Tuesday, April 15, 2008

The Muddle That Is Macro

Arnold Kling:

Without irony, Greg Mankiw points to both John Makin, arguing in the Wall Street Journal for loose money, and Martin Feldstein, arguing the next day for tight money.

Meanwhile, today's Washington Post has a story with a typical headline:

Economy's Fate Hinges On Shoppers' Stamina
This is what I call "folk macroeconomics" or "folk Keynesianism." I think that it ultimately derives from what my co-blogger has documented as the make-work fallacy, the popular belief that jobs are inherently scarce.

In general, I think that the economy's fate hinges on its ability to adapt to changes in relative prices. If there are few large shocks, then full employment will not be disturbed. With large shocks, then people need to respond to incentives to exit some occupations and industries in order to enter others.

My daughter who is a freshman left a message that she wants me to explain macro to her. I can do that, in the sense that I can teach what is in her textbook. In reality, however, macro is a muddle that no one can explain. The undergraduate textbook, a graduate textbook, and macroeconomics as practiced by policymakers (what Mankiw calls the "engineering approach") have nothing in common with one another.

Every macroeconomic pronouncement should be accompanied by a disclaimer that says, "This is just my opinion. We don't really know."

Unfortunately, this seems to be true.

The two books I found that helped me understand the jumbled mess of macroeconomics were Modern Macroeconomics by Snowdon and Vane and Macroeconomics by Greg Mankiw. While I learned enough macro to pass my PhD prelim exam, I agree with Kling. I am highly skeptical of the validity of most of macroeconomics.

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