1. Econ 314S History of Modern Macroeconomics Fall 2017
History of Modern Macroeconomics Lecture 6. The Empirical Microfoundations of Macroeconomics ( ) Kevin D. Hoover Department of Economics Department of Philosophy Center for the History of Political Economy Duke University
Econ 314S History of Modern Macroeconomics Fall 2017

2. The Neoclassical Synthesis and Microfoundations
How are micro and macro related?
distinct, but compatible
Neoclassical synthesis: Samuelson, Economics: An Introductory Analysis, 3rd edition (1955)
Interventionist attitude
The Neoclassical Synthesis:
already in Keynes: classical is special case of the general theory
picked up by Klein (The Keynesian Revolution)
Econ 314S History of Modern Macroeconomics Fall 2017

3. The New Empirical Macroeconomics
Walrasian:
general equilibrium
individual optimization (microfoundations)
IS-LM Keynesian
Aggregation
practice demands
must be eliminable in theory
work towards maximum disaggregation
Lawrence Klein ( )
Econ 314S History of Modern Macroeconomics Fall 2017

4. IS-LM-AS Sets the Agenda for Macroeconmetric Models
Econ 314S History of Modern Macroeconomics Fall 2017

5. The “Keynesian” Microfoundational Program
Consistency with microeconomics vs. derivation from microeconomics
Microeconomics as an analogical resource
Econ 314S History of Modern Macroeconomics Fall 2017

6. Microfoundations : Transactions Demand for Money (Baumol) – 1
Econ 314S History of Modern Macroeconomics Fall 2017

7. Microfoundations : Transactions Demand for Money (Baumol) – 2
Econ 314S History of Modern Macroeconomics Fall 2017

8. Microfoundations : Transactions Demand for Money (Baumol) – 3
Implications:
Income-elasticity of money demand = ½
Interest-elasticity of money demand = –½
Compare to the Traditional Quantity Equation:
Income-elasticity of money demand = 1
Interest-elasticity of money demand = undetermined (possibly zero)
Econ 314S History of Modern Macroeconomics Fall 2017

9. Microfoundations: The Kuznet’s Puzzle – 1
The “Keynesian” linear consumption function: C = a + bY
mpc = b; if a > 0, then apc = C/Y = a/Y + b and falls as Y rises C
Consumption Function
mpc = b C* a
apc = C/Y Y Y*
Econ 314S History of Modern Macroeconomics Fall 2017

10. Microfoundations: The Kuznet’s Puzzle – 2
Long-run consumption function
Short-run consumption function
falling apc
constant apc
Econ 314S History of Modern Macroeconomics Fall 2017

11. The Permanent Income Hypothesis – 1
Individual Intertemporal Optimization Problem
Qualitative Analogies
Resolution of the Puzzle
consumption related to asset value of income stream
transitory income adds little to asset value  low mpc in short run
transitory income cancels out over time higher mpc in long run
Macroeconomic Implications
Include interest rate and/or calculation of permanent income
distinguish populations wage and salary earners from self employed
separate analysis for nondurable consumption and durable consumption goods
Econ 314S History of Modern Macroeconomics Fall 2017

12. The Permanent Income Hypothesis – 2
The “Keynesian” linear consumption function: C = a + bY
mpc = b; if a > 0, then apc = C/Y = a/Y + b and falls as Y rises C
Permanent Consumption Function
Apparent Consumption Function C* a
Y* + rY
apc = C/Y Y Y*
Y* + Y
Econ 314S History of Modern Macroeconomics Fall 2017

13. The “Keynesian” Macroeconometric Strategy
Individual optimization analysis for each of the main “functions” in the macroeconomic model:
consumption function
investment function
money demand and supply functions
labor demand and supply functions
production functions
Use results as qualitative analogies:
variable choice
disaggregation
choice of functional form
Test at aggregate level
Econ 314S History of Modern Macroeconomics Fall 2017

14. Microfoundations of the Various “Keynesian” Functions
Transaction Demand for Money: Baumol (1952)
Speculative Demand for Money: Tobin (1958)
Consumption Function: Duesenberry (1949); Modigliani and Brumberg (1952); Friedman (1945; 1955)
Investment: Jorgensen (1966)
Production Function: (Franklin Fisher 1969)
Labor Supply: Lucas and Rapping (1969)
Econ 314S History of Modern Macroeconomics Fall 2017

15. Klein’s Modeling Agenda
In contrast with the parsimonious view of natural simplicity, I believe that economic life is enormously complicated and that the successful model will try to build in as much of the complicated interrelationships as possible. That is why I want to work with large econometric models and a great deal of computer power. Instead of the rule of parsimony, I prefer the following rule: the largest possible system that can be managed and that can explain the main economic magnitudes as well as the parsimonious system is the better system to develop and use. [Klein 1992]
Econ 314S History of Modern Macroeconomics Fall 2017

16. Econ 314S History of Modern Macroeconomics Fall 2017
Thanks 
The End
Econ 314S History of Modern Macroeconomics Fall 2017