Is Macroeconomics hard? -- Brad DeLong

8/11/2019 Is Macroeconomics hard? -- Brad DeLong

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June 28, 2010

Is Macroeconomics Hard?

Is Macroeconomics Hard?

"Math is hard," said Malibu Barbie, famously--and a ton of criticism came down on her for the

implicit message that her auditors should go off and do other, easier, things instead and leave

the math to the trained professionals. Is macroeconomics hard in this sense? I confess that I do

not think so. I think that macro is pretty easy...[1]

Let's go back in time almost two centuries, to the days when--first after the end of the

Napoleonic Wars and then in 1825-6--the nascent intellectual community of economists

confronted the question of whether the circular flow of economic activity as mediated by the

market system could break down and the economy become afflicted by a "general glut" of

commodities.

There was no question that there could be a "glut" of particular commodities. An example may

make this clear:

Suppose--this is Berkeley, after all--that households decide that they want to spend less than

they have been spending on electricity to power large-screen video and audio entertainment

systems and more on yoga lessons to seek inner peace. The immediate consequence--within

the "market day," as late-nineteenth century British economist Alfred Marshall would have put

it--of this shift in preferences is excess demand for yoga instructors and excess supply of

electric power. Prices of electricity (and of large-screen TVs, and of audio systems) fall as

unsold inventories pile up in stores and as generators spin down and stand idle. Yogainstructors, by contrast, find themselves overscheduled, working ten-hour days, and stressed

out--and find the prices they can charge for their lessons going through the roof. Workers in

electric power distribution and in video and audio production and sales find that they must either

accept lower wages or find themselves out on the street without jobs.


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Over time the market system provides individuals with changing incentives that resolve the

excess-supply excess-demand disequilibrium and restore the economy to equilibrium balance.

Seeing the fortunes to be earned by teaching yoga, more young people learn to properly regulate

their svadisthana chakra and teach others to do so. Seeing unemployment and stagnant wages

in electrical engineering, fewer people major in EECS. The supply of yoga instructors grows. Thesupply of electrical engineers shrinks. Wages of yoga instructors fall back towards normal.

Wages of electrical engineers rise. And balanced equilibrium is restored.

Thus we understand how there can be a glut of a particular commodity--in this case, electric

power. And we understand that it is matched by an excess demand for another commodity--in

this case, yoga instructor services to properly align your svadisthana chakra.

But can there be a general glut, a glut of everything?

Some economists early in the nineteenth century said yes--and that the economy was

experiencing one, and that the fact that such "general gluts" could manifest themselves was a

problem with the market system that economists needed to figure out how to solve. Thomas

Robert Malthus was the most prominent of those who protested. He agreed that the

then-fashionable economic theory said that a glut in one market had to be balanced by a surplus

of excess demand in another. But, he said, so much the worse for economic theory:

Malthus on Ricardo: [A]ccording to [Ricardo's]... theory of profits... the master manufacturers would have been in a

state of the most extraordinary prosperity, and the rapid accumulation of their capitals would soon have employed

all the workmen that could have been found. But, instead of this, we hear of glutted markets, falling prices, and

cotton goods selling at Kamschatka lower than the costs of production. It may be said, perhaps, that the cotton

trade happens to be glutted and it is a tenet of the new doctrine on profits and demand, that if one trade be

overstocked with capital, it is a certain sign that some other trade is understocked. But where, I would ask, is there

any considerable trade that is confessedly under-stocked, and where high profits have been long pleading in vain

for additional capital? The [Napoleonic] war has now been at an end above four years and though the removal of

capital generally occasions some partial loss, yet it is seldom long in taking place, if it be tempted to remove by

great demand and high profits but if it be only discouraged from proceeding in its accustomed course by falling

profits, while the profits in all other trades, owing to general low prices, are falling at the same time, though not

perhaps precisely in the same degree, it is highly probable that its motions will be slow and hesitating...
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Jean-Baptiste Say defended the theory. He wrote to Malthus claiming that theory was sound, and

that the idea of a "general glut" was logically inconceivable:

