Unit 15: Review and Summary

We now come to the end of the course.  There is a lot more we could say and a lot more we could study, but our time is limited (economists might say “scarce”).  I have tried to give you the best overview I can about modern macroeconomics.  My goal has been to help you understand how the economy around you functions and how to understand the terms and ideas involved.

Macroeconomics is constantly evolving. And with it policy guidance is also evolving. For non-economists, there is a temptation to just ignore it. But the economy is too important to ignore. It affects all of us. It determines what opportunities are available to us in our lives. Like it or not, policy will be made. Politicians will continue to make spending and taxing decisions and thereby, effectively create fiscal policy. Central bankers will continue to make decisions about the money supply and thereby affect the interest rates we all pay, the growth of the economy, and the presence of inflation.

Very few of us will ever hold professional positions where we can make significant macro policy decisions – that’s a world that’s reserved for the few who become Presidential advisors and central bankers. Yet I feel its important that all of us understand what’s happening and be able to form our own intelligent opinions.  Democracy depends on an informed electorate.  A widespread knowledge of macroeconomics is also I believe one of the few decent checks we have against having some narrow segment of society (the rich and powerful) being able to bend policy to their benefit instead of to the benefit of all society.

Therefore I’ve tried to teach the controversies and contrasts between the different theories.  Odds are that the vast majority of my students will not go on to become economists (which is good, it reduces competition for me!) so I haven’t tried to “make you an economist”. Instead I hope you can better understand the economists and politicians you hear.

We began this course by establishing that society, any society, has four macroeconomic goals:

  1. growth in GDP
  2. a stable price level (no significant inflation and no deflation)
  3. stability in the business cycle
  4. full employment.

Indeed, the major reason why economists study macroeconomics is to help devise ideas for how to help society achieve these goals. Yet there is not much agreement in macroeconomics.  The last couple years have been particularly contentious as earlier, widely accepted theories have run into difficulties trying to explain the real world.

It is true that macroeconomics is a contentious field in both theory and in policy advice. Macroeconomists do disagree as should be very clear by this point in the course. The reasons for this disagreement are really four-fold.

First, as a science, economics is very difficult. Unlike physical sciences such as physics, chemistry, or biology, it is largely impossible to conduct research experiments. The best we can manage is to observe the actual economy, theorize, and test our theories by seeing if they explain what the economy has done in the past – a sub-field we call econometrics. But econometrics is very tricky statistical business and rarely settles any debate definitively.

A second problem is because the subject being studied, the economy, keeps changing in unpredictable ways.  Again, contrast this to physics.  Physicists have had it easy.  Gravity has worked the same way thousands of years.  But a macroeconomy keeps evolving. We now have global electronic instant banking – something that didn’t exist 100 years ago. We now have huge multi-national corporations. They didn’t exist 150 years ago (with literally perhaps a dozen exceptions). It’s tough to be “scientific” and “definitive” when the subject being studied keeps changing!

An example of this evolving macroeconomy and theory is what happened to Classical theory of the real sector. It accurately predicted the performance of an economy with very competitive markets, small firms and households, a large agricultural sector, and gold-based money. The policy guidance it provided proved useful and successful for a long period of time. But by 1929 the economy had changed. Agriculture was no longer dominant. Gold no longer backed money in many nations. Many markets were monopolistic instead of competitive. As a result, the Keynesian theory emerged to explain the economy.

A third challenge of macroeconomics arises because of the large system-wide nature of the economy. Everything really does affect everything else.  In micro, it’s possible to make a few reasonable assumptions and isolate the primary factors going on. For example, in micro it’s reasonable to assume that buyers (demand) and sellers (supply) are separate groups. It simplifies the analysis. But in macro, we constantly run into the fallacy of composition – just because it’s mostly true at the micro level doesn’t mean it’s true at the economy-wide level.

For example, if a single firm lowers the wage it pays, then the firm makes more profits because sales stay the same but costs drop.  In macro, that’s not true.  If all firms lower the wages paid, then all firms sell less goods because the customers (us) are also the workers (us).  Profits actually decline.  This leads to a lot of what seem to be counter-intuitive conclusions, but upon further careful analysis prove to be correct.

 

The final reason why macro is prone to contention and not simple is precisely because macro theory ideas lead to policy.  And policy can benefit particular groups or harm them. And policy means politics which brings ideology.  Unfortunately economists haven’t always been open about the ideological foundations of their theories.  It’s often hidden. The key, as I hope you’ve learned, is to look at the assumptions they make about how the economy is structured and how people make decisions. Anybody (well almost anybody) can do the math to build the models, but the conclusion largely derives from the assumptions.

You may be curious (or not) about my views. I’ve tried to be balanced and “teach the controversy” but obviously I have views and I know they come out.  Let me, as I usually do, give a brief history.  I first caught a bug to study economics back in high school (a long time ago, though not back with the dinosaurs as my son might suggest).  In undergraduate school I was thoroughly taught what we call “original Keynesianism” now.  I was somewhat skeptical at the time and began independent studies of what we now call Monetarism/Neo-classical views (mostly Friedman).  In my first stint at grad school (my masters) I was exposed to a wide variety of theories including Keynesian, Monetarist, Neo-classical, and even Marxist.  For a long time I could have been considered Monetarist-Neoclassical.  In my doctoral studies (1990’s) I was heavily taught New Classical and New Keynesian techniques.  But in recent years, especially since the 2007-09 recession and crisis, I’ve returned to some heavy study. And with that study, new data, and new information, I’ve changed my views. I’m now very heterodox and strongly “Post-Keynesian” and “MMT- modern monetary theory”.

I will leave you with four of my favorite quotes from John Maynard Keynes. I don’t agree with Keynes on everything, but I definitely share these sentiments:

“When I am presented with new information and facts, I change my mind. What do you do sir?”

“If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.”

“Ideas shape the course of history”

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”

— John Maynard Keynes