Macroeconomic Theory and Economic Policy

K. Vela Velupillai

• Publisher: Routledge
• Year: 2004
• ISBN:
  9781134358717
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Jean-Paul Fitoussi needs no introduction as one of the world's foremost Macroeconomists of his generation. This celebration of his work includes contributions from Nobel Prize - winning economists Robert W. Clower and Robert Solow as well as Olivier Blanchard and leading economic theorist, Edmond Malinvaud.

1 Preface and Summary

K. Vela Velupillai

One of the distinguished contributors¹ to this volume of essays in honour of Jean-Paul Fitoussi, when initially approached, responded warmly but with a genuine puzzle:

I’m shocked that Jean-Paul is anywhere near 60! Have you ever checked your dates? It was only a few years ago that he moved into his 50s.

Tempus fugit! It was, indeed a few years ago that almost all of us ‘moved into our 50s’, and not long before that into our 30s.

When I first met Jean-Paul Fitoussi, at the Badia Fiesolana in Fiesole, almost a quarter of a century ago, he was a young man in his 30s; when I last met him in Paris, a few months ago, he was still a young man, but had entered his 60s. This volume was conceived before his sixtieth birthday, as a tribute by a few close friends and admirers, to honour his sixtieth birthday, on 19 August 2002. I am sure I speak for all the contributors, and many others, when I wish him many happy years through his 60s and many more decades of professional and personal adventures.

Whenever we meet, particularly in Paris, he asks me to recite, appropriately, a stanza from Auden’s Many Happy Returns:

So I wish you first a

Sense of theatre: only

Those who love illusion

And know it will go far:

Otherwise we spend our

Lives in a confusion

Of what we say and do with

Who we really are.

The generosity, kindness and promptness with which all the contributors to this volume agreed to participate in this interesting and rewarding tribute to a friend, sometimes colleague and an always interesting companion and coauthor to many of us, made my potentially arduous task a pleasure and a privilege. We have all shared memorable moments of intellectual and other adventures with Jean-Paul Fitoussi. This is only a very small token of our friendship, esteem and warmth for the person he is, was and always will be.

The rest of this chapter is an attempt at summarizing and collating the different contributions in a concise way.

The chapters have been arranged in alphabetical order by author’s surname, although they could have been arranged in thematic or other ways. Had I arranged them in terms of purely thematic content I may have grouped the contributions by Bénassy, Clower and myself together as belonging to the more purely theoretical end of macroeconomic theory; the Leijonhufvud and Malinvaud chapters together as belonging to a broad-based narrative of the development of the interaction between the development of visions of macroeconomic theory and their impact on macroeconomic policy, the chapters by Le Cacheux, Phelps and Solow on the macrotheoretical underpinnings of macroeconomic policy and the Blanchard-Tirole chapter, closely related in structure to the latter three, as one concentrating on the theoretical underpinnings of a particular institutional aspect of macroeconomic policy. However informing these delineations may well be and may have been useful in providing structure to a collection of essays, there is a danger that it may place some or even all of the contributions in unwarranted straitjackets. It may also carry with it the danger that I would be distorting some of the subtle messages in the individual intents and aims. Hence, I have chosen to order and organize them alphabetically and provide, in the ensuing few pages, brief summaries to try to link them together.

The central concern of all contributions is the interaction between macroeconomic theory and economic policy – two themes that have characterized Fitoussi’s lifelong research, and academic and administrative efforts.

Bénassy’s contributions takes up a theoretical theme that has concerned Fitoussi’s own macrotheoretic concerns, in a slightly different context, for a long time (cf. [1], p. 25 and note 40, p. 40). It is the undoubted empirical fact of the existence, in advanced industrial economies of all shades, of staggered wage and price contracts. Given this empirical fact, how can we theorize about, and answer questions on, their impact on output and employment persistence? Theoretical frameworks were suggested in a series of pioneering papers by Stanley Fischer, Jo-Anna Gray, Edmund Phelps, John Taylor, Guillermo Calvo and others during the late 1970s and early 1980s. That early research seemed to have lost some of the initial steam till it was revived in more recent years. Bénassy carries on this revival and, in the context of a solvable dynamic stochastic general equilibrium model, he incorporates a Calvo-type staggered wage and price contract scheme. The explicit optimal solution he obtains suggests that price staggering produces less output persistence, for the same average duration of contracts, than wage staggering.

