Monthly Archives: August 2013

What macro do we teach at the Principles level?

Every time I take a look at the principles level texts, it turns out to be a thoroughly entertaining experience! I usually look at how the authors have dealt with business cycles and more often than not the treatment turns out to be biased. For example take a look at this passage (pp. 273) from Hall and Libermann’s principles text. It looks at changes in labor demand as a cause of business cycles:

A Change in Productivity? One possibility is that the labor demand curve shifts leftward because workers have become less productive and therefore less valuable to firms. This might happen if there were a sudden decrease in the capital stock, so that each worker had less equipment to work with. Or it might happen if workers suddenly forgot how to do things— how to operate a computer or use a screwdriver or fix an oil rig. Short of a major war that destroys plant and equipment, or an epidemic of amnesia, it is highly unlikely that workers would become less productive so suddenly. Thus, a sudden change in productivity is an unlikely explanation for recessions. What about booms? Could they be explained by a sudden increase in productivity, causing the labor demand curve to shift rightward? Again, not likely. Even though it is true that the capital stock grows over time and workers continually gain new skills— and that both of these movements shift the labor demand curve to the right— such shifts take place at a glacial pace. Compared to the amount of machinery already in place, and to the knowledge and skills that the labor force already has, annual increments in physical capital or knowledge are simply too small to have much of an impact on labor demand.

So in making fun of the RBC school or the classical model, they totally forget to mention oil price shocks, creative destruction because of technological changes, weather shocks in developing countries, etc. According to the discussion that follows, business cycles are caused by sudden autonomous miscalculations of demand on the part of producers coupled with herd behavior or changes in spending coupled with malfunctioning credit markets or people keeping unspent money under the mattress!

Dismissing changes in labor supply as a reason for business fluctuations, they say the following:

One way the classical model might explain a recession is through a shift in the labor supply curve. Figure 3 shows how this would work. If the labor supply curve shifted to the left, the equilibrium would move up and to the left along the labor demand curve, from point E to point G. The level of employment would fall, and output would fall with it. This explanation of recessions has almost no support among economists. First, ­remember that the labor supply schedule tells us, at each real wage rate, the number of people who would like to work. This number reflects millions of families’ preferences about working in the market rather than pursuing other activities, such as ­taking care of children, going to school, or enjoying leisure time.  A leftward shift in labor sup-ply would mean that fewer people want to work at any given wage— that preferences have changed toward these other, non work activities. But in reality, preferences tend to change very slowly, and certainly not rapidly enough to explain recessions.

Now here the treatment is somewhat reasonable. However, there is no mention of preferences for work and leisure over time and how they could affect the labor supply curve or the fact that every time there is a recession, graduate enrollment goes up or government policies like welfare programs could affect unemployment duration (The Redistribution Recession story!).

Now I am sure Robert E Hall knows better than that.  For example look at this paper where he talks about preference shifts as causing changes in employment.  So instead of taking sides with one model why not present alternative explanations of an economic phenomenon?  Yes, the economy could be hit by real shocks or aggregate demand shocks or a combination of both or one turning into another. It is important to emphasize this to foster critical thinking and developing a balanced perspective.  When it comes to lack of a balanced perspective, most macro-principles texts are to be blamed and not just the one mentioned above. Thankfully, though, the textbook I use fares better and I kind of feel proud for not bombarding students with only one version of the story.

PS: Came across one more Principles of Macroeconomics that has a balanced treatment: Macroeconomics: Theory through Applications by Russell Cooper and A Andrew John published by Flatworld Knowledge.

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Kalecki-Krugman Deconstructed!

Michael Kalecki is/was one of the favorite authors in Center for Economic Studies and Planning, JNU, India. But frankly speaking I did not understand what he said much while I was a student there. However, recently Steve Williamson has done a very good job of putting Kalecki’s ideas in a very accessible way. Of course, the whole thing began as usual with Krugman trudging up Kalecki’s ghost!

You can read Steve’s analysis here and here.

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Filed under current economic issues, Macroeconomics and the crisis