Letters to Mr. Malthus: I shall not attempt, Sir, to add... in pointing out the just and ingenious observations in your

book the undertaking would be too laborious.... [And] I should be sorry to annoy either you or the public with dull

and unprofitable disputes. But, I regret to say, that I find in your doctrines some fundamental principles which...

would occasion a retrograde movement in a science of which your extensive information and great talents are so

well calculated to assist the progress.... What is the cause of the general glut of all the markets in the world, to

which merchandize is incessantly carried to be sold at a loss?... Since the time of Adam Smith, political

economists have agreed that we do not in reality buy the objects we consume, with the money or circulating coin

which we pay for them. We must in the first place have bought this money itself by the sale of productions of our

own. To the proprietor of the mines whence this money is obtained, it is a production with which he purchases

such commodities as he may have occasion for.... From these premises I had drawn a conclusion... that if certain

goods remain unsold, it is because other goods are not produced and that it is production alone which opens

markets to produce.... [W]henever there is a glut, a superabundance, [an excess supply] of several sorts ofmerchandize, it is because other articles [in excess demand] are not produced in sufficient quantities... if those

who produce the latter could provide more... the former would then find the vent which they required.... You, on the

contrary, assert that there may be a superabundance of goods of all sorts at once and you adduce several facts in

favour of your opinion. M. Sismondi had already opposed my doctrine...

As the young John Stuart Mill put it, the core of the argument of Say, Ricard, and their school

was that:

There can never, it is said, be a want of buyers for all commodities because whoever offers a commodity for sale,

desires to obtain a commodity in exchange for it, and is therefore a buyer by the mere fact of his being a seller. The

sellers and the buyers, for all commodities taken together, must, by the metaphysical necessity of the case, be an

exact equipoise to each other and if there be more sellers than buyers of one thing, there must be more buyers

than sellers for another...

Thus a general glut was as impossible as a square circle or a solid gas.

Yet Say changed his mind. By 1829, in his analysis of the British financial panic and recession of

1825-6, Jean-Baptiste Say was writing that there could indeed be such a thing as a general glut
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of commodities after all: "every type of merchandise had sunk below its costs of production, a

multitude of workers were without work. Many bankruptcies were declared..."

The general glut, Say wrote in 1829, had been triggered by a panicked financial flight to quality

which had led the Bank of England to shrink its liabilities:

The Bank [of England], legally obliged to redeem its banknotes in specie... [t]o limit its losses... forced the return of

its banknotes, and ceased to put new notes into circulation. It was then obliged to cease to discount commercial

bills. Provincial banks were in consequence obliged to follow the same course, and commerce found itself

deprived at a stroke of the advances on which it had counted, be it to create new businesses, or to give a lease of

life to the old. As the bills that businessmen had discounted came to maturity, they were obliged to meet them, and

finding no more advances from the bankers, each was forced to use up all the resources at his disposal. They

sold goods for half what they had cost. Business assets could not be sold at any price. As every type of

merchandise had sunk below its costs of production, a multitude of workers were without work. Many bankruptcies

were declared among merchants and among bankers, who having placed more bills in circulation than their

personal wealth could cover, could no longer find guarantees to cover their issues beyond the undertakings of

individuals, many of whom had themselves become bankrupt...

What was going on?

The answer was nailed by John Stuart Mill in that same year.

Mill's explanation: there was indeed a "general glut" of newly-produced commodities for sale and

of workers to hire. But it was also the case that the excess supply of goods, services, and labor

was balanced by an excess demand elsewhere in the economy. The excess demand was an

excess demand not for any newly-produced commodity, but instead an excess demand for

financial assets, for "money":

Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells... there may

be, at some given time, a very general inclination to sell with as little delay as possible, accompanied with an

equally general inclination to defer all purchases as long as possible.... In order to render the argument for the

impossibility of an excess of all commodities applicable... money must itself be considered as a commodity....


