do like how it challenges generally accepted directions of causality, despite the fact that they lack evidence to support their ideas.  Why does the money supply necessarily have to effect output? They appear to provide logical, inductive reasoning as to why this and other assumptions may not be true as they are understood, but fail to fully support them. They appear to have been stirring things up in economic theory just for the hell of it, ultimately. Mankiw’s final remarks state that real business cycle theory has internal consistency and credibility, but lacks external consistency (which is real evidence). Perhaps I would have a deeper appreciation for the theory if I hadn’t read an article written by a critic, but nonetheless I enjoyed learning about cyclist rationale.

*I’m not brick dumb; I know that cyclists are people riding bicycles. I felt like shortening the term “Real business cycle economists” and “cyclists” was the most amusing alternative that flashed through my mind.

Mankiw, N. Gregory. 1989. “Real Business Cycles: A new Keynesian perspective.” In Journal of Economic Perspectives 3, Summer: 79-90.

Traditional classical thought assumed that price and wage flexibility were such that the economy always managed to move toward the market clearing level. This assumption was questioned by Keynes who argued that firms adjusted quantities because of price and wage stickiness, which decreased the likelihood of full employment. In reality, the traditional classical thought applied to larger items, such as homes and things that could be auctioned off, where price adjustment was a feasible option. The Keynesian way of looking at things applied more to smaller items, where a fixed price was a more pragmatic approach. New Classical economic thought provided a theoretical explanation for why this dichotomy exists.

New Classical thought introduces the profit maximization behavior of firms into their macro model. They assert that an equilibrium will not be achieved without information. In order for markets to clear, there must be perfect information which is only attainable by specialized traders with relatively clear rational expectations. Realistically, these assumptions can only refer to homogeneous products. (Heterogeneous products are a little trickier, and therefore more interesting.)

The price for information on expectations in the heterogeneous product market is greater than its homogeneous counterpart, and therefore specialized traders have no place in this marketplace. Therefore prices are more likely to be fixed. Heterogeneous products refer to anything where there is variation among specific choices of the same thing. Think of going to the grocery store and picking out fruit: you don’t want to just send a person to pick up a piece of fruit at random, because there’s a chance that it will be of a lower quality than what you expect. Choosing your piece of fruit requires deliberation, and therefore you need to cut out the middleman and set standard prices so the quality of the fruit isn’t up for debate. The labor market is the same way – an employer will want to assess the quality of a worker because of the abundance of variables involved in the labor market, and therefore is not likely to delegate the task to an arbitrary specialized labor trader (at least not in countries that respect human rights, more or less).

Price fixing allows firms to make a good available at a variety of locations with minimal transactions costs, and also avoids adjustment costs that he would need to accrue if he were interested in adjusting his prices to be market clearing. Therefore, price setters establish their prices to match their expected long run economic trends. This requires less coordination since the final price is created with enough leeway to account for short run price variation. Firms’ efforts to maximize their profits relative to competing firms also will inhibit them from adjusting their prices, as no firm wants to be the first to lower prices and thereby lose profits for the sake of being in equilibrium. They are more likely to adjust their quantities to account for a decrease in aggregate prices.

I don’t remember what it was about exactly, but the term “fixpricety” was somewhere in this chapter.

Shaw, G.K. 1984. Rational Expectations and Price Flexibility. in Rational Expectations: An Elementary Exposition, 73-82. New York, NY: St. Martin’s Press.

It’s half past one in the morning. This blog post requires a disclaimer. Since those weaken arguments, I’m not putting one on here – just imagine that I included a really killer one that COMPLETELY makes up for any inconsistencies or grammatical errors.

As Greenlaw said in class today, it is difficult to disentangle Reagan’s economics from his politics. I have thus far read two of his speeches: one from 1964 when he’s advocating presidential candidate Goldwater, one from 1983 when he was addressing the Heritage Foundation.  I also skimmed through an address he made to the national Evangelical church association, or some organization like that. My favorite line from that one was: Girls termed “sexually active” — and that has replaced the word “promiscuous” — are given this help in order to prevent illegitimate birth or abortion. This statement was in his argument of how planned parenthood-type organizations should be required to inform parents of girls who they were providing birth control to, and how the morality of the issue is greater than the respect for these girls privacy (this is how he phrases it, by the way, not me this time!). Granted, I’m sure that to some extent he had adjusted his language to appeal to his audience. Regardless, I find it a bit inconsiderate to assume that minors who are sexually active are necessarily promiscuous. This isn’t an economic argument, but I feel it is still important.

