Macroeconomic Problems, Microeconomic Solutions

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Macroeconomic Problems,
Microeconomic Solutions

Peter J. Boettke

Econ 881/Spring 2005

February 28

Main Points to Stress


Macroeconomic problems are
coordination

problems


Production plans must mesh with consumption demands


Capital and Labor


Incentives must be aligned and capabilities must be
exploited


Incentive problems are knowledge problems and
knowledge problems are incentive problems


Changing circumstances result in disturbances, but
the crucial question is one of
adjustment


Feedback and learning through time

Macroeconomic Problems


Errors of Over optimism


Produce products which nobody wants


Errors of Over pessimism


Don’t product products which people want




Capital goods are allocated incorrectly; capital investments are
inappropriate; labor is misallocated; and as a result the economy
underperformed from the point of view of realizing the mutual gains from
exchange, employing resources efficiently, and satisfying the demands of
consumer sovereignty.

What is the solution to these problems?


Classical


Market discipline


Keynesian


Government correctives


Fiscal policy


Mix of fiscal and monetary policy


After Keynes


Market equilibrium

Fiscal Policy Versus Monetary Policy as a
Corrective

Keynesian World View

Monetarist World View

LM

IS

IS

LM

Y

Y

r

r

Liquidity
trap
makes
monetary
policy
ineffective

Crowding
out
makes
fiscal
policy
ineffective

Neo
-
Keynesian Synthesis

r

Y

IS

LM

r

Y

Goods Market
equilibrium;
Money Market
equilibrium

What is Wrong With this Picture?


Unconnected to the Choices of Individuals


Labor Market


Money Illusion


Capital Market


Fiscal Illusion


Autonomous Investment


Capital Goods Market


Time and the Process of Production


Complementarity and Substitutability in the chain of
production

Labor Market Response


Workers do not persistently suffer from
money illusion

N

W/P

W/P
0

W/P
1

N
0

N
1

Short Run Phillips Curve

U

I

Long
Run at
Natural
Rate

Short Run Trade Off as
Workers Suffer Money
Illusion

Lucas Critique of Keynesian System


Adaptive Expectations
→ Rational
Expectations


Bayesian Learning


Expectations on underlying distribution


Methodological Rule
---

economist cannot assume a level
of knowledge greater than the participants in the economy


Equilibrium Theory of the Business Cycle


Monetary Neutrality and Market clearing


Noise and disturbances to the system (signal extraction)


Invariance proposition


Upshot of Lucas Critique


Short Run and Long Run Phillips Curve are
the same


Microfoundations of Macroeconomics
provides coherence to the discipline


General Competitive Equilibrium


Optimizing behavior


Continuous Market Clearing


Is New Classical Economics Austrian
Economics?


Microfoundations


Aggregate economics unconnected to choice


Compositive Method, 233
-
234


Rationality


Hypothesis or axiom


Choice under uncertainty


Expectations and the Equilibrium Construct


Logical coherence


Process theory and adjustment, 236, fn. 25

The Classic Austrian Theory of the Cycle

r

Q

D

S
o

S
1

r

Q

S/C

Higher Order
Goods

Lower
Order
Goods

Main Tenets of the ABTC


Non
-
neutrality of Money


Injection effects through Relative price adjustments


Capital Structure


Heterogeneous and multi
-
specific goods


Capital maintenance and entrepreneurial decision making


Intertemporal Coordination and Monetary
mechanism


Interest rates as signals between present and future


Complimentarity of Capital and Labor


Employment of scarce resources

Critique of ABCT


Theory


Bias error and bias toward particularly costly
errors


Incoherence of grafting a disequilibrium story on
an equilibrium theory


Empirical


Co
-
movement of investment and consumption


Limited applicability of interest rate mechanism as
trigger