What is Macroeconomics?

What is macroeconomics? All too often I read detailed analyses, in texts, the literature etc, which are the basis for the policies postulated. All too often these policies just do not work. Again and again I come back to Romer and her fallacy regarding employment and the Stimulus. Perhaps I have been the only one holding her feet to the fire.

I just spent a few days helping my grandson in Prep school understand physics, 5th former, but the fact is that I could explain by demonstrating. I can demonstrate a pulley, I buy a few at Staples, then connect them and then measure. Predictions equal experiment. It happens each and every time. Not so with anything in macroeconomics.

I wrote recently regarding the observation that the economy is all too often driven by people's opinions and beliefs. The question may be whose beliefs and opinions but that is irrelevant just now.

I saw a piece today in The Money Illusion which reinforces my point:

Most of us macro teachers work with some sort of new Keynesian model.  This is roughly the AS/AD model, with an upward sloping SRAS curve.We teach the model by repeatedly lying to our students. 

Yes indeed, they are lying, lying but having convinced themselves that somehow the math makes it all true. AD is really a belief system, consumers are happy, they believe, we have a Reagan recovery. They do not believe, Johnson and Carter, and we have inflation and recession. Do fundamentals matter? Somewhat, but I am afraid not much. Trust is key. Trust was something that an old friend Dave Staelin had been trying to get me to believe in before he passed. I was not getting it at the time, now I do, thanks Dave.

The article continues:

If oil shocks are going to raise inflation, they should lower RGDP.  Yet even during the worst of the oil shock period (mid-1973 to mid-1981) RGDP rose by 2.6% per annum.  So the inflation was almost all monetary, even if you generously assume RGDP growth would have been 3.6% in the absence of the oil shocks.  In fact, growth slowed sharply after 1973 for reasons mostly unrelated to oil; the rapid improvement in products like jet airliners and home appliances came to a screeching halt.  We shifted toward a slower growing service economy.  We couldn’t even average 3.6% growth in the 1990s, when oil got cheap and the computer revolution took off. Are these lies justified?  It’s nice to give students some real world examples of fiscal shocks and supply shocks.  But what if the message they take from this exercise is that monetary explanations of inflation and NGDP determination are “just a theory,” just as evolution or global warming are “just a theory.”  What if the public doesn’t realize that the Fed drives the nominal economy?  Might that lead to less effective public policies?  Might that have contributed in some small way to the fiasco of 2008? I think our students can handle the truth.  Why don’t we stop lying?”

Now again Trust in the leaders are essential. I think Reagan understood that, not clear of Clinton, perhaps he was just preoccupied elsewhere.

Now my favorite economist, Nick Rowe, has a posting today regarding teaching of monetary policy in macro. He states:

I always suffer self-doubt when I teach the Money part of Intro Economics. Perhaps I'm over-thinking it, and it would be better for my students if I told myself to shut up, and just give them some simple clear story. But how to get it simple and clear, yet not horribly wrong or incomplete?

 Sense a theme here folks? The Gnome from the South who blasts his instant thoughts to us from the Times would never make a statement like these two. The Blob from the West would never have such humility. But here we have two clear statements.

As Nick states when speaking of the meaning of money:

Words don't really mean anything either. But people use "cat" to mean cat, because everybody else does too. Sometimes which equilibrium we are in depends on history.

A bit of Ockham and nominalism,  but money is just easy to hold, unless and until there is a replacement, and we have been using it for a few decades now, agreed upon credit.

As Nick finishes his piece:

Because once you start talking about "the demand for money", in the same way you talk about "the demand for apples", you end up with (orthodox) nonsense like the idea that the stock of money is determined by the quantity demanded at the rate of interest set by the central bank. Which makes sense for a good like apples, which is  traded in only one market, and which people either buy or sell. But doesn't make sense for a good like money, which is a medium of exchange traded in n-1 markets, that everyone both buys and sells. The quantity of money will be determined by the demand for loans at that rate of interest, but the demand for money is not the same as the demand for loans. But that's a topic for another post. This is far too complex and too abstract. How is a first year student supposed to understand all that?

 Yes it is far too abstract. I have been tracking the FED Balance Sheet for four years plus now, watching it explode, as a result of the debt. It should make me terrified of inflation since most of that stuff has a duration and when it expires one hope they roll it over as they seem to be doing. But what if they don't, what if people believe they will not, what if people lose Trust in their Government? You see Trust really counts, it is the AD, it is the ability to "believe" in money, and it is not really measurable, you cannot come up with a stochastic differential equation defining Trust. Even at MIT, I have seen it tried.