Intellectual frameworks in Macroeconomics (by Stiglitz and Sala-i-Martin)

Broad consensus today on a. Macro-economics should be derived from micro-economic principles b. Dynamics are central Short run dynamics adjustments in wages, prices, output, and employment Long run dynamics changes in capital, labor, and technology But two conflicting views a. The perfect markets view The economy is well described by the competitive equilibrium model The economy is, by and large, in equilibrium, both at each moment of time and over time, with markets clearing. The actors in the economy are, by and large, rational, with expectations that are rationally formed A useful way to study the macro-economy is to analyze it as if there were a representative agent Government interventions to stabilize the economy are unnecessary. Government interventions are, by and large, ineffective, as the private sector undoes whatever the government does. To the extent that they have any effect, government interventioins to stabilize the economy are counterproductive. To ensure that government does not mismanage the economy, one has to restrict the scope of its actions, particularly the scope for it using discretion. And when there is discretion, it should be delegated to independent agencies (an independent central bank).

b.

The imperfect markets view The competitive equilibrium model provides a poor description of the macro-economy Labor market often does not clearthere is unemployment Capital market often does not clearthere is credit rationing rationality Imperfections in information and markets are pervasive So that firms act in a risk averse manner With highly limited information With expectations that are often far from rational And behavior that often deviates in other ways from Representative agent models have limited usefulness No scope for problems of asymmetries of information No scope for unemployment No scope for borrowing and lending

Markets are, in general, not constrained Pareto efficient, so that, in principle There is scope for government interventions that are welfare improving Well designed interventions cannot/will not be undone by private agents And government policies can change the structure of the economy in ways that enhance stability (automatic stabilizers) Even discretionary interventions have, by and large, been effective, increasing length of expansions and reducing the duration and depth of downturns

There are important trade-offs in policy, in terms of who bears costs and receives benefits and who bears risk, and accordingly macro-economic policy making should be part of the political process.