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Comments on “Integrated Keynesian disequilibrium dynamics”
Journal of Macroeconomics 28 (2006) 131–135 www.elsevier.com/locate/jmacro
Discussion
Comments on ‘‘Integrated Keynesian disequilibrium dynamics’’ Peter Skott
*
Department of Economics, University of Massachusetts, Amherst, MA 01003, United States Received 19 September 2005; accepted 24 October 2005 Available online 24 January 2006
Abstract This comment on Asada et al.’s paper discusses the contrast between ‘integrated Keynesian disequilibrium dynamics’ (IKDD) and New Keynesian theory. Two areas are singled out: the treatment of stability issues and the approach to behavioral foundations. IKDD present a sophisticated stability analysis and rightly avoid the New Keynesian obsession with microfoundations based on optimizing behavior. The IKDD program, however, might benefit if behavioral questions were given greater prominence. Ó 2005 Elsevier Inc. All rights reserved. JEL classification: E12; E32 Keywords: Stability; Behavioral foundations; Integrated Keynesian disequilibrium dynamics; New Keynesian theory
1. Introduction Along with various coauthors, Chiarella and Flaschel have been engaged over the last 15 years in a research program on integrated Keynesian disequilibrium dynamics (IKDD). This program stands in opposition to the main trend in macroeconomics since the 1970s. It is dismissive of the obsession with optimization-based microeconomic foundations and instead wants to revitalize a Keynesian analysis of the dynamic interaction between dis*
Tel.: +1 413 545 6358; fax: +1 413 545 2921. E-mail address: [email protected]
0164-0704/$ - see front matter Ó 2005 Elsevier Inc. All rights reserved. doi:10.1016/j.jmacro.2005.10.008
132
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
equilibria across different markets. The results so far have been highly impressive. Using sophisticated mathematical and computational techniques, the research has greatly increased our understanding of Keynesian models and the very complex dynamics that these models may generate. The contrast between the IKDD and New Keynesian approach (NK) is striking, and in this note I shall tie in my comments on the paper by Asada, Chen, Chiarella and Flaschel (2006; henceforth ACCF) with some more general observations on the relation between IKDD and NK.
2. Stability New Keynesian models may include unemployment and allow for real effects of aggregate demand policy, at least in the short run. But unlike IKDD (and Keynes himself), they largely disregard stability problems: if only prices and wages were flexible, there would be fast convergence to some structurally determined level of employment and no need for aggregate demand policy. This position is at odds with Keynes’s own insistence that, far from eliminating involuntary unemployment, increased nominal wage flexibility would only ‘‘cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live’’ (1936/1973, p. 269). Old Keynesians were well aware of the stability problem (e.g. Hicks, 1974; Tobin, 1975), but the treatment of dynamics in Keynesian models of a 1970s vintage was unsatisfactory. There was a lack of integration between the analysis of the short run and more long-term issues, and even the short-run analysis often relied on unstated assumptions concerning the process leading to a short-run Keynesian equilibrium. Models of IKDD analyze these dynamic issues using new and powerful mathematical tools. The aim has been to construct a framework in which ‘‘contributions to the non-market clearing paradigm could be reformulated on a common basis and extended systematically, leading successively to more and more coherent integrated models of disequilibrium growth with progressively richer interactions between markets and sectors’’ (Chiarella and Flaschel, 2000, p. xix). ACCF present an example of this kind of analysis. Starting from a simple AS-AD framework, ACCF analyze the interaction between multiple feedback mechanisms. Agents respond to disequilibrium signals in a number of different markets, and the analysis demonstrates that it is essential to look at interactions across these markets. Thus, their 5D dynamical system is ‘‘much more complicated in its reaction patterns’’ than suggested by partial analysis or informal verbal reasoning (ACCF, p. 116). Secondly, local instability is confirmed as the most likely outcome, but plausible non-linearities ensure that the movements of the variables remain bounded and economically meaningful. Is there a New Keynesian answer to these conclusions? Not really. Stability – usually involving saddlepoints and jump variables – is simply assumed in new Keynesian models, and most of the feedback mechanisms analyzed by ACCF and other contributions to IKDD are left out of the New Keynesian analysis. Thus, to the extent that there is an answer, it comes from the New Keynesian focus on microfoundations and rational behavior, and from the implicit rejection of the IKDD program because of its alleged deficiencies in these areas.
