Must-Read: Robert Waldmann: Repairing Macroeconomics: "A good first step is to go back to the old Keynesian research program... and pick up where Tobin, Solow and Samuelson left off...
...Macroeconmic research has suffered because the questions to be addressed are either too easy or too hard.... It is very hard to answer any question about behavior which depends on long term expectations.... It is too easy to understand macroeconomic issues which don’t depend on long term expectations.... The appeal of assuming rational expectations is that models with rational expectations are tractable but not trivial.... The resulting advantages for the academic made the assumption irresistible. Unfortunately... it leads to a sterile research program....
I think the too-easy problems include the determination of aggregate consumption and short term fluctuations in employment. The old model of consumption... determined mostly by current disposable income... also higher when the ratio of financial wealth to current income is higher. This fits a model in which people mostly consume from income, are myopic, and have habits so their consumption slowly adjusts to new levels.... It fits the data amazingly well.... There are theoretical arguments for why such a primitive model shouldn’t work, but it does....
The average non-economist assumes that employment is determined by labor demand because there are unemployed workers looking for jobs. There are theoretical arguments that this can’t be true. However, it is very hard to fit the data unless one assumes that there is excess supply of labor.... Similarly, the average person and most working mainstream macroeconomists assume that current sales of goods and services are determined by demand.... This assumption is now mainstream but it wasn’t either 15 or 30 years ago. Again, I think the extent to which current NK models are similar to old Keynesian models isn’t universally recognized....
My proposal is to admit that many problems are very simple and were solved decades ago, and that others won’t be solved any time soon. I think the hard problem of how people really form expectations is still unsolved and must be solved before macroeconomics can amount to a social science. I think (as I have for over 30 years) that we have to listen to psychologists and (shudder) sociologists. I am pleased to note that many very famous economists do just that (cough Akerlof cough)....
We can still ask if there is anything useful we can say any time soon.... We agree that fluctuations in nominal aggregate demand can affect output and welfare, that demand is currently still slack in most of the developed world, and that temporary government spending increases are effective fiscal policy. That isn’t all that much (and adds nothing at all to Keynes). However, it implies policy recommendations which are too radical to be seriously considered by policy makers and supported by the majority of macroeconomists...
