Center for the History of Political Economy Summer School June 2012 History of Modern Macroeconomics Lecture 3.3. Macroeconometrics and the New Economics (1930-1950) Kevin D. Hoover Department of Economics Department of Philosophy Center for the History of Political Economy Duke University Center for the History of Political Economy Summer School June 2012

Ragnar Frisch Inventor of important terminology: microeconomics/macro-economics econometrics Influential in development of: dynamic economics econometric (empirical) methods Creator of modern professional institutions Founder of Econometric Society First editor of Econometrica Ragnar Frisch (1895-1973), Nobel Laureate (1969) Center for the History of Political Economy Summer School June 2012

Contrasts and Complementarities Between Frisch and Keynes micro vs. macrodynamics econometrics pragmatism and aggregation dynamics pervasive micro analysis system properties and emergence against econometrics Frisch Keynes Center for the History of Political Economy Summer School June 2012

Frisch: Dynamics and the Macro/Micro Distinction “micro-dynamic analysis is an analysis by which we try to explain in some detail the behaviour of a certain section of the huge economic mechanism, taking for granted that certain general parameters are given . . .” “macro-dynamic analysis, on the other hand, tries to give an account of the fluctuations of the whole economic system taken in its entirety.” Macro not built on micro; micro presupposes macro. Center for the History of Political Economy Summer School June 2012

Frisch: The Economic Pragmatist “it is always possible to give even a macro-dynamic analysis in detail if we confine ourselves to a purely formal theory . . . Such a theory, however, would only have a rather limited interest” for actual business-cycle problems. “We may perhaps start by throwing all kinds of production into one variable, all consumption into another, and so on, imagining that the notions ‘production,’ ‘consumption,’ and so on, can be measured by some sort of total indices.” Center for the History of Political Economy Summer School June 2012

Center for the History of Political Economy Summer School June 2012 Keynes on Dynamics “The real task of [monetary] theory is to treat the problem dynamically, analysing the different elements involved, in such a manner as to exhibit the causal process . . . and the method of transition from one position of equilibrium to another.” Treatise on Money Center for the History of Political Economy Summer School June 2012

Keynes and the Centrality of Microeconomic Analysis All the main Keynesian functions analyzed microeconomically: consumption function labor supply labor demand liquidity preference investment Center for the History of Political Economy Summer School June 2012

An Illustration: Keynes on Liquidity Preference Speculative demand for money normal rate of interest—individual and heterogenous hold bonds if market rate above normal  expected capital gain; hold money if market rate below normal  expected capital loss market rate = rate at which market is divided into balanced groups of bulls and bears no aggregation; market rate = some particular agent’s normal rate Center for the History of Political Economy Summer School June 2012

Another Illustration: Keynes on the Labor Market – 1 Labor demand: standard firm optimization problem Labor supply: not principally money illusion but a relative efficiency-wage argument: “the struggle for money-wages is . . . essentially a struggle to maintain a high relative wage . . .” General Theory Kevin Hoover, “Relative Wages, Rationality, and Involuntary Unemployment in Keynes’s Labor Market,” History of Political Economy 1995. Center for the History of Political Economy Summer School June 2012

Another Illustration: Keynes on the Labor Market – 2 Defines unemployment not by aggregative version of individual situation: real wage > marginal disutility of labor but by market test: “Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. “ No reference to aggregate labor-supply function. Center for the History of Political Economy Summer School June 2012

Keynes vs. Frisch: Role of Theory macro system a giant machine approximated by coarser simplifications; the “economic engineer”; models as mechanical analogues. Keynes: economy organic; macro properties emergent; the “economic physician”; models as diagnostic tools Center for the History of Political Economy Summer School June 2012

Frisch’s Vision: Two Versions of the Tableau Economique Ragnar Frisch 1933 François Quesnay 1759 Center for the History of Political Economy Summer School June 2012

Keynes’s Vision: Mandeville’s Fable of the Bees “the gay of tomorrow are absolutely indispensable to provide a raison d'être for the grave of to-day” (Keynes, General Theory, pp. 105-106). Center for the History of Political Economy Summer School June 2012

Keynes vs. Frisch: Aggregation and Econometrics Frisch: aggregation pragmatically necessary for econometrics; Keynes: against econometrics; despite introducing terms such as aggregate supply and aggregate demand, aggregates do not drive dynamics Center for the History of Political Economy Summer School June 2012

Center for the History of Political Economy Summer School June 2012 Frisch: The Economy as Machine: A Simple Pendulum as an Analogue of the Business Cycle Center for the History of Political Economy Summer School June 2012

Center for the History of Political Economy Summer School June 2012 Complex Pendulums Center for the History of Political Economy Summer School June 2012

Propagation and Impulse Mechanisms Center for the History of Political Economy Summer School June 2012

Jan Tinbergen and Applied Macroeconometrics Trained as physicist Created first modern econometric models: Smaller Dutch model Larger U.S. model Two-volume study of U.S. business cycles for the League of Nations (1939) methodology and application object of Keynes’s attack on econometrics Jan Tinbergen (1903-1994) Center for the History of Political Economy Summer School June 2012

Jan Tinbergen Socialist In 1950s director of the Dutch Central Planning Bureau Jan Tinbergen (1903-1994), Nobel Laureate (1969) Center for the History of Political Economy Summer School June 2012

Keynes Meets Frisch and Tinbergen – 1: The Cowles Commission Cowles Commission for Research in Economics founded in 1932 by Alfred Cowles Moved to Chicago in 1939 Early research: Econometric methodology (especially structural macromodels) General equilibrium models Center for the History of Political Economy Summer School June 2012

Keynes Meets Frisch and Tinbergen – 2: Hicks Value and Capital (1939): Keynes in light of Walras Dynamics of type Frisch thought impractical Formal analysis of aggregation The IS-LM Model Sir John R. Hicks (1904-89), Nobel Laureate (1972) Center for the History of Political Economy Summer School June 2012

Klein and the Aggregation Program Keynesian Walrasian Econometrician Socialist Lawrence Klein (1920- ), Nobel Laureate (1980) Center for the History of Political Economy Summer School June 2012

Keynes and Bretton Woods Keynes and Harry Dexter White (U.S. Delegate) Bretton Woods (NH) Resort Keynes and the Soviet Delegate Center for the History of Political Economy Summer School June 2012

Making the Economy Work - 1 Lord Beveridge (1879-1963) Center for the History of Political Economy Summer School June 2012

Making the Economy Work - 2 Harry S. Truman (1884-1972, President 1945-53) Alvin Hansen (1887-1975), American popularizer of Keynes Center for the History of Political Economy Summer School June 2012

Center for the History of Political Economy Summer School June 2012 Abba Lerner (1903-1982) Center for the History of Political Economy Summer School June 2012

Center for the History of Political Economy Summer School June 2012 Thanks  The End Center for the History of Political Economy Summer School June 2012