Barro and Grossman’s Dynamic Disequilibrium Macroeconomics1
Abstract
During the 1970s, most macroeconomists developed “fixed-price” equilibrium models. Such models featured equilibria with rationing on markets. Not the dynamic of non-clearing markets. However, this was the original project. “Fixed-price” equilibrium models emerged out of Don Patinkin ([1956] 1965), Robert Clower (1965), and Axel Leijonhufvud’s (1968) interpretation of the General Theory (1936). All three considered that John Maynard Keynes (1936) was concerned with the dynamic of markets when individuals behaved under rationing constraints. From there, they all tried to provide microfoundations to a model capable of portraying disequilibrium adjustment processes occurring in capitalist economies. The question is whether “fixed-price” theorists abandoned this project. My paper shows that Robert Barro and Herschel Grossman did not. When elaborating the seminal “fixed-price” model (1971), they had a second step in mind. It was to build a dynamic disequilibrium model. It turns out to be very much in the spirit of Patinkin ([1956] 1965) and Clower’s (1965). I present its main features and discuss its scope. By doing so, I account for the richness and limits of the research line that Patinkin ([1956] 1965) and Clower (1965) initiated but barely explored.
JEL Codes: B13, B21, B22, D45, D5, E12.
Keywords: dynamics, disequilibrium, microfoundations of macroeconomics, Barro and Grossman.
1 Duke University, Department of Economics, Center for the History of Political Economy, e-mail: [email protected]
1 Introduction
During the 1970s, most macroeconomists, including Robert Barro and Hershel Grossman (1971), Jean-Pascal Bénassy (1975), Jacques Drèze (1975), Jean-Michel Grandmont and Guy Laroque (1976), and Edmond Malinvaud (1977), developed “fixed-price” equilibrium models. Such models featured equilibria with rationing on markets. Not the dynamic of non- clearing markets. However, this was the original project. “Fixed-price” equilibrium models emerged out of Don Patinkin ([1956] 1965), Robert Clower (1965), and Axel Leijonhufvud’s (1968) interpretation of the General Theory (1936). All three considered that John Maynard Keynes (1936) was concerned with the dynamic of markets when individuals behaved under rationing constraints. From there, they all tried to provide microfoundations to a model capable of portraying disequilibrium adjustment processes occurring in capitalist economies. The question is whether “fixed-price” theorists abandoned this project. My paper shows that Barro and Grossman did not.2
While presenting the seminal “fixed-price” equilibrium model, Barro and Grossman (1971) showed a concern for disequilibrium dynamics. They argued that their “analysis did have implications for the appropriate specification of the forces making for changes in prices and wages” (1971: p. 84); they considered “a parenthetical example concerning the cyclical behavior of real wages” (1971: p. 84); and they referred to an article in which Grossman (1971) addressed “in details (…) the disequilibrium behavior of prices and interest” (1971: p. 85). All these remarks suggest that the 1971 model was just a stage in the process of developing a dynamic disequilibrium model. A conjecture which becomes even more plausible when reading the contents of Money, Employment, and Inflation (Barro and Grossman, 1976). Section 2.5 offered a “Dynamic analysis in the absence of recontracting”, Section 4.4.3 analyzed the “Dynamic effects of monetary policy”, Chapter 5 explored the dynamic of “Inflation and unemployment”, and Chapter 6 focused on “The Dynamics of aggregate demand” (1976: vi- vii).
The challenge is to place dynamics at the heart of Barro and Grossman’s disequilibrium program of microfoundations. This requires to show that when writing the 1971 article, Barro and Grossman had a dynamic approach to disequilibrium economics. Then, I have to determine how Barro and Grossman modeled the operation of economic activities during the adjustment
2 Matthieu Renault, Goulven Rubin, and I express a similar viewpoint in a recent working paper, centered on French “fixed-price” theorists.
