Measuring the Elephant
I used to say that macroeconomics was like fortune telling. Microeconomists had their ducks in a row, but macro was a hodgepodge of conflicting stories. I’ve studied a pretty wide variety of schools of macro and I’m starting to see some patterns emerging. I still think most macroeconomists are like the blind men describing the elephant, each knows a particular pattern or story, but is hostile or ignorant toward other economists’ stories. I don’t know what I would tell a student learning macro. I didn’t start to see how the different schools fit together until after I really groked quasi-monetarism. I think it is better for students to be exposed to many different schools of thought after learning the basic building blocks of macroeconomic thought.
Parts of the Elephant (Macroeconomic Ideas)
Price Changes – What causes prices to change? Which prices change quickly/slowly?
Interest rates – Price of loanable funds. Equilibrate supply and demand across time.
Savings and Investment – How are loanable funds turned into capital? What determines how much people invest?
Theory of money – Where does money come from? What does it represent? What determines its value?
Theory of what causes spending – Net assets, composition of assets, animal spirits, or something else entirely?
Expectations – What people expect to happen in the future impacts their behavior today.
Capacity for production – What causes production of output? What are the limits to that production?
Government spending – How is it different from private spending? How is it funded?
Descriptions of the Elephant (Schools of Thought)
Classical Economics – The macro school of instant price adjustment.
Keynesianism – Explained the impact of government spending on the economy. Interest rate centered worldview of Knut Wicksell.
Austrian Business Cycle Theory – Showed how the channel through which monetary policy operated caused dislocations in capital markets. Highlighted how poor investment decisions based on past monetary disequilibrium could cause recession.
Gold Standard – Focuses on institutional constraints to government devaluation of money.
Real Bills Doctrine – What a Post-Keynesian would write if they learned macro from a gold bug instead of a Keynesian. Spending depends on assets rather than money. Focus on balance sheets.
Monetarism – Inflation is always and everywhere caused by too much money. Deflation caused by too little money.
Neo-Keynesianism – Reconciliation of monetarism, expectations and Keynesianism. Modern macroeconomics education consists of almost entirely of this school, except for a few Real Business Cycle holdouts.
Real Business Cycle/Rational Expectations – Classical economics back with a vengeance. Money doesn’t matter, supply shocks matter a lot. If the Fed were competent, this school would be 100% true.
Post-Keynesianism/MMT – Focus on balance sheets and net assets. Fiscal policy is the big mover, monetary policy is secondary.
Monetary Disequilibrium Theory/Free Banking – Neo-Austrian school focused on maintaining spending through equilibrating the supply and demand for money. Central banks are unnecessary/harmful.
Quasi-monetarism/Market Monetarism – A very young school which meshes monetarism with market expectations and ignores interest rates.
The Argument in the Town (Major Controversies)
Savings vs. Investment – Does one cause the other? Are they definitively identical? What explains the difference (if any)?
The Multiplier – How much does an increase in government spending, increase total spending?
Role for the Government – Big or small, how cyclical should/can they be? Is fiscal or monetary policy the better stabilization device? How much government spending is microeconomically efficient?
Prices adjustment – How fast are they? Which prices adjust first?
The Velocity of Money – How fast are the various types of money spent? What causes that to change?
Can Empirical Observation resolve theoretical disputes?
Note: Each of these items could be its own long post, so I don’t want to go into them too much now. If you have requests on any one, please let me know in the comments and I’ll write a post about it.
Arnold Kling comments.