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Rebuilding Macroeconomic Theory

Summary:
Image is from Chapter 22 of Dynamic Macroeconomics by George Alogoskoufis. Martin Sandbu has written a nice piece in the FT about the latest issue of the Oxford Review of Economic Policy, which is dedicated to an idea I have been promoting for more than three decades. Multiple Equilibria matter. For David this is a ...

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Rebuilding Macroeconomic Theory

Image is from Chapter 22 of Dynamic Macroeconomics by George Alogoskoufis.

Martin Sandbu has written a nice piece in the FT about the latest issue of the Oxford Review of Economic Policy, which is dedicated to an idea I have been promoting for more than three decades. Multiple Equilibria matter. For David this is a new revelation. For some of us labouring on the coal front, it has been obvious for a long long time. And Martin is correct to point out that the ship of research is finally beginning to change course, albeit thirty years after the initial ideas were first floated. Recent books that feature the Indeterminacy School are Dynamic Macroeconomics from George Alogoskoufis and A History of Macroeconomics by Michel De Vroey. Said Aurelian and Beatrice Cherrier wrote a very nice survey piece linked here) and I recently published an encyclopaedia article on the history of The Indeterminacy School in Macroeconomics.

For a glimpse at the truly revolutionary implications of adopting the multiple equilibria approach see my piece in the Vines volume (ungated preprint here). This project, as I have argued for sometime, has the potential to do for Keynesian economics what the RBC school did for classical economics. And don’t be fooled by the claim of ‘New’ Keynesian economists that economics has already ‘been there’ and ‘done that’. NK economics is neither new, nor Keynesian. It is a beautiful recreation of the verbal theory of business cycles that Pigou wrote about in 1923.

What’s missing in almost all NK economics, with some rare exceptions, is the possibility of being permanently stuck in a high unemployment equilibrium. Why has the mainstream ignored the existence of multiple equilibria for more than three decades? The answer, is that it was deeply subversive to the rational expectations agenda. When I published this piece in 1991 , Bob Lucas sent me a personal letter (quoted below in Aurelian and Cherrier’s) survey pushing back against the indeterminacy agenda.

“I don't see any reason to imagine that the fact that equilibrium is indeterminate on a 'big' set of parameters values in a certain class of theoretical models suggests that equilibrium is likely to be indeterminate in a 'lot' of real-world markets. Do you think that God is drawing pieces of reality at random from some probability space on a Kehoe-Levine parameter space?” 

There are great possibilities for pushing these ideas in new directions and for uniting them with Post Keynesian economics. If you are a grad student interested in pursuing a thesis that explores multiple equilibria, you can get some ideas from my second year lectures in the University of Warwick MRes programme linked here.

Roger Farmer
ROGER E. A. FARMER is a Distinguished Professor of Economics at UCLA and served as Department Chair from July 2008 through December 2012. He was the Senior Houblon-Norman Fellow at the Bank of England, January-December 2013.

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