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
133
3. Expectations New Keynesians include stickiness in wages and prices but insist on clear foundations in individual optimization: ‘‘rather than postulating that prices and wages respond mechanically to some measure of market disequilibrium, they are set optimally. that is, so as to best serve the interests of the parties assumed to set them, according to the information available at the time’’ (Woodford, 2003, p. 7). Thus, prices and wages are set in a forward-looking manner, expectations are assumed to be rational, and preferences are seen as structural and invariant to changes in policy. Rational expectations have been used before Muth and Lucas, of course. Harrod’s warranted growth path, for instance, was a rational expectations path. But the extension of rational expectations to all models – and not just steady growth paths or Robinsonian ‘mythical ages’ – is more than dubious. ACCF rightly stress (p. 101) the ‘‘demanding calculational capabilities’’ required by the assumption of rational expectations, even in the context of highly simplified models, and cite the empirical failure of the New Keynesian Phillips curve as additional evidence. Along with other models in the IKDD framework they therefore avoid a ‘‘rational expectations perfect foresight methodology according to which variables, when out of steady-state equilibrium, are allowed to jump to their stable paths in order to ensure convergence back to steady state’’ (Flaschel et al., 1997, p. xi). It is a major theme of the paper, however, that even though medium-run expectations may be wrong, ‘‘a Keynesian approach to economic dynamics . . . should allow for myopic perfect foresight on inflation rates without much change in its implications’’ (ACCF, p. 93). I find this claim surprising. If one leaves a world of complete perfect foresight, there must be times when expectations fail to be met, and disappointed medium- or long-run expectations must show up in the form of disappointed short-run expectations at some moment. Thus, an assumption of myopic perfect foresight concerning all variables at all times would seem to imply globally perfect foresight. Putting it differently, why should the current inflation rate lead anyone to adjust his or her medium-run expectations (the ‘‘inflationary climate’’) if the current rate is exactly as expected?1 Disappointed expectations may show up as unanticipated changes in inventories (or some other quantity) rather than as unanticipated inflation. But if the surprises manifest themselves in quantity movements, presumably adjustments in the inflation climate should be related to these quantity movements, rather than to the deviations between the current inflation rate and the inflation climate as in ACCF’s equation (18). ACCF do not discuss their specification in any detail. They simply state on p. 103 that ‘‘[i]nflationary expectations over the medium term, pc, i.e. the inflationary climate in which 1
Adjustments to the inflation climate may occur, even in the absence of surprises, if the inflation climate is defined as Z 1 pc ðtÞ ¼ pe ðsÞqeqðstÞ ds t
In this case, an unchanged trajectory of future expected inflation rates implies that Z 1 pe ðsÞq2 eqðstÞ ds pðtÞ ¼ qðpc ðtÞ pðtÞÞ p_ c ðtÞ ¼ t
But this specification, which corresponds to a negative adjustment parameter bpc in ACCF’s equation (18), is clearly not what ACCF have in mind.
134
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
current wage and price inflation is operating, may be adaptively following the actual rate of inflation’’. As argued above, I think this interpretation of pc as an expectational variable may be hard to sustain, but what matters from a technical perspective is the existence of an inertial element in wage and price formation. If there is myopic perfect foresight, it is essential that something prevents wage and price setters from acting fully on their foresight. That something in ACCF’s specification is the adaptive inflation climate; an alternative source might be institutional features of the economy, including staggered wage contracts as in some NK formulations. The precise source of the inertial element may be irrelevant for the analysis of the dynamic properties of the model. The source becomes important, however, if one wants to evaluate the model in relation to real-world economies and discuss the robustness of the specification to various shocks or changes in policy rules. The economic reasoning behind the ‘‘inflationary climate’’ and the specification of the dynamics of inflation exemplify a more general issue of behavioral foundations.