2 of markets. To overcome these difficulties, I place their disequilibrium program of microfoundations in its intellectual context. Emphasis is given to two sources of inspirations: disequilibrium macroeconomics à la Patinkin ([1956] 1965) and Clower (1965), and non- tâtonnement economics à la Frank Hahn and Takashi Negishi (1962). Besides, I analyze in depth “Market Disequilibrium in a Macro-Economic Context”, an unpublished manuscript written by Grossman in 1968, and Money, Employment, and Inflation (1976).3
In that process, two interpretations of Barro and Grossman’s microfoundational program are challenged. The first one asserts that Barro and Grossman either marginalized or abandoned Patinkin ([1956] 1965), Clower (1965), and Leijonhufvud’s (1968) project to model the dynamic of non-clearing markets. The extreme position is supported by Michel de Vroey (2016), in A History of Macroeconomics from Keynes to Lucas and Beyond. Whilst acknowledging that Barro and Grossman “found inspiration in reading Patinkin, Clower, and Leijonhufvud”, De Vroey argue that like other “fixed-price” theorists, they “were striving to produce an equilibrium result, a radically different project” (2016: p. 124). Roger Backhouse and Mauro Boianovsky (2013) are more nuanced in Transforming Modern Macroeconomics: Exploring Disequilibrium Microfoundations, 1956-2003. They acknowledge that Barro and Grossman (1976) extended their “[1971] model to encompass dynamics” (2013: p. 78). But this is not presented as a central element of their disequilibrium program of microfoundations. The treatment of “wage and price dynamics” would be just one extension “amongst” others of the 1971 model (2013: p. 72). The second interpretation concerns the analytical proximity between Patinkin ([1956] 1965), Clower (1965), and Barro & Grossman’s models. The three historians consider that it is limited. Barro and Grossman would use simply Patinkin ([1956] 1965) and Clower’s (1965) foundations – i.e., the spillover effect and the dual-decision hypothesis.
By contrast, I argue that just like Patinkin ([1956] 1965), Clower (1965), and Leijonhufvud (1968), Barro and Grossman’s project was to model disequilibrium adjustment processes. They completed it by elaborating a disequilibrium model very much in the spirit of Patinkin ([1956] 1965) and Clower’s (1965). I present its main features and discuss its scope. By doing so, I account for the richness and limits of the research line that Patinkin ([1956] 1965) and Clower (1965) initiated but barely explored.
3 Juan Carlos Acosta found this manuscript in Franco Modigliani’s Papers, at Duke University. I would like to thank him for giving me access to it.
3 1. A dynamic approach to disequilibrium economics
Just like Patinkin ([1956] 1965) and Clower (1965) or Hahn and Negishi (1962), Barro and Grossman adopted a dynamic approach to disequilibrium economics. They considered disequilibrium as a phenomenon occurring only during the market-clearing process. From there, the challenge was to provide microfoundations to a dynamic theory of spillover and to study the stability properties of Walrasian equilibrium.
1.1 Background
Barro and Grossman initiated their disequilibrium program of microfoundations between 1968 and 1971, at Brown University.4 In 1968, Grossman wrote “Market Disequilibrium in a Macro-Economic Context”. In this research project (submitted to the National Science Foundation), he argued that the “existing macro-economic literature” (i.e., Walrasian macroeconomics à la Hicks) was inappropriate for “explaining and predicting the behavior of the actual economy.5 For the actual economy may rarely, if ever be in equilibrium” (1968: p. 5). According to Grossman, the bulk of actual exchange took place while individuals would like to buy and/or to sell more, given market prices. Hence the need to “analyze explicitly the behavior of macro-economic systems which [were] not necessarily or even typically characterized by market equilibrium” (1968: p. 5). Such an approach to macroeconomics already attracted Barro’s interest while he was in graduate school at Harvard (Backhouse and Boianovsky, 2013: p. 67). Thus, when arriving at Brown University in 1968, he engaged with Grossman.6 This resulted in a collaboration which culminated in the publications of “A General Disequilibrium Model of Income and Employment” (1971) and of Money, Employment, and Inflation (1976).
