Posted by: Dirk | October 7, 2011

“Advanced” Macroeconomics

This semester, I will teach Advanced Macroeconomics at the Master level (together with a colleague). We have decided to use David Romer’s book of the same name (new 4th edition), but more because of lack of alternatives than because the book is well written. An example for this would be ch. 6, now titled “Nominal rigidity” (formerly ch. 3: “Traditional Keynesian Theories of Fluctuations”). Page 245 reads:

Case 1: Keynes’s Model

The supply side of the model in Keynes’s General Theory (1936) has two key features. First, the nominal wage is completely unresponsive to current-period developments (at least over some range):

W = W* (it’s W with a hat in the original, but I don’t know how to get a hat with html)

[..] Second, for reasons that Keynes did not specify explicitly, the wage that prevails in the absence of nominal rigidity is above the level that equates supply and demand.

This is interesting. Interesting like reading: “Darwin in his theory of evolution claims that apes turned into men.” It is an absolute failure to understand the theory at all, or perhaps even worse, it is closer to the opposite of the theory. Now let me quote from the General Theory in order to quickly dispel the two “key features” from above. Chapter 19 (Changes in Money-Wages) starts with this sentence:

IT would have been an advantage if the effects of a change in money-wages could have been discussed in an earlier chapter.

Well, that doesn’t sound like Keynes assumed wages to be fixed, does it? Let’s turn the page and read on whether Keynes thought the wage was fixed at a too-high level:

But it would, I think, be more usual to agree that the reduction in money-wages may have some effect on aggregate demand through its reducing the purchasing power of some of the workers, but that the real demand of other factors, whose money incomes have not been reduced, will be stimulated by the fall in prices, and that the aggregate demand of the workers themselves will be very likely increased as a result of the increased volume of employment, unless the elasticity of demand for labour in response to changes in money-wages is less than unity. Thus in the new equilibrium there will be more employment than there would have been otherwise except, perhaps, in some unusual limiting case which has no reality in practice.

OK, so at least this point was correct in Romer’s text-book. Or perhaps … wait – let’s read on:

It is from this type of analysis that I fundamentally differ; or rather from the analysis which seems to lie behind such observations as the above.

D’oh!

Some will now say: well, just a little mistake, won’t do much to the real world discussions where economists have probably figured it out by now. Here is Laurence Kotlikoff on Bloomberg:

4. Get prices and wages unstuck.

Some prices and wages are set too high, thereby damping demand for output and for the workers needed to produce it. This is the standard sticky wage and price explanation for our economic malaise offered by Keynesian economists such as Paul Krugman and James Galbraith.

You can read the story about the Kotlikoff article at Economist’s View. And if you know a good text-book on Advanced Macroeconomics, let me know. Otherwise I am stuck with David Romer’s judgement about Keynesian economics on page 246:

This prediction has been subject to extensive testing beginning shortly after the publication of the General Theory. It has consistently failed to find support. As described in the next section, our current understanding suggests that real wages are moderately procyclical.

To end this on a more positive note, here is true-Keynesian, eh, … Wicksellian, no, … heterodox heretic Axel Leijonhufvud on Keynes:

Keynes’s fundamental contention that a competitive, private enterprise market economy (with all its prices “flexible”) may fail to home in automatically on its equilibrium time-path stems from the contemplation of states like the one just sketched [and the one depicted in Figure 8.3]: the interest rate is wrong, but that market “clears” (without “punishment,” so to speak, of those responsible); the money wage is right, but large-scale unemployment prevails and persists and even the willingness of labor to reduce the money wage will not help. The system’s “automatic” adjustment tendencies presumed in pre-Keynesian analysis to be self-regulatory, are working to change prices that are right and leaving those we need to have changed alone.

Got it?

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Responses

  1. Hello,
    As a Econ Major undergrad who just finished intermediate macro, I’m looking for an advanced undergrad macro textbook to study by myself during the summer. I’ve heard many people complaining about Romer’s book, and found two possible alternatives, which are:
    1. Macroeconomics Theory, by Jean-Pascal Benassy
    2. Macroeconomic Theory: A Dynamic General Equilibrium Approach 2e, by Michael Wickens

    Just wondering If you’ve used them before, and What’s your comment about them? And if possible, can you also give me some guidance about how best one should study this course (what level of math is expected? should I study dynamic optimization, stochastic calculus, etc,. before I start?)

    Thanks!

    • Hello,

      although I have not used the two books you mentioned, I am sure they give you more or less the same view on the economy. Markets always work, and problems arise from (external) shocks. Dynamic stochastic general equilibrium rules, which is the neo-calssical perspective. Benassy is doing the same thing, it seems to me.

      For a different (Keynesian) view try Peter Montiel and his “International Macroeconomics”. It presents a balance sheet perspective which I find very enlightening. You can also use Krugman/Melitz/Obstfeld and their “International Economics: Theory & Policy”.

      Whatever you choose, I would strongly recommend the “MMT primer” by Randall Wray, which you can read for free on his website. It gives you an institutional perspective, which is absolutely necessary in my eyes. Endogenous money is something you do not find in the four textbooks above, and it is crucial to understand the economic problems of today.

      best,
      Dirk

  2. Another interesting book is Foundations of Modern Macroeconomics, by Ben Heijdra: http://www.heijdra.org/fomm2.htm


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