4. Behavioral foundations ACCF may be dismissive (quite rightly, in my view) of the current view of what constitutes behavioral foundations. Over the last 30 years macroeconomists have struggled to analyze optimization problems that grossly simplify real-world optimization problems, the implicit presumption being that agents in the real world have already solved (or act as if they had solved) the more complex real-world problems. Interactions between agents, on the other hand, are usually brushed aside by representative-agent assumptions. This approach to economic modelling shows precisely how not to use mathematics. It may sometimes be reasonable to include optimization in economic models as a stylized representation of goal-oriented behavior, but mathematical models arguably are useful primarily because they allow a clear analysis of complex interactions between agents, each of whom may follow relatively simple (but possibly changing) behavioral rules. A rejection of the optimization-based approach, however, does not settle the substantive questions concerning the appropriate specification of the various behavioral functions or, for that matter, the choice of variables to be explicitly considered by the model. ACCF take a neoclassical-synthesis model as their starting point. I am probably more sympathetic than most economists to this kind of model and do not think that this is necessarily a bad choice. However, as the synthesis model itself loses ground in the profession and as their own work progresses, the detailed specifications of the equations and the choice of extensions have to be explained and justified. The justification need not be rigorous and mathematical, and if it involves reference to heterogeneity among agents, aggregation issues, and stylized facts arising from experimental work, econometric results or economic surveys, then all the better. Looking at the microissues need not entail a return to New Classical/New Keynesian obsessions with rationality and optimization. On the contrary, the burgeoning literature on behavioral economics would seem to provide a natural complement to research on IKDD (and be consistent with the approach to microeconomic foundations in Keynes’s own work and the old Keynesian tradition). Inspiration and valuable insights, moreover, may also be found in the post Keynesian, neo-Marxian and structuralist traditions with their emphasis on institutional structures and social relations between groups.
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
135
Contributors to the IKDD do, of course, consider the behavior underlying their formal relations. But arguably the main emphasis has been on the intricacies of the resulting dynamic systems. In my view the program would be strengthened if the balance shifted somewhat and the behavioral questions were given greater prominence. Perhaps this represents the main challenge in the further development of the IKDD program. References Asada, T., Chen, P., Chiarella, C., Flaschel, P., 2006. Keynesian dynamics and the wage-price spiral: A baseline disequilibrium model. Journal of Macroeconomics, this issue, doi:10.1016/j.jmacro.2005.10.007. Chiarella, C., Flaschel, P., 2000. The Dynamics of Keynesian Monetary Growth. Cambridge University Press, Cambridge. Flaschel, P., Franke, R., Semmler, W., 1997. Dynamic Macroeconomics Instability, Fluctuations, and Growth in Monetary Economies. MIT Press, Cambridge, MA. Hicks, J., 1974. The Crisis in Keynesian Economics. Blackwell, Oxford. Keynes, J.M., 1936/1973. The General Theory of Employment, Interest and Money. Macmillan, London and Basingstoke, published for the Royal Economic Society. Tobin, J., 1975. Keynesian models of recession and depression. American Economic Review 65, 195–202. Woodford, M., 2003. Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press, Princeton and Oxford.
Discussion
Comments on ‘‘Integrated Keynesian disequilibrium dynamics’’ Peter Skott
*
Department of Economics, University of Massachusetts, Amherst, MA 01003, United States Received 19 September 2005; accepted 24 October 2005 Available online 24 January 2006
Abstract This comment on Asada et al.’s paper discusses the contrast between ‘integrated Keynesian disequilibrium dynamics’ (IKDD) and New Keynesian theory. Two areas are singled out: the treatment of stability issues and the approach to behavioral foundations. IKDD present a sophisticated stability analysis and rightly avoid the New Keynesian obsession with microfoundations based on optimizing behavior. The IKDD program, however, might benefit if behavioral questions were given greater prominence. Ó 2005 Elsevier Inc. All rights reserved. JEL classification: E12; E32 Keywords: Stability; Behavioral foundations; Integrated Keynesian disequilibrium dynamics; New Keynesian theory
1. Introduction Along with various coauthors, Chiarella and Flaschel have been engaged over the last 15 years in a research program on integrated Keynesian disequilibrium dynamics (IKDD). This program stands in opposition to the main trend in macroeconomics since the 1970s. It is dismissive of the obsession with optimization-based microeconomic foundations and instead wants to revitalize a Keynesian analysis of the dynamic interaction between dis*
Tel.: +1 413 545 6358; fax: +1 413 545 2921. E-mail address: [email protected]
0164-0704/$ - see front matter Ó 2005 Elsevier Inc. All rights reserved. doi:10.1016/j.jmacro.2005.10.008
132
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
equilibria across different markets. The results so far have been highly impressive. Using sophisticated mathematical and computational techniques, the research has greatly increased our understanding of Keynesian models and the very complex dynamics that these models may generate. The contrast between the IKDD and New Keynesian approach (NK) is striking, and in this note I shall tie in my comments on the paper by Asada, Chen, Chiarella and Flaschel (2006; henceforth ACCF) with some more general observations on the relation between IKDD and NK.