Blanchard and Tirole, in a chapter with rich and copious documentation of the historical facts and experiences of labour market institutions, tackle, against that backdrop, the crucial but thorny problem of designing ‘optimal employment protection’ institutions, norms and regulations. Their chapter addresses the problem, appropriately in a volume in honour of Jean-Paul Fitoussi, in the specific context of institutional reform in France. The general principle that underpins their approach is squarely in the tradition of underpinning a macroproblem in a rigorous micro setting: ‘that of making firms internalize, to the extent possible, the social cost of unemployment’. With this general principle as a guiding light, they construct, first a benchmark model and, then, ‘explore three main deviations from the benchmark, and their implications for employment protection’. Having done this, and informed and guided by it, they look at the ‘employment protection system in place in France today’. This enables them, finally, to outline the contours of a possible scheme for reforming the institutional basis for employment protection in France. The Blanchard-Tirole chapter places the Bénassy framework in its institutional context and makes it possible to read it in a precise policy oriented way. Moreover, it is highly complementary to the issues raised in the chapter by Phelps. Above all, the ‘usual culprits’, invoked in the popular political press, are given short shrift in a meticulously documented, theoretically impeccable framework, and an institutionally informed and underpinned discussion. In the clarity with which the argument proceeds, in the way the evidence – empirical and institutional – is marshalled and corralled into a theoretical framework, it is a masterpiece of pedagogy, as well.

Thomas Sowell opened his magisterial book, Say’s Law, with the remark ([6], p. 3) that the ‘idea’ of Say’s Law, ‘that supply creates its own demand, appears on the surface to be one of the simplest propositions in economics, and one which should be readily proved or disproved’. And goes on:

Yet this doctrine has produced two of the most sweeping, bitter, and long-lasting controversies in the history of economics – first in the early nineteenth century and then erupting again a hundred years later in the Keynesian revolution of the 1930s. Each of these outbursts of controversy lasted more than twenty years, involved almost every noted economist of the time, and had repercussions on basic economic theory, methodology and sociopolitical policy.

Clower, in his chapter, returns to this topic, in its second incarnation, one that has remained central to macroeconomic theory and economic policy: the correct understanding, formalization and interpretation of Say’s Law. We have debated – and, in this, Fitoussi, too has played his part – endlessly about ‘what Keynes actually meant’, and variations on that theme. Much of that debate has taken for granted a particular codification, if not an ossification, of what Keynes meant with his strictures against Say’s Law. But no one seems to have taken the trouble to go back and check with Say, himself, whether he did mean what all and sundry seem to attribute to him! Clower, with characteristic pungency, and scholarly accuracy, has done just that and stripped a host of emperors, particularly Lange and Patinkin, of their clothes in the process.

Jacques Le Cacheux is unique among the contributors to this volume in not only being an ongoing collaborator and consistent coauthor with Fitoussi on matters at the frontiers of macroeconomic policy issues in the European Community in general and in France in particular, but also in having been his doctoral pupil at the European University Institute. In a felicitous and almost balanced blend of theory and policy, Le Cacheux revisits a question that had occupied Fitoussi’s efforts – together with Phelps – for quite some time in the 1980s: the Slump in Europe. To put it in more contemporary terms, the question is not ‘why are we so rich and they so poor’, but, ‘why are we so productive and they so unproductive’ and ‘why do we tax so little and they so much’. Hence, in effect, ‘why are we enjoying prosperity and they depression’ – the ‘we’ being the US and the ‘they’ being ‘old’ Europe and Japan.² Le Cacheux returns to the framework suggested by Fitoussi and Phelps in the 1980s, but with due attention paid to the changed contexts and circumstances brought about by financial globalization. There is an underlying reliance on the theoretical vision provided by an overlapping generations framework to highlight the role played by demographic factors in the dynamics of assets and debts and their induced macroeconomic effects via their impacts on behaviour at the individual level of firms and households.