4 In the preface of Money, Employment, and Inflation (1976), Barro and Grossman explained that their “monograph [was] the outgrowth of ideas developed while [they] were colleagues at Brown University from 1968 to 1971. During that period, [they] became aware that [they] shared similar reservations about the weak foundations of conventional macro-economic analysis. [They] both felt the need for a substantial restructuring of these foundations, especially to deal adequately with the problem of exchange under non-market-clearing conditions” (1976: xi). 5 “The existing macro-economic literature deals primarily with analysis of the characteristics and stability properties of market equilibrium: that is, the condition of equality between aggregate supply and demand. The classic example is the Hicksian comparative static analysis of the values of dependent variables consistent with market equilibrium” (1968: p. 5). 6 In “Money, Interest, and Prices in Market Disequilibrium” (1971), Grossman acknowledged that his article “benefited from extensive discussions with Robert Barro” (1971: p. 943).
4 Initially, the research program was designed as a synthesis between disequilibrium macroeconomics and non-tâtonnement economics. According to Grossman:
The Hahn and Negishi, Patinkin, and Clower models should be regarded as complementary. Future fruitful work might be based on development of a synthesis (1969: p. 479).
The aforementioned models addressed the behavior of markets when exchange took place out of Walrasian equilibrium. But not in the same way. Grossman (1969) indicated that Hahn and Negishi (1962) focused on distribution effects, i.e., how excess supplies or excess demands are distributed among individuals during the exchange process. Effects ignored by Patinkin ([1956] 1965) and Clower (1965). On their side, what mattered was to account for spillover effects, i.e., how a firm or a household is forced to revise its plans when failing to sell (or buy) what it desires given market prices. Effects ignored by Hahn and Negishi (1962). However, “distribution and spillover effects [were the] “two distinct channels [through which] trades carried out at non-clearing prices should affect” the functioning of markets. Hence the project to elaborate a disequilibrium model synthesizing the Hahn and Negishi (1962), Patinkin ([1956] 1965) and Clower’s (1965).
1.2 A common approach to disequilibrium economics
What is common to these four economists is a dynamic approach to disequilibrium economics. Hahn and Negishi’s was adopted in reaction to contemporaneous developments in general equilibrium theory – in particular, Herbert Scarf’s (1960) examples of global instability of competitive equilibrium. Scarf’s examples showed that it was not possible to demonstrate that Walrasian equilibrium was stable in general, i.e., very special assumptions were necessary to prove that individuals found common grounds to exchange. Hahn and Negishi concluded that the tâtonnement hypothesis did not provide a satisfactory representation of market economies. Accordingly, they started studying the stability properties of competitive equilibrium, under an alternative rationalization of exchange (Hahn’s non-tâtonnement process).7 Around the same period, Patinkin ([1956] 1965) and Clower (1965) were also concerned with the dynamic of non-clearing markets. But in their case, this reflected how they
7 In “The Stability of the Competitive Economy: A Survey Article”, Negishi (1962) claimed that: “It is possible to interpret [Scarf’s] examples as showing [that] the tâtonnement process does not provide a correct representation of the dynamics of markets. See Hahn (1960). The failure of the general stability of the tâtonnement process suggests the study of the stability of the non-tâtonnement process” (1962: p. 659).
5 addressed the microfoundations of the General Theory. Neither Patinkin ([1956] 1965) nor Clower (1965) considered the existence of an equilibrium featuring involuntary unemployment. In their market models, the sole equilibrium position was the full-employment. This resulted in the association between involuntary unemployment, disequilibrium, and the dynamic of markets. The central issue was whether price and quantity adjustments were stabilizing when firms and/or households failed to realize their Walrasian optimizing plans.
Just like Patinkin and Clower or Hahn and Negishi, Barro and Grossman adopted a dynamic approach to disequilibrium economics.8 They viewed disequilibrium as a dynamic phenomenon; asserted the need to study the stability of Walrasian equilibrium; and in turn, set a roadmap for a dynamic disequilibrium model. All these aspects are emphasized through a combination of arguments found in Grossman’s (1968) research project and in other articles written with or without Barro, in the early 1970s.
A dynamic conception of disequilibrium phenomena
While “analyzing the causes of market disequilibrium in a macro-economic context” (1968: p. 3), Grossman argued that:
sluggish market clearing in either the product market or the debt market [was] responsible for disequilibrium in the sense of nonzero notional excess demand (1968: p. 12).
