There are two reasons why modern macro irks me. First is that we simply don’t understand it, yet we act as if we do. Second is that for modern macro policy to “work” it has to rely on tricking people. And pardon me, but if we have to rely on tricking people for something to work, count me out.
Where does the trick come from? Right now you are surely aware that we’ve had a long, slow recovery – with unemployment at the time of writing still above 8%. Historically, macroeconomists noticed that employment picks up when inflation picks up and vice versa (the famous Phillips curve). Hence the calls for higher inflation today as a way to help us out of the employment slump. The problem with this idea is that it only works when firms and workers do not think inflation is happening. Each needs to be tricked into expansionary activity.
If firms do not notice that more money is floating in the economy but that the same number of goods and services are still out there, they may falsely think that the willingness of folks to pay more for their goods implies an increase in real demand for their goods. They will expand. Similarly for workers if they do not realize that the reason firms can pay them more is that they are able to charge more for their products, then they will be lured to accept jobs that they otherwise would not take (after all, if you are paid higher wages only to have to pay more for everything you consume, you are no better off).*
Without spending too much time illustrating, the point is that when prices unexpectedly rise, firms will expand and workers will accept jobs, but this is an illusion. The firms and workers are no better off under the high price world than the low price world, since the real amount of goods and services available in the economy is unchanged. The unwinding of these unnecessary expansions can actually leave both firms and workers worse off – unless we shoot the economy up with some more unanticipated inflation.
The point is, workers and firms are tricked – and ultimately these tricks leave them worse off. Now, where are the behavioralists out there? I thought the behavioral economics revolution was an effort to make people better off on their own terms. Wouldn’t the behavioralists be aghast at this idea? Or would they say that the tricking actually serves as a macro-nudge, at least in the short-term? Of course, that is odd, since the nudgers argue rather persuasively that people have discount rates that are way too high – so wouldn’t the behavioralists push for warnings that such inflationary policies are short-sighted and against our long-term interests? I regularly come across defenses of behavioralism indicating that the purpose of paternalism is not really to expand the power of government. Fine. Sure. But if that were really the case, then where are all of the paternalistic nudgers on this issue? Here is another example of what I mean. Here is another.
* That is not strictly true, as our micro students can show you.