Size Does Matter
If you use the term
"microeconomics" in a WordPerfect document, the spelling checker will flag it
and suggest "macroeconomics" instead. The spelling checker has a point. You
see, macroeconomics has gone out of fashion. Not only academic economists but
also some of our most influential economic pundits seem to regard it as bad
manners to talk about recessions and recoveries and how governments might
alleviate the former and engineer the latter. Ordinarily reasonable people now
argue that the business cycle is a trivial matter, unworthy of attention when
compared with microeconomic issues like the incentive effects of taxes and
regulation. Trying to do anything about recessions is bad for growth, they say,
and even thinking about the business cycle is a bad thing, because it
distracts people from what really matters.
What is
so peculiar about this attitude, which seems to become more prevalent each
year, is that we live in a world in which those old-fashioned macroeconomic
concerns are more pressing than they have been for generations. Not since the
days of John Maynard Keynes have his questions (if not necessarily his answers)
been so relevant. So an occasional reminder that the big things do matter, that
getting microeconomic policy right is no help if you stumble into a depression,
is welcome from any source--even a deficient dictionary.
To see what I'm talking about, consider a recent
Washington Post column by Robert Samuelson, in which he seems to dismiss all
macroeconomic analysis--all attempts to understand the behavior of aggregates
such as gross domestic product and the price level--as useless, even malign.
"What we've learned," declares Samuelson, "is that the little picture is the
big picture." Economic success, he argues, is simply a matter of getting the
incentives right. And he goes on to deride macroeconomics for its "illusion
that it could make the whole system run smoothly almost regardless of how the
economy's underlying sectors functioned. ... It's as if a car could run at
breakneck speed even if the engine was corroded and missing some parts."
One
wonders why the usually judicious Samuelson found it necessary to invent this
straw man. Who is supposed to have had that illusion? Even when Keynesian
macroeconomists were at their most hubristic, none of them claimed that
macroeconomic "fine-tuning" could make an economic jalopy into a Porsche. But
they did claim that even a Porsche won't perform very well if you don't give it
enough gas--that using three workers very efficiently is not much help if the
fourth is unemployed because consumers don't spend enough. And this is not an
abstract point: Just look at the economic storms ravaging quite a lot of
today's world.
For example, Japan's economy has been shrinking
at an alarming pace the last few quarters. Is this because Japanese workers
have become lazy or because the country's factories have fallen into disrepair?
Or to take a more extreme case, has Indonesia become a 15 percent less
productive society than it was a year ago? Of course not: Whatever the ultimate
sources of the crisis in Asia, the immediate cause of these slumps is a
collapse in that good old-fashioned macroeconomic variable, aggregate
demand.
I don't
know what provoked Samuelson's outburst. But if one of our most well informed
economic journalists has come to disdain macroeconomics, this may be because he
has been listening to economists themselves. Over the past 30 years,
macroeconomics--and especially that part of macroeconomics that concerns itself
with recessions and depressions, in which the economy as a whole is less than
the sum of its parts--has fallen steadily into disfavor within the economics
profession. As late as the mid-1970s, many textbooks still followed the lead of
Paul (no relation to Robert) Samuelson's classic 1948 Economics ,
beginning with the macroeconomics of booms and slumps and turning to
microeconomics only in their second half. Nowadays, however, every textbook
(yes, even the one I'm writing) relegates macro to the second half. Even within
the macroeconomics half, more and more books (like the much-hyped new text by
Harvard's N. Gregory Mankiw) dwell on "safe" issues like growth and inflation
as long as possible, introducing the question of recessions and what to do
about them almost as a footnote.
In graduate education the situation has become even more
extreme. While most Ph.D. programs continue to require that students take a
year of macroeconomics, more and more of that year is devoted to long-run
issues, less and less to that part of the subject that might tell you who Alan
Greenspan is and why he might matter. (When I gave an honorific lecture at one
prominent department, students there told me that their macroeconomics course
did not even mention money until the last two weeks, and never so much as
suggested that monetary policy might have anything to do with business
cycles.)
The
reasons for this aversion to macroeconomics are a little hard to explain to a
lay person. It's not that the business cycle has become less relevant--the U.S.
economy has lately had a smooth few years, but macroeconomics was already in
retreat during the anything but tranquil '70s and '80s. (I remember one famous
anti-Keynesian, challenged during an early '80s conference to explain how his
model could be reconciled with the savage recession then gripping the United
States, snapping "I'm not interested in the latest residual"--i.e., the latest
statistical blip.) Nor did macroeconomics fail the test of empirical relevance.
Though it is widely believed that events such as the combination of inflation
and unemployment in the 1970s, or the noninflationary growth from 1982 to 1989,
baffled and astounded macroeconomists, this turns out to be another of those
oddly popular anti-economist legends--similar to the legend that economists
refused to believe in increasing returns. The truth is that stagflation was
predicted as a possibility long before it emerged as a reality and that the
disinflation of the 1980s played out just the way the (old) textbooks said it
should.
The real problem with macroeconomics, from a
professor's point of view, is the shakiness of its "microfoundations." Most
economic theorizing is based on the assumption that individuals behave
rationally--that companies set prices to maximize their profits, that workers
choose to accept or reject jobs based on a rational calculation of their
interests, and so on. You don't have to believe in the literal truth of this
assumption to recognize how powerful it is as a working hypothesis. But while
macroeconomists generally try to put as much rationality into their models as
they can, --the kind in which Greenspan does matter--always depend crucially on
the ad hoc assumption of "sticky prices." In other words, they assume that at
least in the short run, companies do not immediately reduce their prices when
they cannot sell all their production, and workers do not immediately accept
lower wages even when they have trouble finding jobs. This assumption
works ; that is, it transforms the otherwise incomprehensible reality of
the business cycle into something that is not only understandable but, to some
extent, controllable. But it makes many economists uncomfortable; it is the
classic case of something that works in practice but not in theory.
And so
economists have, more and more, simply avoided the subject; and being human,
have tended to rationalize that avoidance by asserting that the subject isn't
really important anyway.
The trouble with this evasion is, of course, that
macroeconomics is important. Paul Samuelson had good reasons for
beginning his textbook with Keynesian analysis. He knew that students would not
find microeconomics, with its emphasis on efficiency, interesting unless they
were first convinced that the economy could achieve more or less full
employment, that it need not relapse into depression. He also knew what too
many latter-day economists have forgotten: Macroeconomics is crucial to the
public credibility of economics as a whole. Analytical, model-oriented thinking
came to dominate American economics mainly because supernerds like Samuelson
had something useful to say about the Great Depression, and their pompous,
windy rivals did not. By abandoning macroeconomics the profession not only
leaves the world without guidance it desperately needs; it also risks letting
the fuzzy-minded literati reclaim the ground they so deservedly lost 60 years
ago.
Of course the little things
matter. But the big things matter too, and if economists try to pretend that
they don't, one of these days they are going to get stomped on.
If you didn't stop to
find out why useful business cycle models still need to incorporate
"sticky prices," click . And if you missed the article by Robert Samuelson on
macroeconomic analysis, click here.