Quite similarly, in “Suppressed Inflation and the Supply Multiplier”, Barro and Grossman explained that disequilibrium situations such as:
suppressed inflation and suppressed deflation both [resulted] from the inability of wages and prices to adjust instantaneously, in response to shifts in aggregate demand or supply, to satisfy the conditions for general market clearing (1974: p. 87).
Taken together, these two quotations show that in Barro and Grossman’s view, disequilibrium occurred only during the market-clearing process. There was only one equilibrium. It featured full market clearing, and was stationary. That explains why Barro and Grossman always
8 The same is true for much of the economists who furthered researches on disequilibrium and non-tâtonnement economics. Among these economists, some drew Barro and Grossman’s attention when developing their disequilibrium program of microfoundations. Let me mention Peter Frevert (1968, 1971), Axel Leijonhufvud (1968), Donald Tucker (1966, 1968), Robert Solow and Joseph Stiglitz (1968), and Emiel Veendorp (1975).
6 considered the same experiment when undertaking a disequilibrium analysis. Grossman summed it up in “Money, Interest, and Prices in Market Disequilibrium” (1971):
The experiment begins with particular values of r and P [market prices] which are not consistent with general equilibrium. An ‘instantaneous-multiplier’ process then determines […] ‘fixed-price-equilibrium’ quantities, in the sense that they would have no tendency to change so long as P and r did not change. […] At the same time, but as a conceptually distinct operation, P and r are being adjusted (Grossman, 1971: p. 958).
Initially, the economy was supposed to be at full-employment. An exogenous shock disturbed this equilibrium position (e.g., downward shift of aggregate demand). Since prices and wages varied too slowly to ensure an instantaneous return to full-employment equilibrium, disequilibrium analyses were undertaken. The goal was to explain the determination of output and employment at given non-clearing market prices, and the dynamic of markets.
Stability of full-employment equilibrium or the central issue for macroeconomics
In 1974, while commenting on Leijonhufvud’s (1973) article “Effective Demand Failures”, Grossman acknowledged that the stability of full-employment equilibrium was the central issue for macroeconomics:
According to Leijonhufvud […] the essential question for macroeconomics is the following ‘Does the market system…tend to move automatically towards a state where all market excess demands and supplies are eliminated? How strong or weak are those tendencies?’ (p.29). As evidenced by my own writing – see, for example, Grossman [1969, 1971, 1973] and Barro & Grossman [1971, January 1974, July 1974] – I have much sympathy with Leijonhufvud’s perspective and I agree with Leijonhufvud’s identification of the central issue for macrotheory (1974: p. 358).
A roadmap for a dynamic disequilibrium macroeconomics
In his research project, Grossman (1968) argued that his “major objective was the development of a theory of spillover” (1968: p. 3). This was because:
the notional excess demands generally should not be regarded as appropriate measures of market pressures making for [price] change [out of Walrasian
7 equilibrium]. As Patinkin [1952] points out, the notional excess demands measure the ‘net amount demanded on the assumption that the individuals who constitute the market are able to buy or sell as much as they desire at the prevailing set of prices. But this is precisely the situation that does not obtain under [disequilibrium] conditions; for then, by assumption there are unsatisfied buyers and sellers. For example, suppose that the array of prices is such that the amount demanded exceeds the amount supplied for both shoes and clothing. Then, the pressure on the price of, say, shoes comes from two sources: first, the buyers who have not succeeded in obtaining all the shoes they which to purchase at the given prices; second, the buyers who have not succeeded in spending all they intended to (at the given prices) on clothing, and who redirect part of this unspent income to the shoe market.’ […] The second of these factors Patinkin [1965] has called ‘spillover’ (1968: p. 10).
