My macroeconomic framework, circa 2015

A while ago Scott Sumner laid out at least part of his framework, I thought I should lay out some key parts of mine.  Here goes:

1. In world history, 99% of all business cycles are real business cycles.  No criticism of RBC can change this fact.  Furthermore the propagation mechanism for a “Keynesian business cycle” (arguably a misleading phrase) also relies on RBC theory.

2. In the more recent segment of world history, a lot of cycles have been caused by negative nominal shocks.  I consider the Christina and David Romer “shock identification” paper (pdf, and note the name order) to be one of the very best pieces of research in all of macroeconomics.  Sometimes central banks tighten when they shouldn’t, and this leads to a recession, due mainly to nominal wage stickiness.

3. Workers are laid off because employers are often (not always) afraid to cut their nominal wages, for fear of busting workplace morale, or in Europe often for legal and union-related reasons.

4. Overall I favor a nominal gdp rule for monetary policy.  But most of its gains would come in a few key historical episodes, such as 1929-1932, or 2008-2009.  In most periods I don’t think we know what the correct monetary policy should be, nor do we know that it matters.  Still, that uncertainty does not militate against an ngdp rule.

5. Once workers are unemployed, nominal wage stickiness is no longer the main reason why they stay unemployed.  In fact nominal wage stickiness is largely taken out of the equation because there is no preexisting nominal wage contract for these workers.  There may, however, be some residual stickiness due to irrational reservation wages, also known as voluntary unemployment due to stupidity.  (You will find a different perspective in Scott’s musical chairs model, which I may cover more soon.)

5b. Monetary stimulus to be effective needs to be applied very early in the job destruction process of a recession.  It is much harder to put the pieces back together again, so urgency is of the essence.

6. The successful reemployment of workers depends upon a matching problem, a’la Pissarides, Mortensen, and others.  Yet this matching problem is poorly understood, and it can involve a mix of nominal and real imperfections.  Sometimes it is solved more quickly than expected, such as in the recent UK experience, and other times more slowly than expected, as in current Spain.  Most of the claims you will read about this reemployment of workers are wrong, enslaved to ideology or dogmatism, or at the very least unjustified.  Hardly anyone wants to admit this.

7. Really bad recessions involve deficient aggregate demand, negative shocks to intermediation, some chronic supply-side problems, negative wealth effects, and increases in the risk premium, all together.  It is hard to find a quick fix.  Furthermore models where AS and AD curves are independent and separable are often misleading, despite their analytic convenience.

8. Given that weak AD is only one of the problems in a bad downturn, and that confidence, risk, and supply side problems matter too, the best question to ask about fiscal policy is how well the money is being spent.  The “jack up AD no matter” approach is, in the final political equilibrium, not doing good fiscal policy any favors.

9. You should neither rule out nor overstate the relevance of Hayek and Minsky.  Their views have much in common, despite the difference in ideological mood affiliation and who — government or the market — gets blamed for the downturn.  For really bad recessions, usually both institutions are complicit to say the least.

10. All propositions about real interest rates are wrong.

There is more, but I’ll stop there for now.


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