Teaching macro after the crisis

Olivier Blanchard, pound for pound one of the best macroeconomists out there, is revising his famous textbook. His experience at the IMF has forced him to reconsider the basic short- to medium-term models we teach.

In particular Blanchard wants to keep the ‘IS’ curve, which relates savings to investment, and mostly dump the ‘LM’ curve, which supposedly connects the demand for real balances to the interest rate via the money supply. He also wants to ditch the aggregate supply and demand model, which relates changes in aggregate demand and supply to employment and expectations over the medium term.

Blanchard wants to scrap this and connect the IS curve to an older idea, the Philips Curve, which will be paired with a new curve, called the MP curve in many formulations. Karl Whelan, formerly of this parish, has a nice exposition of the whole IS-MP-PC system here (.pdf). This should replace the older IS-LM and AS-AD formulations over time, but for that to happen, lecturers will need to update their notes, and textbook authors will need to update their offerings. We know Blanchard is doing his bit. What about our Irish colleagues?

A while ago Brian Lucey and I looked at how much the teaching of economics had changed in Ireland since the crisis. Not much, was the short answer. The presentation of our initial results is here (.ppt).

The next thing to do is to change how economists are taught about finance. I have quite a few thoughts on this, perhaps best expressed in my own teaching about financial economics, but Blanchard’s suggestions around the introduction of more than one interest rate reminds me a lot of this classic paper by Jack Treynor, and maybe that can be worked in, in a sensible way.

Either way, Blanchard’s textbook will be top of my recommended reading list when it comes out.

By Stephen Kinsella

Senior Lecturer in Economics at the University of Limerick.

12 replies on “Teaching macro after the crisis”

Stephen, you need more than an update on those mathy models to get economics back on track. Economists need (as in critical understanding of – ) that all economies; ancient, feudal, medieval, classical, neo-classical and neo-liberal are man (and woman) made, political and social constructs and most importantly for our contemporary economies, they are highly interconnected, deeply interdependent physical systems consuming copious amounts of finite energy and raw material resources. I did not find any reference to the aforementioned in my undergrad texts. Funny that.

But what’s very unfunny, is that such physical systems consuming finite resources will later-or-sooner (the latter being more probable) experience some nasty problems if the human puppeters tweak the wrong strings or ignore the certitude that the system must stagnate (ie. dY/dt => 0). Again, no mention of this in my undergrad texts. Unfunny.

I’ve mentioned this before (at least twice on this blog) – that economic rate-of-growth variable is an exponential function (no mention of this also in texts), compounding the amplitude of the economy annually, like compound interest compounds a capital principal. So what is the current doubling time for our economies then? – 40 years? It used to be 23 years: that’s a 70% time-interval increase!! Reckon there might be something not right? If so, then those nicey mathy models will be damn-all use.

As for Blanchard. I thought he was just so-so. Samuelson (1948) was far superior. Basics are always best. Read Robert Gordon’s “The Rise and Fall of American Growth – the US standard of living since the Civil War” [2016]?

This “new” approach appears to be very similar to the core, closed economy model in the Carlin and Soskice (2014), “Macroeconomics: Institutions, Instability, and the Financial System”, textbook. Draft chapters from the textbook were available for a number of years before 2014.

Agreed; sounds exactly like Carlin and Soskice, which, to my knowledge, has been taught at UCD by Morgan Kelly for a number of years. On the ball as ever. Fair dinkum.

The Phillips curve is dead. It only works when the 1% are faoi smacht and debt levels are rational. The Fed’s modelling is in awful trouble because of the curve. 4.7% unemployment and risible earnings inflation.

“If anything, the crisis has shown the importance of the financial system for macroeconomics. Traditionally, the financial system was given short shrift in undergraduate macro texts. The same interest rate appeared in the IS and LM equations; in other words, people and firms were assumed to borrow at the policy rate set by the central bank.”

Wall St and the City have for decades been stuffed to the gills, by and large, with very bright people who didn’t read economics at university. What reaction do you think they would generally have upon reading the above, other than FFS! ?

Adopting a model in which the central bank sets the policy interest rate is certainly more realistic but one is still left with the implication that the money supply is now determined by the banking sector’s willingness to create loans, in turn affected by capital , liquidity and other regulatory constraints. In practice, the impact of lower rates has been offset to some degree by monetary tightening via higher capital ratios .
Another issue is the value of the parameters in the model. For example, it would appear that the relationship between wage growth and unemployment has changed markedly; in effect the Phillips curve is extremely flat so a tightening labour market , per se, is not generating the kind of inflation seen in the past.
Similarly, spending does not seem to be very responsive to interest rate changes, begging the question as to whether monetary policy is effective at all when growth expectations have been severely dampened.

The new (7th) edition of Blanchard is apparently already available in the United States. See pearsonhighered.com

The problem with the teaching of macro-economics, as viewed from outside the academic world, is that it appears to have zero relevance to what is actually happening in the national economy and, for this reason, has lost most, if not all, credibility.
One could take, for example, the evident near total lack of interest in the changes taking place, or at least proposed, in the management of the government’s finances.
This bit, in particular, of the government’s submission ought to raise a few questions (page 4).
“The OECD in its report found that the National Economic Dialogue (“NED”) is an initiative in civic participation that is in keeping with OECD principles of good budgetary governance and open government more generally. However, it recommended that the risk of a perceived sidelining of parliament should be avoided through aligning the NED, to a greater extent, with the deliberations of parliament, and though anchoring the process of ex ante budgetary engagement within the Houses of the Oireachtas and its committees. The OECD advised that, in the near term, this should involve ensuring that the Houses of the Oireachtas are a key partner in the NED. The Government is committed to ensuring that this is the case, and intends, for the forthcoming NED, to involve the Oireachtas through inviting members of the Select Committee on Arrangements for Budget Scrutiny to attend and participate at the event. In future years it can be considered how best to facilitate greater partnership in the conduct of this event.”
This is unbelievable stuff! An un-elected body, conjured from nowhere, is to be placed on a par, it would seem, with the elected representatives of the Dáil, that have to actually APPROVE any budget.
It is Ireland’s membership of the EU, and notably abiding by its fiscal rules, that matter, not the wishy-washy advice of a body such as the OECD which has as much clout as any other inter-governmental international organisation i.e. not much.

“The problem with the teaching of macro-economics, as viewed from outside the academic world …”
Outside of the academic world – its life’s trivia that command folks’ attention. Inside of the academic world its too cloistered to care.

“An un-elected body, conjured from nowhere, is to be placed on a par, it would seem, with the elected representatives of the Dáil …”

I assume you are also referring to the EU or the Commission or the CB or the IMF – or whatever. Eirexit anyone!!!

I believe Behavioural Psychologists refer to this sort of ‘out-siding’ of one’s life-problems as Displacement Therapy. Works fine – until it does not, and you have to have a meaningful intellectual engagement with the matter in hand. And: start making adult decisions!

I wonder what proportion of the typical macro course covers the ponzi scheme and its bezzle. We appear to be in the middle of a serious bond ponzi scheme. Irish ten years yield less than 100bps. If BEB was around he would point out the spread over German bonds which are neg yield. Why anyone would buy a neg yield bond is beyond me.

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