Center for the History of Political Economy Summer School June 2012 1 History of Modern Macroeconomics Lecture 3.3. Macroeconometrics and the New Economics.

Center for the History of Political Economy Summer School June

2012 1

History of Modern MacroeconomicsLecture 3.3. Macroeconometrics and

the New Economics (1930-1950)

Kevin D. HooverDepartment of EconomicsDepartment of Philosophy

Center for the History of Political EconomyDuke University

Center for the History of Political Economy Summer School June

2012 2

Ragnar Frisch

Inventor of important terminology: microeconomics/macro-

economics econometrics

Influential in development of: dynamic economics econometric (empirical)

methods Creator of modern professional

institutions Founder of Econometric Society First editor of Econometrica

Ragnar Frisch (1895-1973), Nobel Laureate (1969)

Center for the History of Political Economy Summer School June

2012 3

Contrasts and Complementarities Between

Frisch and Keynes micro vs. macrodynamics

econometrics pragmatism and

aggregation dynamics

pervasive micro analysis system properties and

emergence against econometrics

Frisch

Keynes

Center for the History of Political Economy Summer School June

2012 4

Frisch: Dynamics and the Macro/Micro Distinction

“micro-dynamic analysis is an analysis by which we try to explain in some detail the behaviour of a certain section of the huge economic mechanism, taking for granted that certain general parameters are given . . .”

“macro-dynamic analysis, on the other hand, tries to give an account of the fluctuations of the whole economic system taken in its entirety.”

Macro not built on micro; micro presupposes macro.

Center for the History of Political Economy Summer School June

2012 5

Frisch: The Economic Pragmatist

“it is always possible to give even a macro-dynamic analysis in detail if we confine ourselves to a purely formal theory . . . Such a theory, however, would only have a rather limited interest” for actual business-cycle problems.

“We may perhaps start by throwing all kinds of production into one variable, all consumption into another, and so on, imagining that the notions ‘production,’ ‘consumption,’ and so on, can be measured by some sort of total indices.”

Center for the History of Political Economy Summer School June

2012 6

Keynes on Dynamics

“The real task of [monetary] theory is to treat the problem dynamically, analysing the different elements involved, in such a manner as to exhibit the causal process . . . and the method of transition from one position of equilibrium to another.”

Treatise on Money

Center for the History of Political Economy Summer School June

2012 7

Keynes and the Centrality ofMicroeconomic Analysis

All the main Keynesian functions analyzed microeconomically:o consumption functiono labor supplyo labor demando liquidity preferenceo investment

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2012 8

An Illustration: Keynes on Liquidity Preference

Speculative demand for moneyo normal rate of interest—individual and

heterogenouso hold bonds if market rate above normal

expected capital gain; hold money if market rate below normal expected capital loss

o market rate = rate at which market is divided into balanced groups of bulls and bears

o no aggregation; market rate = some particular agent’s normal rate

Center for the History of Political Economy Summer School June

2012 9

Another Illustration: Keynes on the Labor Market – 1

Labor demand: standard firm optimization problem

Labor supply: not principally money illusion but a relative efficiency-wage argument:o “the struggle for money-wages is . . . essentially a

struggle to maintain a high relative wage . . .” General Theory

o Kevin Hoover, “Relative Wages, Rationality, and Involuntary Unemployment in Keynes’s Labor Market,” History of Political Economy 1995.

Center for the History of Political Economy Summer School June

2012 10

Another Illustration: Keynes on the Labor Market – 2

Defines unemployment not by aggregative version of individual situation: real wage > marginal disutility of labor but by market test:

“Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. “

No reference to aggregate labor-supply function.

Center for the History of Political Economy Summer School June

2012 11

Keynes vs. Frisch: Role of Theory

Frisch: macro system a giant machine

approximated by coarser simplifications; the “economic engineer”; models as

mechanical analogues.

Keynes: economy organic; macro properties

emergent; the “economic physician”; models as

diagnostic tools

Center for the History of Political Economy Summer School June

2012 12

Frisch’s Vision: Two Versions of the Tableau Economique

François Quesnay 1759

Ragnar Frisch 1933

Center for the History of Political Economy Summer School June

2012 13

Keynes’s Vision: Mandeville’s Fable of the Bees

“the gay of tomorrow are absolutely indispensable to provide a raison d'être for the grave of to-day” (Keynes, General Theory, pp. 105-106).

Center for the History of Political Economy Summer School June

2012 14

Keynes vs. Frisch: Aggregation and Econometrics

Frisch: aggregation pragmatically necessary for econometrics;

Keynes: against econometrics; despite introducing terms such as aggregate supply and aggregate demand, aggregates do not drive dynamics

Center for the History of Political Economy Summer School June

2012 15

Frisch: The Economy as Machine: A Simple Pendulum as an Analogue of

the Business Cycle

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2012 16

Complex Pendulums

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2012 17

Propagation and Impulse Mechanisms

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2012 18

Jan Tinbergen and Applied Macroeconometrics

Trained as physicist Created first modern

econometric models: Smaller Dutch model Larger U.S. model

Two-volume study of U.S. business cycles for the League of Nations (1939) methodology and

application object of Keynes’s

attack on econometricsJan Tinbergen (1903-1994)

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2012 19

Jan Tinbergen

Socialist

In 1950s director of the Dutch Central Planning Bureau

Jan Tinbergen (1903-1994), Nobel Laureate (1969)

Center for the History of Political Economy Summer School June

2012 20

Keynes Meets Frisch and Tinbergen – 1: The Cowles

Commission Cowles Commission for Research in Economics founded in 1932 by Alfred Cowles

Moved to Chicago in 1939 Early research:

Econometric methodology (especially structural macromodels)

General equilibrium models

Center for the History of Political Economy Summer School June

2012 21

Keynes Meets Frisch and Tinbergen – 2: Hicks

Value and Capital (1939): Keynes in light of Walras

Dynamics of type Frisch thought impractical

Formal analysis of aggregation

The IS-LM ModelSir John R. Hicks (1904-89), Nobel Laureate (1972)

Center for the History of Political Economy Summer School June

2012 22

Klein and the Aggregation Program

Keynesian

Walrasian

Econometrician

Socialist

Lawrence Klein (1920- ), Nobel Laureate (1980)

Center for the History of Political Economy Summer School June

2012 23

Keynes and Bretton Woods

Bretton Woods (NH) Resort

Keynes and Harry Dexter White (U.S. Delegate)

Keynes and the Soviet Delegate

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2012 24

Making the Economy Work - 1

Lord Beveridge (1879-1963)

Center for the History of Political Economy Summer School June

2012 25

Making the Economy Work - 2

Harry S. Truman (1884-1972, President 1945-53)

Alvin Hansen (1887-1975), American popularizer of Keynes

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2012 26

Abba Lerner (1903-1982)

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2012 27

Thanks

The End