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outsidemoney and some inside money are AAA assets) and not of bonds (some of

which are AAA assets, but not all). You fix a depression by restoring market

confidence and so shrinking demand for AAA assets and by increasing the supply of

AAA assets. Eliminating the excess demand for high-quality assets is eliminated will

bring the goods and labor markets out of excess supply and back into balance.

From the perspective of this Malthus-Say-Mill framework Keynes's General Theory is a not

entirely consistent mixture of (1), (2), and (3)...

Note that these financial market excess demands can have any of a wide variety of causes:

episodes of irrational panic, the restoration of realistic expectations after a period of irrational

exuberance, bad news about future profits and technology, bad news about the solvency of

government or of private corporations, bad government policy that inappropriately shrinks asset

stocks, et cetera. Nevertheless, in this Malthus-Say-Mill framework it seems as if there is always

or almost always something that the government can do to affect asset supplies and demands

that promises a welfare improvement over, say, waiting for prolonged nominal deflation to raise

the real stock of liquid money, of bonds, or of high-quality AAA assets. Monetary policy open

market operations swap AAA bonds for money. Quantitative easing that raises expected inflation

diminishes demand for money and for AAA assets by taxing them. Non-standard monetary policy

interventions swap risky bonds for AAA bonds or money. Fiscal policy affects both demand for

goods and labor and the supply of AAA assets--as long as fiscal policy does not crack the statusof government debt as AAA and diminish rather than increasing the supply of AAA assets.

Government guarantees transform risky bonds into AAA assets. Et cetera...

And then there are, of course, those who never read their John Stuart Mill of 1829, and who

never noticed that Jean-Baptiste Say in 1829 had retracted his 1803 claim that a general glut is

impossible. They continue claim that a depression is not an economic disequilibrium that can be

cured by proper government policy at all--but rather an economic equilibrium that can only be

made even less pleasant by government intervention. Think of Karl Marx, Friedrich Hayek,Ludwig von Mises, Andrew Mellon, Robert Lucas, et cetera.


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This fraction maintains that in a depression there is no excess supply of goods and labor in any

meaningful sense. But, instead, they say:

goods and labor markets are in balance--no government policy to raise employment

and production is welfare-increasing--it is just that technological regress has lowered

the productivity of labor, and employment is low because real wages are low and

workers would rather be unemployed or

goods and labor markets are in balance---no government policy to raise employment

and production is welfare-increasing--it is just that workers have an increased taste

for leisure that has raised their reservation wage, and employment is low because

real wages are high and businesses would rather not hire or


and production is welfare-increasing--it is just that previous overinvestment has given

us a capital stock that is too large and misallocated, and employment is low because

workers cannot quickly be redeployed into jobs in the consumption goods sector or


and production is welfare-increasing--it is just that workers have mistaken nominal

shocks for real shocks, and think that real wages are lower than they are because

they misperceive the price level.

It is pretty clear that they are wrong. Indeed, John Stuart Mill and Jean-Baptiste Say back in 1829

had pretty clear and convincing arguments that this no-disequilibrium fraction is wrong. And Mill's

and Say's arguments have not become less clear and convincing in the past 180 years.

I like this Malthus-Say-Mill framework. I think that this framework allows me to at least

characterize every position on our current macroeconomic dilemmas that I have heard--like, for

example, that the advocates of austerity are convinced that further debt issue by the U.S.

government will crack the U.S. Treasury bond's status as a safe asset and thus increase, not

decrease, the excess demand for AAA assets and increase, not decrease, the excess supply of

recently-produced commodities and labor.

And it is not rocket science.


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But it is, however, cutting-edge economics--cutting edge for 1829, that is.

[1] People who, along with me, took Olivier Blanchard's Economics 2410b course in spring 1983

will note how closely this tracks what Olivier was trying to teach us in the three classes--the

week and a half--he spent on Lloyd Metzler's "Wealth, Savings, and the Rate of Interest." (The

only distinction Metzler is missing that I think is needed is the distinction between safe and risky

bonds.) And, of course, Edmond Malinvaud's Theory of Unemployment Reconsidered

Is Macroeconomics hard? -- Brad DeLong

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