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The economy moving through time

If you are into critiques of mainstream macro involving its cavalier treatment of the role of time, you might try this interesting blast from the Washington Center for Economic Growth, a Keynesian-leaning think tank.

Here is the paper’s abstract from the organization’s website.

Expansionary macroeconomic policy is ineffective because, according to the policy ineffectiveness hypothesis (PIH), which is based on the rational expectations hypothesis (REH), it does not affect the real economy. This conclusion is false for several reasons. In their critique on Keynes’ theory, Lucas and Sargent (1978) argue that economic agents erroneously react with positive output and labor supply responses to expansionary macroeconomic policy. But they learn the long-run solution of the Lucas/Sargent model, which involves price reactions only, and do not repeat their mistakes when again confronted with expansionary macroeconomic policy. Thus, learning makes expansionary macroeconomic policy in the Lucas/Sargent model ineffective.

The PIH is derived from models based on neoclassical micro-foundations where economic agents optimize in a stationary environment in ‘logical time.’ Experiencing and learning in ‘logical time’? In this paper, we take historical time seriously; that is, we investigate what economic agents actually experience regarding the effectiveness of expansionary macroeconomic policy in ‘historical time.’ We conclude that even if neoclassical micro-foundations are rigorously applied, if economic agents behave as assumed in the Lucas/Sargent model but that they move through time, the economy will not settle at the predicted long run equilibrium. Instead expansionary macroeconomic policy will be perceived as a virtue.

The authors of the paper are Ronald Schettkat and Sonja Jovicic, Schumpeter School of Economics, University of Wuppertal

Compare this view to that of one of the great Post Keynesian economists:

We are to think of the schedule or curve of the marginal efficiency of capital not as a stable function whose form can be taken as unchanging throughout an analysis of historical events real or imaginary but as a tree branch in a gale sweeping up and down with the gusts of politics and of the emerging consequences of past action and by this bodily shift providing the nearest approach Keynes is willing to allow to a formal link between the inducement to invest and the behavior of the other variables of the economy or of the model. This scheme of thought, Keynes’s invention, the kaleidic […] analysis of a development through time in which one situation or event grows out of another.

From G. L. S. Shackle, The Years of High Theory, Cambridge University Press, 1967, paperback edition 1983, p. 151.
(This ellipsis indicates omission of a note.)

The points made about how the economy moves through historical time are very similar, though the WCEG working paper carefully focuses its attention on the current version of neoclassical macro.

Shackle also connects the possibility of big shifts in psychology to possible moves in interest rates on bonds. This story helps us to understand the connection between views about an uncertain future and the real economy. Its argument is similar to that of the Keynesian exegesis contained in the WCEG working paper. So, watch out for big moves; they are in the DNA of the system, though of course there is more to it than that.


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