2. Stability New Keynesian models may include unemployment and allow for real effects of aggregate demand policy, at least in the short run. But unlike IKDD (and Keynes himself), they largely disregard stability problems: if only prices and wages were flexible, there would be fast convergence to some structurally determined level of employment and no need for aggregate demand policy. This position is at odds with Keynes’s own insistence that, far from eliminating involuntary unemployment, increased nominal wage flexibility would only ‘‘cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live’’ (1936/1973, p. 269). Old Keynesians were well aware of the stability problem (e.g. Hicks, 1974; Tobin, 1975), but the treatment of dynamics in Keynesian models of a 1970s vintage was unsatisfactory. There was a lack of integration between the analysis of the short run and more long-term issues, and even the short-run analysis often relied on unstated assumptions concerning the process leading to a short-run Keynesian equilibrium. Models of IKDD analyze these dynamic issues using new and powerful mathematical tools. The aim has been to construct a framework in which ‘‘contributions to the non-market clearing paradigm could be reformulated on a common basis and extended systematically, leading successively to more and more coherent integrated models of disequilibrium growth with progressively richer interactions between markets and sectors’’ (Chiarella and Flaschel, 2000, p. xix). ACCF present an example of this kind of analysis. Starting from a simple AS-AD framework, ACCF analyze the interaction between multiple feedback mechanisms. Agents respond to disequilibrium signals in a number of different markets, and the analysis demonstrates that it is essential to look at interactions across these markets. Thus, their 5D dynamical system is ‘‘much more complicated in its reaction patterns’’ than suggested by partial analysis or informal verbal reasoning (ACCF, p. 116). Secondly, local instability is confirmed as the most likely outcome, but plausible non-linearities ensure that the movements of the variables remain bounded and economically meaningful. Is there a New Keynesian answer to these conclusions? Not really. Stability – usually involving saddlepoints and jump variables – is simply assumed in new Keynesian models, and most of the feedback mechanisms analyzed by ACCF and other contributions to IKDD are left out of the New Keynesian analysis. Thus, to the extent that there is an answer, it comes from the New Keynesian focus on microfoundations and rational behavior, and from the implicit rejection of the IKDD program because of its alleged deficiencies in these areas.
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
133
3. Expectations New Keynesians include stickiness in wages and prices but insist on clear foundations in individual optimization: ‘‘rather than postulating that prices and wages respond mechanically to some measure of market disequilibrium, they are set optimally. that is, so as to best serve the interests of the parties assumed to set them, according to the information available at the time’’ (Woodford, 2003, p. 7). Thus, prices and wages are set in a forward-looking manner, expectations are assumed to be rational, and preferences are seen as structural and invariant to changes in policy. Rational expectations have been used before Muth and Lucas, of course. Harrod’s warranted growth path, for instance, was a rational expectations path. But the extension of rational expectations to all models – and not just steady growth paths or Robinsonian ‘mythical ages’ – is more than dubious. ACCF rightly stress (p. 101) the ‘‘demanding calculational capabilities’’ required by the assumption of rational expectations, even in the context of highly simplified models, and cite the empirical failure of the New Keynesian Phillips curve as additional evidence. Along with other models in the IKDD framework they therefore avoid a ‘‘rational expectations perfect foresight methodology according to which variables, when out of steady-state equilibrium, are allowed to jump to their stable paths in order to ensure convergence back to steady state’’ (Flaschel et al., 1997, p. xi). It is a major theme of the paper, however, that even though medium-run expectations may be wrong, ‘‘a Keynesian approach to economic dynamics . . . should allow for myopic perfect foresight on inflation rates without much change in its implications’’ (ACCF, p. 93). I find this claim surprising. If one leaves a world of complete perfect foresight, there must be times when expectations fail to be met, and disappointed medium- or long-run expectations must show up in the form of disappointed short-run expectations at some moment. Thus, an assumption of myopic perfect foresight concerning all variables at all times would seem to imply globally perfect foresight. Putting it differently, why should the current inflation rate lead anyone to adjust his or her medium-run expectations (the ‘‘inflationary climate’’) if the current rate is exactly as expected?1 Disappointed expectations may show up as unanticipated changes in inventories (or some other quantity) rather than as unanticipated inflation. But if the surprises manifest themselves in quantity movements, presumably adjustments in the inflation climate should be related to these quantity movements, rather than to the deviations between the current inflation rate and the inflation climate as in ACCF’s equation (18). ACCF do not discuss their specification in any detail. They simply state on p. 103 that ‘‘[i]nflationary expectations over the medium term, pc, i.e. the inflationary climate in which 1
Adjustments to the inflation climate may occur, even in the absence of surprises, if the inflation climate is defined as Z 1 pc ðtÞ ¼ pe ðsÞqeqðstÞ ds t
In this case, an unchanged trajectory of future expected inflation rates implies that Z 1 pe ðsÞq2 eqðstÞ ds pðtÞ ¼ qðpc ðtÞ pðtÞÞ p_ c ðtÞ ¼ t
But this specification, which corresponds to a negative adjustment parameter bpc in ACCF’s equation (18), is clearly not what ACCF have in mind.