The article from 1983 was the first I read, and was intended as an address to the members of the Heritage Foundation but felt more like Reagan advocating his own policies. Apparently the economy was doing well at this point, having emerged from the recession of ‘82 (possibly ‘81, I’m not sure). He boasted that no one was using the term “Reagonomics” anymore because his policies were working. By cutting the federal budget by 40%, most of which was from welfare, he was able to give tax breaks of 25%. On the bright side, his administration did decide to work inflation indices into the tax system to ensure that people were not being taxed too much for their salary. He switches to discussing the Cold War, and the threat from the Soviets. It’s easy to see how his demonization of  socialist policies fueled his economic policy seeking less government involvement and fewer welfare programs. The Soviet Union was clearly not upholding the ideals it had been founded upon, and instead of acknowledging this inconsistency Reagan decided to not only identify the reality of the Soviet Union as the enemy, but also the sham ideals they were supposed to represent. He closes by discussing how America has become a city on a hill; given his audience, this is acceptable… but may not make for the best international policy of all time. Another oddity was that he glorified conservative thought and the possibilities it presents for our nation, but never really clarifies what exactly conservative thought is. He even at one point just says “I know it when I see it.” It seems that a general school of thought that is supposedly the beacon of success for our nation should be more identifiable than that.

The second real article I read was from 1964. Reagan didn’t discuss supply-side economics as much in this one, however he seems to already be teasing out the details of that theory, despite his goal being to advocate Barry Goldwater. He describes America as, more or less, the Mecca of freedom and the ONLY source of hope for those living in injustice. He attacks recent regimes for failing to balance the budget in 28 of the previous 34 years, and for allowing inflation to get out of hand. Most of all, he attacks government welfare, taxes, and subsidizing. When discussing agriculture, he is distraught that farmers have been put out of business while more government officials in the agriculture department are being appointed. He considers subsidies a waste of money, as the government is effectively paying people to not grow things on their land. It reminds me rather of a part in Catch-22 where one character specializes in not growing alfalfa and exploits the government  by using his subsidy money to purchase more and more land to not grow alfalfa on. From this I gather that he would prefer a free market for agricultural produce, which may drive prices down because of an increase in the surplus of goods. The subsidy is more or less an insurance mechanism for the farmers from what I understand, and saves them from their own profit-maximizing behavior.

He considers welfare a source of government expenditure that has gotten WAY out of hand, and highlights the difference between the sum of money that is being put into welfare programs and the sum of money that ends up making its way to the hands of those stricken with the burden of poverty. Given the number of impoverished people (defined as anyone making less than $3,000 per annum) and the amount of money that is going toward welfare programs, these individuals should be receiving an extra $4,600 on top of their $3,000 maximum, making them no longer impoverished. Instead they are receiving about $600, because the government has again assigned itself the task of saving people from themselves and establishing PROGRAMS instead of unregulated hand outs. While I agree that people take welfare for granted, it’s more responsible to spend the extra money to establish programs as opposed to giving potentially financially irresponsible people income they haven’t had to work for without any restrictions as to its use. This goes along with his rather exhausted theme of wanting to reduce the influence of government in all aspects of society. I say exhausted because he discusses this point ad nauseam in the remainder of the speech.

All of that sounds a little snide. Reagan’s speeches rub me the wrong way, but I don’t mean to attack him as a person. Also these are just my reactions to what I’ve read. Maybe I’ll appreciate his policies more as I continue to read, but it doesn’t look promising right now. I think I just dislike how politicians speak in general… so that might also do it. Anyway, I’m just making sure no one thinks I’m attacking Reagan personally, because sometimes people get really combative about that.