We construct a microfounded, dynamic version of the IS-LM-Phillips curve model by adding two elements to the money-in-the-utility-function model of Sidrauski (1967). First, real wealth enters the utility function. The resulting Euler equation describes consumption as a decreasing function of the interest rate in steady state–the IS curve. The demand for real money balances describes consumption as an increasing function of the interest rate in steady state–the LM curve. The intersection of the IS and LM curves defines the aggregate demand (AD) curve. Second, matching frictions in the labor market create unemployment. The aggregate supply (AS) curve describes output sold for a given market tightness. Tightness adjusts to equalize AD and AS curve for any price process. With a rigid price process, this steady-state equilibrium captures Keynesian intuitions. Demand and supply shocks affect tightness, unemployment, consumption, and output. Monetary policy affects aggregate demand and can be used for stabilization. Monetary policy is ineffective in a liquidity trap with zero nominal interest rate. In contrast, with a flexible price process, aggregate demand and monetary policy are irrelevant when the nominal interest rate is positive. In a liquidity trap, monetary policy is useful if it can increase inflation. We discuss equilibrium dynamics under a Phillips curve describing the slow adjustment of prices to their flexible level in the long run.
That is the abstract of a new paper by Pascal Michaillat and Emmanuel Saez. It was while I was in graduate school that this sort of mathematical self-abuse took over the field.
Macroeconomics quit you.
PSST isn’t macro, but math theater is?
Math isn’t the enemy of course. It’s the reductive universe where the givens are given and then you are judged on how impenetrable you can make the math. Didn’t some wise guy once say something about being precisely wrong?
To the careful observer, there is even more math available to a PSST paradigm. And the nice thing about a new status quo is that the current status quo will like the new one just fine once we get there. They will never even realize they weren’t always there.
“Blackboard Economics” – Ronald Coase
Macro uses some of the concepts of systems theory, e.g. shocks, without the systems math. PSST seems to fundamentally embrace the systems approach.
What is obvious just by being human, but hard to cram into Greek letter math, is that what you do changes based on relative price.
For example, my Amazon Save for Later cart is always full. What I plan to order changes daily depending on price fluctuations.
Let a thousand equilibriums bloom!