134
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
current wage and price inflation is operating, may be adaptively following the actual rate of inflation’’. As argued above, I think this interpretation of pc as an expectational variable may be hard to sustain, but what matters from a technical perspective is the existence of an inertial element in wage and price formation. If there is myopic perfect foresight, it is essential that something prevents wage and price setters from acting fully on their foresight. That something in ACCF’s specification is the adaptive inflation climate; an alternative source might be institutional features of the economy, including staggered wage contracts as in some NK formulations. The precise source of the inertial element may be irrelevant for the analysis of the dynamic properties of the model. The source becomes important, however, if one wants to evaluate the model in relation to real-world economies and discuss the robustness of the specification to various shocks or changes in policy rules. The economic reasoning behind the ‘‘inflationary climate’’ and the specification of the dynamics of inflation exemplify a more general issue of behavioral foundations.
4. Behavioral foundations ACCF may be dismissive (quite rightly, in my view) of the current view of what constitutes behavioral foundations. Over the last 30 years macroeconomists have struggled to analyze optimization problems that grossly simplify real-world optimization problems, the implicit presumption being that agents in the real world have already solved (or act as if they had solved) the more complex real-world problems. Interactions between agents, on the other hand, are usually brushed aside by representative-agent assumptions. This approach to economic modelling shows precisely how not to use mathematics. It may sometimes be reasonable to include optimization in economic models as a stylized representation of goal-oriented behavior, but mathematical models arguably are useful primarily because they allow a clear analysis of complex interactions between agents, each of whom may follow relatively simple (but possibly changing) behavioral rules. A rejection of the optimization-based approach, however, does not settle the substantive questions concerning the appropriate specification of the various behavioral functions or, for that matter, the choice of variables to be explicitly considered by the model. ACCF take a neoclassical-synthesis model as their starting point. I am probably more sympathetic than most economists to this kind of model and do not think that this is necessarily a bad choice. However, as the synthesis model itself loses ground in the profession and as their own work progresses, the detailed specifications of the equations and the choice of extensions have to be explained and justified. The justification need not be rigorous and mathematical, and if it involves reference to heterogeneity among agents, aggregation issues, and stylized facts arising from experimental work, econometric results or economic surveys, then all the better. Looking at the microissues need not entail a return to New Classical/New Keynesian obsessions with rationality and optimization. On the contrary, the burgeoning literature on behavioral economics would seem to provide a natural complement to research on IKDD (and be consistent with the approach to microeconomic foundations in Keynes’s own work and the old Keynesian tradition). Inspiration and valuable insights, moreover, may also be found in the post Keynesian, neo-Marxian and structuralist traditions with their emphasis on institutional structures and social relations between groups.
P. Skott / Journal of Macroeconomics 28 (2006) 131–135
135
Contributors to the IKDD do, of course, consider the behavior underlying their formal relations. But arguably the main emphasis has been on the intricacies of the resulting dynamic systems. In my view the program would be strengthened if the balance shifted somewhat and the behavioral questions were given greater prominence. Perhaps this represents the main challenge in the further development of the IKDD program. References Asada, T., Chen, P., Chiarella, C., Flaschel, P., 2006. Keynesian dynamics and the wage-price spiral: A baseline disequilibrium model. Journal of Macroeconomics, this issue, doi:10.1016/j.jmacro.2005.10.007. Chiarella, C., Flaschel, P., 2000. The Dynamics of Keynesian Monetary Growth. Cambridge University Press, Cambridge. Flaschel, P., Franke, R., Semmler, W., 1997. Dynamic Macroeconomics Instability, Fluctuations, and Growth in Monetary Economies. MIT Press, Cambridge, MA. Hicks, J., 1974. The Crisis in Keynesian Economics. Blackwell, Oxford. Keynes, J.M., 1936/1973. The General Theory of Employment, Interest and Money. Macmillan, London and Basingstoke, published for the Royal Economic Society. Tobin, J., 1975. Keynesian models of recession and depression. American Economic Review 65, 195–202. Woodford, M., 2003. Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press, Princeton and Oxford.