The development of a dynamic theory of spillover was challenging. The first challenge was to offer a microeconomic framework adapted to market adjustment processes. According to Grossman (1968), “Clower’s [1965] dual decision hypothesis” was a good “starting point” (p. 15). This was because when generalized to the firms, this theory of choice could be used to deduce effective excess-demands for all individuals (1968: p. 15). Both Barro and Grossman considered that these functions measured properly the forces making for change in wages and prices out of full-employment equilibrium (1971: p. 84). That said, the dual-decision hypothesis was not sufficient to base the analysis of wages and prices adjustments on maximizing behavior. Barro and Grossman (1971) explained why:
The inability of a firm to sell its desired output at the going price violates an assumption of the perfectly competitive model. Kenneth Arrow has stressed this inconsistency of perfect competition with disequilibrium. Essentially, he argues that economic units which act as perfect competitors in equilibrium must (at least in certain respects) perform as monopolists in disequilibrium. In this paper, we focus on the reaction of economic units to given (equilibrium or disequilibrium) price levels. If in addition, one wished to analyze explicitly the dynamics of price adjustment, it would be necessary to discard the perfectly competitive paradigm of the producer as a price taker [In this regard, see Barro] (1971: p. 85).
8 Arrow emphasized the incompatibility between disequilibrium and perfect competition, in “Toward a Theory of Price Adjustment” (1959). He argued that the existence of disequilibrium (e.g., an excess supply of goods) contradicted the assumption that in perfect competition, firms were supposed to face a perfectly elastic demand curve. At the same time, just like Tjalling Koopmans’s (1957), Arrow (1959) explained that the law of supply and demand, as price mechanism, reflected no one’s maximizing behavior. Hence the need to discard the perfect competition framework. Reference to Barro’s (1972) article on monopolistic price adjustment suggested that the elaboration of a microeconomic framework adapted to disequilibrium adjustment processes was on the agenda.
The second challenge posed by the development of a dynamic theory of spillover was to study the stability of full-employment equilibrium. In his research project, Grossman argued that “future work on pure theory of market disequilibrium in a macro-economic context will concentrate on […] the relationship of spillover to global stability” (1968: p. 21). In “Money, Interest, and Prices in Market Disequilibrium”, Grossman (1971) provided a first stability analysis. Thereafter, Barro and Grossman investigated systematically the dynamic of non- clearing markets in Money, Employment, and Inflation (1976). By that time, they had stabilized a dynamic disequilibrium model. It turns out to be very much in the spirit of Patinkin ([1956] 1965) and Clower’s (1965). Next section presents its main features.
2. A dynamic disequilibrium model
Barro and Grossman followed in Patinkin ([1956] 1965) and Clower’s (1965) footsteps to elaborate their disequilibrium model. First, they focused on the behavior of aggregates, in a competitive environment. Second, they devised a Walrasian-type technology of exchange. Third, they assumed that market prices responded to effective excess demands.
2.1 Environment
Just like Patinkin ([1956] 1965) and Clower (1965a), Barro and Grossman “abstracted from distribution effects” (1976: p. 9).9 Emphasis was given to the behavior of three
9 Patinkin used the “Hicks Composite-Good Theorem” to build aggregates ([1956] 1965: p. 411). Clower (1965) also did, but without mentioning it. The same is true for Barro and Grossman (1976): “when analyzing the behavior of firms, working households, and retired households, we consider the ‘representative’ unit; that is, a unit whose behavior, expect for its atomistic scale, is identical to the behavior of the aggregate of such units. The representative unit is essentially an average unit. Consequently, we are able to move freely between the individual and aggregate, and we use the same notation to represent both” (1976: p. 9).
9 “representative units” (1976: p. 9): a firm, a household, and a government.10 These three economic units were supposed to interact through two markets. The labor market, where labor services were exchanged against money, and the market for goods, where consumable commodities and public services were exchanged against money. Within this framework, government provided public services by collecting taxes and/or supplying money balances; the firm demanded labor and supplied commodities in view of maximizing profits; and the household aimed to maximize an intertemporal utility function by choosing the quantity of goods to demand, the quantity of labor to supply (until they retired), and the quantity of real balances to transfer from one period to another.11
Moreover, economic units acted in a competitive environment. Barro and Grossman assumed that on each market, an “agent” set the price and provided economic units with information about their level of constraint on sales or purchases (1976: p. 31 and p. 95). On the basis of these information, firms and/or households revised their plans and expressed either an effective supply or an effective demand in the other market (dual-decision hypothesis).
