The Case for Killing Textbook Macro
Seeing two posts today on macro, I am ready to share Nassim Taleb’s despair.
Tyler Cowen writes,
I agree with your point that fiscal policy can work through V and that is the correct way to think about it. In fact Alex and I present this in our forthcoming Principles text.
I’m sorry to hear that. I think that the main lesson of the past few years is that monetarism is not even close to right when the inflation rate is reasonably low (say, less than 5 percent). The notion that “fiscal policy can work through V” (that is, it can increase the velocity of money) is embedded within a faux-physics paradigm that has no value, in my view. It s my view that financial institutions, bubbles, and crashes matter. Monetary policy does not.
Some Austrians will insist that monetary policy is responsible for bubbles and crashes. I will suggest instead that institutional factors, including perverse regulations, are far more important.
Next, we have Greg Mankiw.
What is the distinction between a shock to potential output (aka the natural level of output) and a shock to the Phillips curve?
Back when I still followed textbook macro, I thought that potential output was the long-run aggregate supply curve and the Phillips Curve was the short-run aggregate supply curve. I am not sure why Greg did not answer the question along these lines.
But my main point is that I think this whole framework is not helpful. It is important to remember that for the economy as a whole, “supply and demand” is only a metaphor.
Instead, I prefer to describe the economy as having labor markets that are close to equilibrium or far away from equilibrium. When labor markets are close to equilibrium, there are lots of people taking new jobs and lots of people leaving old jobs (not necessarily voluntarily), but there is an overall balance. When markets are far away from equilibrium, there is an excess of people leaving jobs relative to people finding jobs, and this excess persists.
What should we call this labor market imbalance? In the textbooks, we might call it a demand shock if we think that most of the unemployed could go back to working at their old jobs. Otherwise, we might call it a supply shock.
The working assumption in textbooks is that there is something that policy can do to solve the labor market imbalance, particularly if it is a demand shock. I think that we rarely, if ever, observe a pure demand shock. I think that monetary policy is ineffective, for reasons stated above. I think that fiscal policy is likely to be ineffective, unless policymakers can outguess the market about the sorts of jobs that need to be created in the long term.
In my view, the policymaker who thinks like a textbook macroeconomist, and therefore believes that he sits at a control center with buttons to press and levers to push that will create jobs, is deceived. The buttons and levers are there all right, but they do not work as the textbooks propose.
If I were a policymaker in the current environment, I would try Bryan Caplan’s idea of cutting the employer portion of the payroll tax. My thinking is that with more profits and a lower marginal cost of labor, we might get back to labor market balance faster. I would not be confident that this policy would produce great results. But I am persuaded that it stands a better chance than other stimulus policies, both enacted and proposed.
The key point is that the problem is not to create jobs. The problem is to hasten the process of restoring labor market balance.