Macroeconomic Problems,
Microeconomic Solutions
Peter J. Boettke
Econ 881/Spring 2005
February 28
Main Points to Stress

Macroeconomic problems are coordination problems

Production plans must mesh with consumption demands


Incentives must be aligned and capabilities must be
exploited


Capital and Labor
Incentive problems are knowledge problems and
knowledge problems are incentive problems
Changing circumstances result in disturbances, but
the crucial question is one of adjustment

Feedback and learning through time
Macroeconomic Problems

Errors of Over optimism


Produce products which nobody wants
Errors of Over pessimism

Don’t product products which people want
 Capital goods are allocated incorrectly; capital investments are
inappropriate; labor is misallocated; and as a result the economy
underperformed from the point of view of realizing the mutual gains from
exchange, employing resources efficiently, and satisfying the demands of
consumer sovereignty.
What is the solution to these problems?

Classical


Market discipline
Keynesian

Government correctives



Fiscal policy
Mix of fiscal and monetary policy
After Keynes

Market equilibrium
Fiscal Policy Versus Monetary Policy as a
Corrective
r
IS
Liquidity
trap
makes
monetary
policy
ineffective
LM
r
LM
Crowding
out
makes
fiscal
policy
ineffective
IS
Y
Keynesian World View
Y
Monetarist World View
Neo-Keynesian Synthesis
r
LM
Goods Market
equilibrium;
Money Market
equilibrium
r
IS
Y
Y
What is Wrong With this Picture?

Unconnected to the Choices of Individuals

Labor Market


Capital Market



Money Illusion
Fiscal Illusion
Autonomous Investment
Capital Goods Market


Time and the Process of Production
Complementarity and Substitutability in the chain of
production
Labor Market Response

Workers do not persistently suffer from
money illusion
W/P
W/P0
W/P1
N
N0
N1
Short Run Phillips Curve
I
Long
Run at
Natural
Rate
Short Run Trade Off as
Workers Suffer Money
Illusion
U
Lucas Critique of Keynesian System

Adaptive Expectations → Rational
Expectations

Bayesian Learning

Expectations on underlying distribution


Methodological Rule --- economist cannot assume a level
of knowledge greater than the participants in the economy
Equilibrium Theory of the Business Cycle

Monetary Neutrality and Market clearing

Noise and disturbances to the system (signal extraction)

Invariance proposition
Upshot of Lucas Critique



Short Run and Long Run Phillips Curve are
the same
Microfoundations of Macroeconomics
provides coherence to the discipline
General Competitive Equilibrium


Optimizing behavior
Continuous Market Clearing
Is New Classical Economics Austrian
Economics?

Microfoundations

Aggregate economics unconnected to choice


Rationality

Hypothesis or axiom


Compositive Method, 233-234
Choice under uncertainty
Expectations and the Equilibrium Construct

Logical coherence

Process theory and adjustment, 236, fn. 25
The Classic Austrian Theory of the Cycle
Higher Order
Goods
r
So
S1
r
D
Q
Q
S/C
Lower
Order
Goods
Main Tenets of the ABTC

Non-neutrality of Money


Injection effects through Relative price adjustments
Capital Structure

Heterogeneous and multi-specific goods


Intertemporal Coordination and Monetary
mechanism


Capital maintenance and entrepreneurial decision making
Interest rates as signals between present and future
Complimentarity of Capital and Labor

Employment of scarce resources
Critique of ABCT

Theory



Bias error and bias toward particularly costly
errors
Incoherence of grafting a disequilibrium story on
an equilibrium theory
Empirical


Co-movement of investment and consumption
Limited applicability of interest rate mechanism as
trigger