Stuck in Macroeconomic Purgatory

I got a lot of nice comments about my Lilliputians post. The comments made me think more about why the two parties just can’t seem to face up to current economic issues in the way many of us would like to see. Unlike some of my other posts, this one takes me out of my comfort zone and into what I would call pure conjecture. This is the kind of stuff one talks about in the bar after having one too many JDs.

In my last post I conjectured that it might be better now to view our economic issues as an interrelated set of challenges that would be better handled as a single set rather than in piecemeal fashion. I argued that both parties could get plenty of credit by taking a more holistic approach and that the resulting policies would be an improvement of what we have been seeing lately. While liberals might be partially pleased with recent progress in some policies (In particular healthcare, stimulus, and financial reform) much of what was legislated was done without conservative support and the path forward with respect to those and other policies now seems even harder to travel. While much might be decided by the coming November elections, there is no guarantee that this will produce anything beyond a stalemate.

So not much is going to change and we seem stuck with politicians who seem more concerned with pleasing the extreme wings of their parties than with solving our pressing economic problems. This seems crazy and wrong since no party is going to have the muscle or support to make the compromises that will produce the right kinds of policies—those that address the cause and effect of the issues.

The question then is why we are stuck in Macroeconomic Purgatory. Here is where I take a big gulp of JD and move ahead unsteadily. My conjecture is that none of these politicians took Econ 101 from Art Benavie at the University of North Carolina in Chapel Hill. I was very lucky to have been accepted into the PhD program in Economics at UNC in 1973. I was a teaching assistant for Prof. Benavie and learned a lot from listening to his lectures to freshmen. I learned a lot from him (as well as from Dick Froyen, Roger Waud, and the many other folks involved with the Macro Seminar) but one thing that stood out was the point that policies for income redistribution should be handled separately from those of macroeconomic efficiency and growth. I believe this is a point that Milton Friedman also articulated and espoused. Regardless of where it originated, Prof. Benavie made it come alive in the classroom in Chapel Hill. It all seemed so clear. There was one axiom – you cannot have an economic issue or policy without the problem or the policy having an implication for income redistribution. Benavie’s conclusion was that income distribution should to be treated separately from other issues.

Let me try to give an example that relates to macroeconomics. Macro is the study of the economy of a nation or region. It does not seek to model or explain the behaviors of individual persons or sectors – rather it sees the economy as a whole. So let’s suppose the nation has high unemployment or slow growth. The NATION, therefore, is operating inefficiently. The MACRO ISSUE is that the system is not working as it should or could. The MACRO ISSUE is that workers and the goods and services they make are less than the amounts that ought to be hired and produced. But notice – the story doesn’t end there. The recession also has uneven impacts on persons and sectors. Perhaps the white goods market is more negatively impacted than others. Maybe the Northeast is hurting more than the South. Low income persons may be impacted more than those with higher incomes.

The main point here is that Macro problems always come with unequal and negative impacts on various persons, sectors, regions, etc. BUT MACRO POLICIES ARE ALWAYS DESIGNED TO ADDRESS THE MACRO PROBLEMS. MACRO POLICIES are not designed to deal with the numerous and myriad individual impacts of recessions.

Hearing this you might retort – that’s exactly what’s wrong with macro. How can you not care about all these uneven impacts on people and companies and sectors and so on? But I would snort this retort – a chain saw is a great tool to bring down a dead tree. A chain saw kicks butt when it comes to bringing down a tree. But if you use your chain saw to provide the missing shade or to replace the beauty of the tree, you might be barking up the wrong tree. Sorry – I just couldn’t help myself. But you see the point. To replace the shade provided by the tree – you might be better off with a shovel to dig a hole for another tree. To replace the beauty of the tree you might want to paint the new lovely lawn flamingos you purchased at the limestone store.

You can care a lot about the missing shade and the loss of beauty but if the tree is dead, then you need a tool designed to deal with that problem. You can use other tools for the shade/beauty issue. Similarly in macro, you need macro tools for the recessionary conditions – and other policies and tools for the micro issues. And the traditional MACRO TOOLS are notoriously not designed for the many micro problems – while they are, like the shovel, focused on one problem -- remediating MACRO PROBLEMS.

When I speak of the traditional MACRO TOOLS I specifically refer to monetary and fiscal policy. Since Keynes’ ideas were first cast into a modern macro model by Sir John Hicks and others – the profession has articulated (and debated) using monetary and fiscal policy to target real GDP and employment. These tools can’t do everything. Monetary and fiscal policy do not guarantee any level of effectiveness at moving real GDP or employment – just as a particular chain saw might not always take down the tree. But at least you know it is the right kind of tool for the problem. Most economists would agree, however, that monetary and fiscal policy are NOT designed or appropriate for solving the energy crisis, making American an export dynamo, reducing poverty, or saving education. We view other tools as being superior for those problems.

Congress apparently never got the message – because we hold macro policy hostage to other issues – especially income distribution. Prof Benavie would say – use a Macro Policy for the recession. Then check and see how that might impact income distribution. If income distribution is worsened by the Macro Policy, then design a specific policy to solve that issue. Don’t let the income distribution ramifications cause you to alter the Macro Policy. If you want to do something about incomes of the poor or the middle class – don’t use a chain saw or Macro Policy – use a policy specifically designed to help people move up in the income distribution..

But notice what we argue about tirelessly. Should the Bush-era tax cuts for the rich be extended? Should the Fed expand its program to buy mortgage securities so rates on mortgages will be driven lower and funds be made more available to people who otherwise could not buy houses? Should unemployment benefits be extended for months to provide income for a group measuring probably less than 5% of the US population? Should we direct extra stimulus spending to poor people on Medicaid? The list goes on and on.

Notice that I am not denigrating the need to have policies designed to improve the distribution of income. What I am saying is that Macro Policy cannot and should not solve income distribution problems. If we want to raise GDP or employment let’s debate Macro Policy on its Macro Merits. If we want to improve the income distribution, let’s have debates and legislation designed for that. Failing to understand this simple point means that it is going to be next to impossible to get good policy. It is much too easy for any populist politician (is that redundant?) to use income distribution as the excuse to not stand behind good macro policy. There will always be compromises in policy but watering down a macro policy to achieve income distribution goals is not a positive compromise since it means less than desirable policies for economic growth and income distribution. Preferable would be simultaneous passage of separate and specific policies designed for macro and income distribution. As I suggested above, this would imply a holistic approach to policy – not a sequential and piecemeal approach. As a result, instead of getting a nice burger and fries, we will be presented with mush.