In a sense, Leijonhufvud, Malinvaud and Solow tackle an issue that is at the heart of macroeconomics: the kind of vision that dominates the macroeconomics of an era or of a generation.³ Time was when macroeconomic policy was synonymous with stabilization policy and an active government role in the policy-making and implementing process. Now, as Leijonhufvud ruefully ruminates, the pendulum has swung and the drive is to constrain government actions. A generation and an era ago, the vision of industrial societies was permeated by pathological metaphors: instabilities, fluctuations, market failures and the like; to the present generation, reared on theoretical technologies emphasizing equilibrium stochastic dynamics, pathologies have been banished. Economies reside on intertemporal equilibrium paths, buffeted, now and then by shocks of one sort or another, but containing enough self-adjustment capabilities to return to tranquillity. How and why did – and do – visions change? Leijonhufvud tries to pose this challenging question and answers it with a wide ranging, panoramic sweep over the recent development in macroeconomics to extract lessons, precepts and prescriptions.

Malinvaud’s questions are closely related to the concerns expressed in Leijonhufvud’s chapter, but with a more specific focus: the twenty-year period, 1975–1995, spanning the two decades in which there was the emergence, consolidation and dominance of macroeconomic theory by, first, the rational expectations ‘revolution’ and, then, the refocusing of the problem of economic fluctuations as one of real business cycles. His focus is not just the changing visions that imply, for any generation, a particular way of doing macroeconomic theory; but it is also how this particular way of doing theory may impact on the kind of issues that could and would be dealt with in the framework of macroeconomic policy. He does not deny or belittle the substantial contributions of these two related movements in macroeconomic theory – not least in conceptual innovations and methodological, especially mathematical, sophistications. However he rues the fact that the mathematical sophistications seem to have become an end in themselves, without any anchoring in empirical phenomena or policy concerns, indeed, even contributing to a nihilistic attitude towards policy. A wedge is being driven between what was once a seamless continuum, between theory and policy, largely due also to the internal criteria the macroeconomic profession seems to be according the kind of work to be prized, rewarded and published. The poignant point he tries to make is most vividly illustrated in the way he discusses the Lucasian obsession with computing welfare gains – or losses – of a representative consumer, as a result of stabilization policies attempting to control or eliminate business cycles.⁴ Malinvaud, almost plaintively, suggests that economists should also heed the testimonies of scientists in the ancillary social and human sciences when trying to discuss and theorize, using intertemporal stochastic equilibrium models, the welfare consequences of economic booms and depressions.

Phelps, starting from the foundations that underpinned his work with Fitoussi in the 1980s, where they tried to provide a novel theory about the deep slump in which Europe was mired at that time, goes on to explain, first, the genesis of what he has come to call structuralism. This sets the stage for him, second, to be able to delineate and differentiate its nonmonetary bases in comparison with supply-side and real business cycle models and thereby exposing the weaknesses and flaws in the latter and showing how structuralism avoids these pitfalls. Structuralism was set in its felicitous paces in the 1994 book by Phelps, Structural Slumps: The Modern Equilibrium Theory of Unemployment, Interest and Assets. The title makes explicit the difference with The General Theory in its substitution of ‘assets for money’.⁵ Phelps has been indefatigable in emphasizing the importance of taking an ‘asset view’ of business life – a theme taken up in Le Cacheux’s chapter, largely inspired by the work of Phelps and Fitoussi-Phelps. Indeed, it may not even be an exaggeration to summarize the structuralist programme – a previous generation would have been familiar with a different kind of structuralism, just as there was, once, another kind of New Keynesianism – in ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Contents
• List of contributors
• 1. Preface and summary
• 2. The consummate macroeconomist: Jean-Paul Fitoussi
• 3. Price versus wage stickiness and the issue of persistence
• 4. Contours of employment protection reform
• 5. Trashing J.B. Say: the story of a mare’s nest
• 6. Assets, debts and interest in the EU and the US: the slump in Europe revisited
• 7. The long swings in economic understanding
• 8. The difficult dialogue between the development of macroeconomic theory and macroeconomic policy concerns
• 9. What structuralism is - and what errors and omissions it avoids in supply-side and RBC models
• 10. What should we mean by “growth policy?”
• 11. Rational expectations equilibria: a recursion theoretic tutorial
• Author index
• Subject index