Zombie Economics: How Dead Ideas Still Walk among Us by John Quigin

Author:John Quigin [Quigin, John]
Language: eng
Format: epub, pdf
Tags: Princeton University Press, 0691145822
Published: 2012-08-06T21:18:14+00:00

Of course, awareness of this fact will do nothing to moderate the po-

tential impact; if anything the reverse. People who are suddenly worried

about a recession will not, if they are looking to their own well- being,

keep spending in the hope that others will do likewise and thereby keep

the economy afloat. Rather they will reason that others are likely to think

as they do, and that a recession is even more probable than the objective

evidence would suggest.

Keynes’s idea of “animal spirits” has been revived by George Akerlof

and Robert Shiller in their recent book of the same name. Akerlof and

Shiller consider five deviations from the standard model of rational maxi-

mization (confidence/trust, fairness, corruption, money illusion, and sto-

ries) and argue that some combination of these can be used to explain a

range of economic outcomes inconsistent with the standard model. Their

discussion makes a compelling case that macroeconomics needs new, and

more realistic, foundations.

If the prospects for a macroeconomic analysis based on alternatives

to expected utility theory are so promising, why has so little work been

done along these lines? In part, perhaps, this simply reflects the effects of

128

CHAPTER 3

specialization. Decision theorists focus on individual choices, and when

they seek economic applications, this leads them naturally to look at mi-

croeconomic problems.

But there is a more fundamental problem. Individuals who satisfy the

conditions of expected utility theory display a property called “dynamic

consistency” which, as the name suggests, is of fundamental importance

in DSGE models. Dynamically consistent economic agents never change

their view of the world in any fundamental way. They respond to new

information by changing their subjective probabilities for particular

events, but they never change their underlying prior beliefs and prefer-

ences about the world. That means, in particular, that they can fully

anticipate how they will respond to any possible future situation and

would never wish to change their mind about this, or to “lock them-

selves in” to a course of action they might be unwilling to carry through

when the time comes.

Such consistency is admirable, at least in the eyes of decision theorists,

and makes it much easier to obtain well- defined solutions for DSGE mod-

els. Unfortunately, it is far from realistic. It turns out that the decisions

predicted by realistic models of choice under uncertainty always display

dynamic inconsistency under certain circumstances. This problem has

been the subject of considerable controversy on the rare occasions when

economists have sought to introduce more realistic risk preferences into

macroeconomic theory.

From the neoclassical viewpoint that dominates modern macroeconom-

ics, the absence of a coherent dynamic equilibrium concept seems like a

fatal objection. But from a Keynesian perspective, and on the basis of real

world experience, this is a positive, indeed necessary, feature of a sensible

macroeconomic model. The fundamental macroeconomic problem is pre-

cisely that an economy that seems to be enjoying an equilibrium path of

steady growth can suddenly crash, or veer off into an unsustainable boom.

Aggregate Models and Equilibrium

If there is one thing that distinguished Keynes’s economic analysis from

that of his predecessors, it was his rejection of the idea of a unique full

DYNAMIC STOCHASTIC GENERAL EQUILIbRIUM

129

employment equilibrium to which a market economy will automatically

return when it experiences a shock.

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