Quote of the Day

This piece is widely known, but I never tire of reading it. It comes from a 1906 letter by Alfred Marshall to his student Arthur Bowley (of the Edgworth-Bowley Box)

1. Use mathematics as shorthand language, rather than as an engine of inquiry. 
2. Keep to them till you have done. 
3. Translate into English. 
4. Then illustrate by examples that are important in real life.  
5. Burn the mathematics. 
6. If you can’t succeed in 4, burn 3. This I do often.

Old Keynesian Economics and Equilibrium Theory

Noah Smith refers to a vintage piece by Robert Barro that pours scorn on the New Keynesian agenda. I am grateful to Noah for drawing our attention to it. I find much to agree with in Barro’s critique of the New Keynesians and those who would attack his position would be wise to heed the proverb: those who live in glass houses should not throw stones.

More on Rational Agents and Irrational Markets: A Wonkish Response to Andy Harless

In a comment on my most recent blog post, Andy Harless "[wishes he] had a better intuition for what is going on in [my] model." I took a stab at responding to Andy in the comment section, but my response became so long that I turned it into a post. Here is my answer to Andy. You can find additional comments over at Economist's View where Mark Thoma was kind enough to post an excerpt.

Rational Agents: Irrational Markets

Bob Shiller wrote an interesting piece in today's NY Times on the irrationality of human action. Shiller argues that the economist's conception of human beings as rational is hard to square with the behavior of asset markets.

Although I agree with Shiller, that human action is inadequately captured by the assumptions that most economists make about behavior, I am not convinced that we need to go much beyond the rationality assumption, to understand what causes financial crises or why they are so devastatingly painful for large numbers of people. The assumption that agents maximize utility can get us a very very long way.

Congratulations Harold

My colleague Harold Demsetz was honored this year, along with Stanley Fischer, Jerry Hausman and Paul Joskow, as a Distinguished Fellow of the American Economics Association. Congratulations to all!  Here is what the AEA said about Harold.

Harold Demsetz

Harold Demsetz is one of the most creative and deep microeconomists of the 20th century.  Several of his contributions anticipated subsequent research by years or even decades, and have offered unusually insightful analyses of fundamental problems of economic theory.

Demsetz’s most famous paper “Production, Information Costs, and Economic Organization” (with Armen Alchian, American Economic Review 1972) is one of the most cited papers in all of economics. It analyzes the fundamental question first raised by Coase, “What is a firm?” and tries to understand the difference between contracts occurring inside the firm (for example, with employees) and those occurring in the market (for example, with customers).  Alchian and Demsetz argue that some contracts are efficiently brought inside the firm because doing so reduces the costs of monitoring of performance, especially when production occurs in teams.  Alchian and Demsetz’s approach has been challenged by more recent developments, such as Grossman and Hart (1986), but remains a classic in the theory of the firm.

History Matters

I was planning to take a break from blogging today but then I came across Chris House's homily to his students encouraging them not to read the General Theory; or, for that matter, anything else written in economics BME (before the Mankiw era). I simply cannot let that exhortation stand without adding a few words in defense of the history of thought and in support of Scott Sumner's  take on Chris' post.

Where I differ with Bob Hall on Modelling Unemployment

My former class mate Nick Rowe, in a comment on Saturday's blog post, asks: 

Start with a standard model with perfectly flexible prices and wages. Delete one equation, for example the labour market clearing condition. We are now one equation short of a solution, so we have multiple equilibria. Does that mean we are now free to add any additional equation we feel like? Mathematically, we can do that, of course. But one would like some sort of intuition for that extra equation. Why, for example, should it be an equation for stock prices? Why not a different equation for wages?

That's a great question. Until recently, new-Keynesian economists didn't bother to model unemployment. Instead, they followed the new-classical approach in which all that matters is labor hours spent in paid employment. More recently, a number of authors including  Bob Hall, and Mark Gertler and Antonella Trigari have incorporated explicit models of search unemployment into otherwise standard macroeconomic DSGE models. That idea is not new; David Andolfatto and Monika Merz introduced search to RBC models in the 1990s. What is different about more recent work, building on Hall's 2005 paper, is the way the model is closed.

Neo-Paleo-Keynesianism: A suggested definition

There has been a lot written on the blogosphere in recent weeks about the microfoundations of macroeconomics. Tony Yates argues in favour of micro-founded structural models. Adam Posen is sceptical of micro-foundations and Simon-Wren Lewis, Noah Smith and Nick Rowe call for a more eclectic approach. For those looking for a neat summary of these debates, Paul Krugman traces the history of macroeconomic ideas.  Responding to a  piece by Brad Delong, he argues that there has been a recent resurgence of what he calls “neo-paleo-Keynesianism”.  This is very useful concept and I have much in common with the ideas expressed in Paul's piece. This essay offers a novel definition of the term that Paul coined and an invitation to fellow academics to join me in pursuing an agenda based on this definition.