Who is the real revolutionary figure in modern macro, Friedman or Lucas?

 

Who's your daddy?

Just finished my summer macro class (last Friday actually; grades were due Monday). One of the things that always becomes important in the course is how to define the break between Keynes, or at least Keynes and the Old Neoclassical Synthesis, on the one hand, and Friedman and Lucas, in the case of the latter both the New Classical models (monetary misperception) and Real Business Cycle (RBC) models, on the other. Many authors suggest that Lucas should be considered, after Keynes himself, the great scientific revolutionary, and that Friedman's break is incomplete. It is the implicit view in Alessandro Vercelli's book  Methodological Foundations of Macroeconomics: Keynes After Lucas or explicitly in the more recent book by Michel De Vroey's Keynes, Lucas, d'une macroéconomie à l'autre.

The reasons adduced are associated to Friedman's model, which remains in many respects similar to the Neoclassical Synthesis one, that is, an ISLM with a Phillips Curve (PC) with gradual adjustment to the equilibrium position. In one sense it is true that in Lucas' equilibrium model endogenous variables are determined on the basis of real phenomenon, technology, preferences, and factor endowments. The model, which was further developed by RBC authors, emphasizes the intertemporal choices of between leisure and consumption, and the fact that production takes time, and requires inputs over several periods, and has led many to label it Walrasian, in contrast to the supposedly Marshallian model used by Friedman and the Neoclassical Synthesis Keynesians. The other significant difference is that stochastic processes, rather than deterministic ones, become relevant, and Dynamic Stochastic General Equilibrium (DSGE) became dominant [more on that in another post; issues have been dealt to some extent here].

Traditionally a Walrasian model is a General Equilibrium (GE) one, while a Marshallian model represents partial equilibrium. In that sense, the label is a bit of a misnomer, since the ISLM cum Phillips Curve model behind the Friedman’s aggregate demand and aggregate supply model is also a GE model. The Neoclassical Synthesis model solves for the simultaneous equilibrium of the goods, labor, money and bond markets. What Friedman added explicitly is the natural rate. The supply constraint.

The difference between Friedman and Lucas is really that in the Neoclassical Synthesis and Monetarist models some behavior is not derived from intertemporal maximization of individual agents, while that is not true in the RBC models. That should be seen not as a Walrasian feature, but as a result of the abandonment of the Principle of Effective Demand (PED), and the use of a Ramsey Intertemporal model to determine consumption. That is, a dynamic version of Say's Law. In that sense, like the New Classical School, the fundamental change, in this context, is that the equilibration between savings and investment is done by changes in the rate of interest, not income, and that only rigidities would deviate investment from full employment savings.

On the basis of these changes, it is hard to say that Lucas is the more revolutionary figure in modern macro. True, in Lucas framework, the main Monetarist conclusions are less effective or irrelevant. Only unanticipated monetary shocks have effects, and those are strange things to conceive. When shocks are anticipated, monetary shocks have no effects. However, when forced to discuss the Great Depression, Lucas admits that there is little evidence for the RBC view.

Lucas asks: “where is the productivity shock that cuts output in half in that period? Is it a flood or a hurricane? If it really happened, shouldn’t we be able to see it in the data?”* Lucas, even though he has accepted that most cycles are explained by productivity shocks remains convinced that the Great Depression resulted from a monetary contraction by the Fed, as in the Monetarist views of Friedman. And one wonders why that monetary contraction was unanticipated.

Also, even if more extreme, the results do not change the situation in the long run. That is, for Friedman too in the long run (anticipated or not) monetary shocks have no effects. The crucial theoretical variable is the natural rate.

In this sense, it seems that Friedman, and the return of the natural rate of unemployment, and implicitly the interest and output ones too, is crucial for explaining the return of the pre-Keynesian Wicksellian framework that is dominant with the New Macroeconomics Consensus (NMC). Even if Friedman had exogenous money, and a quantitative rule, rather than an interest one, and even if he believed in monetary shocks, rather than the real ones that Wicksell and modern macroeconomists emphasize. Modern macro is neo-Wicksellian, but it owes that to Friedman, more than to Lucas.