2.2 A Walrasian-type technology of exchange
The technology of exchange adopted by Barro and Grossman (1976) was reminiscent of Patinkin ([1956] 1965) and Clower’s (1965). In Chapter XIII, Patinkin drew an analogy between the dynamic adjustment process occurring “when the level of real income [was] held constant during the tâtonnement [and] when the level of income (and hence employment) [was] permitted to vary” ([1956] 1965: p. 328). This suggested that the Walrasian technology of exchange used in the microeconomic part of his book could be adapted to his disequilibrium macroeconomics. But Patinkin did not specify how.12 By contrast, Clower (1965) rationalized the process of exchange in a non-tâtonnement context. On the one hand, a “central market authority” checked the validity of purchase orders and, in turn, determined the level of actual transactions (1965: p. 51). Specifically, in situation of involuntary unemployment, workers’ purchase orders were “cancelled unless [they had] a positive balance of ‘book credit’ to cover the entire value of the purchase order” (1965: p. 51). Hence why workers expressed an “effective” demand for goods instead of a “notional” demand for goods. The determination of output followed – “actual transactions [being] dominated by the “short-side” of the market”
10 Barro and Grossman treated government behavior as exogenous (1976: p. 17). 11 Once retired, households were supposed to consume until their death, by using their saving. 12 For a detailed discussion on Patinkin’s technology of exchange (the Hicksian week) and whether it was compatible with his disequilibrium macroeconomics, see Michel de Vroey (2002).
10 (1965: p. 44). On the other hand, the “central market authority” facilitated transactions by debiting and crediting individuals’ accounts (1965: p. 51). Likewise, Barro and Grossman’s market “agents” ensured the compatibility between individuals’ plans and realized transactions. Barro and Grossman were only more precise about the timing of their operations. Both the determination and the realization of transactions occurred at once. Market “agents” received information about what individuals would like to buy and sell given market prices and their rationing on markets. Simultaneously, market “agents” set output and employment levels according to the principle of “voluntary exchange” – i.e., “actual total transactions of any good will equal the smaller of the quantities supplied and demanded” (1976: p. 40). At the same time, market “agents” ensured the realization of transactions – since the representative firm was not supposed to hold money, receipts and disbursements had to be perfectly synchronized (1976: p. 10). As a result, Barro and Grossman’s “market agents” acted as the Walrasian auctioneer and as the Walrasian clearing house.
2.3 Adjustment rules
Either in Patinkin ([1956] 1965), Clower (1965) or Barro and Grossman’s (1976) disequilibrium model, market prices responded to effective excess demands. Evidence of this can be found in Chapter XIII, even if Patinkin ([1956] 1965) did not formalize a constrained demand for labor. Patinkin explained that wages declined because of the excess supply generated by firms’ decision to revise their demand for labor downward ([1956] 1965: p. 321). The same principle underlined the dynamic model sketched by Clower in the last pages of the “Counter-Revolution” article. He assumed that market prices varied according to effective excess demands (1965: p. 54). An assumption made clearly by Barro and Grossman. This resulted in the following formalization:
= � � − � [1] and = � � + � − � [2], where �
and � [are] positive constants. Relations [(1) and (2)] specify that whenever an effective supply or demand does not coincide with the corresponding notional supply or demand, the effective supply or demand is the relevant magnitude influencing the speed of wage or price adjustment (1976: p. 95).
After transactions occurred, Barro and Grossman’s market “agents” observed effective excess demands and varied market prices accordingly (1976: p. 95). For instance, they increased wages (�) and prices (�) when the effective demand was higher than the effective supply in the labor
11 market and in the market for goods. Otherwise, they decreased � and �. Such variations occurred in between periods where “fixed-price” equilibria were determined. Accordingly, the dynamic of the economy was represented as a sequence of “fixed-price” equilibria.
