the missing motivation in macroeconomics iseo june 24, 2007
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The Missing Motivation in Macroeconomics ISEO June 24, 2007. Thanks to Rachel Kranton. I. Introduction. Macroeconomics changed . Objection to casual ways. Derivation from economic principles. Five Neutralities. Independence of consumption and current income (given wealth). - PowerPoint PPT PresentationTRANSCRIPT
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The Missing Motivation in Macroeconomics
ISEO
June 24, 2007
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Thanks to Rachel Kranton.
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I. Introduction
• Macroeconomics changed.
• Objection to casual ways.
• Derivation from economic principles.
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Five Neutralities
• Independence of consumption and current income (given wealth).
• Modigliani-Miller theorem.• Natural rate theory.• Inability to stabilize output with
rational expectations.• Ricardian equivalence.
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Consequences of Neutralities
• Neutralities fly in face of Keynesian economics.
• Anti-Keynesian conclusions: Previously unsuspected.
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Reaction to Neutralities• New Classical Economists:
• A Tell-Tale:
– Keynesian economists: Wrong thinking.
– Scientific reasoning: More precise economics.
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Reaction of Keynesians
• New Keynesians:
–Acceptance of utility/profit maximization for microfoundations.
–View the neutralities as having generality.
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Generality of Neutralities• Neutralities describe equilibria
of competitive economies with complete information irrespective of preferences:–As long as those preferences
correspond to economists’ typical descriptions of them.
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New Keynesians Add Frictions• Credit constraints.
• Market imperfections.
• Information failures.
• Tax distortions.
• Staggered contracts.
• Uncertainty.
• Bounded rationality.
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New Stance• Derive behavior from utility and profit
maximization.
–Captures purposefulness.
• Question the generality of the preferences that lead to the five neutralities.
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Preferences Narrowly Defined• Missing motivation:
– Fail to incorporate norms of decision-makers.
• Norms:– How they and others should behave.
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Norms: Violation of Neutralities• Consumption dependent on current
income.• Investment dependent on cash flow.
• Wages and prices dependent on nominal considerations.
• Income and employment dependent on systematic monetary policy.
• Consumption dependent on social security.
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Bias in favor of Keynesians• Keynesians:
– Theory based on observations of motivations.
• Neoclassical methodology:
– Cannot pick up differences between real behavior and behavior derived from abstract preferences.
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Exogeneity of Norms• Norms assumed to be exogenous.
• Standard method in economics.
• Withhold doubts until the end.
• Endogeneity of norms will rarely nullify conclusions drawn here.
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Outline of Lecture• I. Introduction.• II. The Missing Motivation.• III. Ricardian Equivalence.• IV. Consumption.• V. Investment.• VI. Natural Rate Hypothesis.• VII. Rational Expectations.• VIII. Methodology.• IX. Conclusion.
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II. Norms: The Missing Motivation
Have already discussed the missing motivation.
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III. Ricardian Equivalence
• Standard Model.
• Parent’s utility:
U1(c1, U2 (c2)).
• Child’s utility:
U2 (c2).
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Reasons for failure of Ricardian equivalence
• (1) infinite horizons. • (2) strategic bequests. • (3) childless families.• (4) uncertainty.• (5) differential borrowing rates• (6) growth in excess of the interest rate. • (7) lack of foresight about future taxes. • (8) foreign ownership of debt.• (9) tax distortions. • (10) no bequests.
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Ricardian Equivalence as Tell-Tale
• Theoretical challenge.
• Unsuspected by economists.
• Two possible conclusions:– Realignment of macro.
– Missing motivation.
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Bequest as Gift• Andreoni.
• Bequest: type of gift.
• Social security transfer:
– More money is parent’s.
– Greater gift to child.
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Warm Glow and Norms• Gift gives “warm glow.”
• Why?
• Parent thinks she is doing what she should be doing.
• Norms for bequests.
• Historic change in nature of bequests.
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IV & V. Consumption & Investment
• Relative to Life Cycle Hypothesis:
–Excess dependence of consumption on current income.
• Relative to Modigliani-Miller:
–Excess dependence of investment on cash flow.
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VI. Natural Rate Theory• Description of reality.
• Acceptance:
– Theoretical:
• Care only about real outcomes.
– Empirical:
• Failure to reject.
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Excess Sensitivity in Wages
• Natural rate theory:
–Only real considerations.
• Excess sensitivity:
–Nominal considerations affect real wage setting.
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Starkest Example• Money wage rigidity:
– Bunching in wage change distributions:• Australia.• Canada.• Germany.• Japan.• Mexico.• New Zealand.• Switzerland.• United Kingdom.• United States.
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Great Depression
• Absence of deflationary spirals.
• Explained by money wage rigidity.
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Norms: Explanation for Sticky Money Wages
• Money wage rigidity:– Impossible to explain with only real
considerations.
• Amendment to standard model:– Norm for wages.
– Employees lose utility from money wage decline.
• Direct evidence:– Bewley interviews.
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Violation of Natural Rate Theory
• Acceptance of money wage rigidity.
• Broader implications of such violation.
• Money wage rigidity:
– Because workers have a norm.
• At least one clear violation of natural rate theory.
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Tip of Iceberg
• Further empirical possibility:
If there is one way in which nominal wages enter utility functions because of norms regarding wages, there could be many other ways.
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Norms for Wage IncreasesRaise InflationBarbara: 5 % 4 %Ann: 2 % 0 %
● 79 %: Barbara worse off economically. 64 %: Barbara happier.
• Explanation: Norms for wage increases.
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Shiller
• If my pay went up I would feel more satisfaction in my job even if prices went up as much.
Public: 49% agreed.
Economists: 90% disagreed.
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Phillips Curve: Downward Sloping
• With such a norm, at higher inflation workers will not experience disappointment from receiving lower nominal wage increases than they think they should receive.
• At higher inflation, all things equal, wage bargains will result in lower real wages.
• That will reduce the relative price that the typical firm wants to set.
• And therefore it will raise the rate of sustainable employment.
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Low Inflation/High Inflation
• Low Inflation: Downward sloping Phillips Curve.
• High inflation: Upward sloping Phillips Curve.
• Reason for monetary vigilance.
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Prices
• Prices are like wages.
• Strong evidence of price stickiness.
• Customers dislike price increases.
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VII. Rational Expectations Theory
• I will skip rational expectations.
• Piggy-backs on natural rate.
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IX. Conclusion• Macroeconomics gives again and again
examples where the substantive economics is changed by the presence of norms regarding how people think they should behave.