* Cited in DeVroey and Pensieroso here.

Two Cents on Birner's 'The Cambridge Controversies in Capital Theory'

I just finished perusing Jack Birner's "The Cambridge Controversies in Capital Theory" (see here). My brief take is that although the author provides a thorough and lucid analysis & exposé of the debates, I certainly do not agree with his assumption that the issues involved primarily dealt with a fundamental difference over research programmatic technique & methodology, with ideology being merely secondary, if not superfluous. This is quite untrue; ideology was at the very core! For more on this, I recommend G.C. Harcourt's "Some Cambridge Controversies in The Theory of Capital" (see here) and Andrés Lazzarini's "Revisiting the Cambridge Capital Theory Controversies: A Historical and Analytical Study" (see here).

Shift happens indeed



The Chronichle of Higher Education has a very good piece on the 50 year anniversary of Thomas Kuhn's classic The Structure of Scientific Revolutions (SSR). It is worth remembering that the official methodology in economics remains Popperian.

The conventional history of ideas in economics, as represented by Schumpeter’s monumental History of Economic Analysis or by Mark Blaug’s work is one that emphasis the continuity and growth of knowledge. Hence, the frontier contains the set of accepted truths and the past is a history of how true knowledge was achieved. Knowledge progresses in a twofold process, first conjectures are made. Conjectures are not the ultimate truth, but are accepted while not proven incorrect. Then, tests are designed to falsify the conjectures. Hence, in Popperian terms theories can never be proven true or verified, but they can be accepted while they are not refuted. In other words, there is rational progress in science, including economics. Falsification is, then, the instrument to measure progress, since it provides the demarcation criteria to define what is and what is not scientific knowledge, and also to determine whether a theory is superior to the other.

Thomas Kuhn provided and alternative to the conventional approach. The evolution of scientific knowledge is tied to history and to the sociology of the scientific community. A paradigm can be described as the set of rules and methods accepted by a scientific community. Scientific knowledge is for the most part the result of normal science, that is, the work of scientists within the confines of their paradigm. However, normal scientists are sometimes confronted with critical anomalies that put in doubt the validity of the whole paradigm (Kuhn’s model of paradigmatic change is the Copernican revolution). An accumulation of anomalies leads eventually to a paradigmatic crisis, and to the emergence of new paradigms.

New paradigms explain the anomalies unexplained by the old one. More importantly, new paradigms often provide a new vision of the object of study. Hence, new paradigms imply that hypotheses are incommensurable in terms of the old paradigm. The methods of testing hypotheses are no longer accepted. Progress is then only possible within the paradigm. Comparisons between paradigms involve the values of the scientific community and the persuasive ability of scientists.

The Kuhnian model was developed to discuss scientific progress in the hard sciences, so a reasonable question is whether it applies to soft sciences too, admitting that economics is a soft science. In economics several paradigms co-exist for long periods, something that should happen only in periods of crisis. Also, the Marginalist Revolution took place even though there was no evident anomaly unexplained by the dominant paradigm (classical political economy; in all fairness Ricardian economics had been abandoned in the 1830s, and vulgar economics dominated the profession). Ideological reasons seem more important in that case. Further, the Keynesian Revolution, that occurred as a result of the high levels of unemployment (an anomaly if there is one for the normal marginalist science) that could not be explained by the dominant paradigm, was to a great extent aborted, and the idea of a natural rate of unemployment was reinstated.

A. W. Coats (1969; subscription required) notes that anomalies and critical experiments are not common, but still the concept of scientific revolutions may serve in economics as an ideal type to clarify the sociological elements in the development of economic ideas. SSR remains vital for economic methodology, in particular after the last crisis has shown, once again, the limitations of the self-adjusting marginalist paradigm.