My latest Macro Musings podcast is with Roger Farmer. Roger is a Professor of Economics at UCLA. He joined me to discuss his latest book, Prosperity for All: How to Prevent Financial Crises.
This was a very fascinating conversation. Roger makes the case that modern macroeconomics as it is formally practiced has gone down the wrong path with the New Keynesian paradigm. He considers it a degenerative research agenda for several reasons. First, it is premised on the natural rate hypothesis (NRH) which he sees as incorrect. He uses the analogy of a child hitting a rocking horse to describe the NRH. The child hitting the horse will cause it to rock, but eventually it will come to rest. Likewise an economy buffeted by shocks will cause fluctuations but eventually the economy will return to its full employment level. Roger sees this view as fundamentally wrong
Roger contends a more accurate analogy would be a rudderless boat blown by various winds to new locations and staying there until new winds come along. Put differently, Roger believes in multiple equilibria for the economy that arise because of various shocks--the winds--pushing the economy to new points. The economy may stay at these equilibria for some time. Some equilibria may be good, some bad. One of the important shocks that determine these equilibria are peoples beliefs or confidence. In his work he has formally modeled this through a 'belief function' that replaces the Philips Curve in the standard New Keynesian model. This was a key theme running throughout our conversation.
Other problems Roger sees with the New Keynesian paradigm include prices being implausibly sticky, the absence of involuntary unemployment, small welfare costs to business cycles, and the inability to explain bubbles and crashes. His modeling approach aims to fix these problems and bring back the original animal spirit theme of Keynes in a formal rational expectations framework.
Moving beyond modeling issues, Roger also believes the reason for economic volatility is not sticky prices but incomplete markets. Specifically, incomplete labor and financial markets. This was interesting because it implies price signals are not working properly and preventing markets from doing their magic. His solution is to have the government stabilize the growth of a stock market index via purchases of ETFs.
This was a fun conversation throughout. And his book is highly recommend. It really gets into the philosophy of science and its implications for the macroeconomic discipline.
also listen via the embedded player above. And remember to subscribe since more shows are coming.
Roger Farmer's Home Page
Roger Farmer's Books