To conclude, Barro and Grossman’s disequilibrium macroeconomics not only built on the foundations laid down by Patinkin ([1956] 1965) and Clower’s (1965) analyses of involuntary unemployment. It also built on Patinkin ([1956] 1965) and Clower’s (1965) approach to disequilibrium economics. Considering disequilibrium as a dynamic phenomenon, Barro and Grossman sought to elaborate a theory of adjustment processes. Its full version was presented in Money, Employment, and Inflation (1976). Following in Patinkin ([1956] 1965) and Clower’s (1965) footsteps, Barro and Grossman (1976) focused on the behavior of representative economic units, in a competitive environment; they devised a Walrasian-type technology of exchange; and they replaced “notional” excess demands by effective excess demands in the price adjustment mechanism. Next section discusses the dynamic properties of their disequilibrium model.
3. Dynamic properties
Just like Patinkin ([1956] 1965) and Clower (1965), Barro and Grossman (1976) were concerned with the stability of full-employment equilibrium and the significance of monetary exchange in the transmission of disequilibria. They showed that Walrasian equilibrium was stable and that quantity adjustments were larger in monetary economies. At the same time, Barro and Grossman (1976) enlarged the investigations. From a theoretical perspective, they discussed how rapidly worked monetary policy. From a more empirical perspective, they addressed the relation between real wage and employment variations, and the relation between wage inflation and unemployment rate. That knowledge-building process results in a rich and accurate picture of the explanatory power of Patinkin ([1956] 1965) and Clower (1965)-type macroeconomics.
3.1 Stability of the full-employment equilibrium
Both Patinkin ([1956] 1965) and Clower (1965) considered that “the central question [was] the efficiency of an automatically functioning market system with flexible money wages in eliminating involuntary unemployment” ([1956] 1965: p. 315). The challenge for them was to provide a formal analysis of the adjustment process. Such an ambition appears in the correspondence that Patinkin and Clower had respectively with Nissan Liviatan and Donald
12 Bushaw.13 In this context, Patinkin and Clower expressed frustration with their inability to offer a formal stability study:
When I tried to [present spillover effects] in a mathematical way, I went through the same problem, and that is why there is no mathematical appendix to that chapter [XIII]!14
My problem is naturally mathematical in character. Consider a price system […] in which the demand and supply functions depend not only on prices, but on quantity actually exchanged, this being defined as quantity demanded if there is excess supply in any market, as quantity supplied if there is excess demand (the short side of the market governs it) […] I emphasize that this could be a really significant breakthrough in economics if you can say something definite; otherwise, I shall just be left to my own literary devices to figure out what one can say about this.15
Like most economists, Patinkin and Clower advocated for formal analyses to facilitate the study and exposition of economic problems. In particular, formalization would have allowed to offer an accurate picture of the relationship between individuals’ behavior and market dynamics. This would have resulted in the clarification of the logical properties of their disequilibrium models. Notably whether price and quantity adjustments were stabilizing when considering spillover effects. Given that neither Patinkin ([1956] 1965) nor Clower (1965) provided a formal stability analysis, the issue of how individuals behaved during the adjustment process remained opened. Just like whether the market system was self-regulating or not.16
13 Liviatan was a former student of Patinkin. He was the only economist with whom Patinkin discussed the disequilibrium model presented in Chapter XIII, before the first edition of Money, Interest, and Prices (1956) was published (Mauro Boianovsky, 2006); Bushaw was a mathematician colleague of Clower at Washington State University. At various stage of Clower’s career, Bushaw helped him to formalize his views. See Plassard (2018b) for an historical investigation on Bushaw and Clower’s ‘stock-flow’ program of microfoundations. 14 Letter from Patinkin to Liviatan (29 January 1955) – Don Patinkin Papers, Rubenstein Rare Book and Manuscript Library. Boianovsky quoted it while tracing “The Making of Chapter 13 and 14 of Patinkin’s Money, Interest, and Prices” (2006: p. 237). For a detailed exposition of the difficulties experienced by Patinkin in the process of elaborating his theory of unemployment, see Boianovsky (2006). 15 Letter from Clower to Bushaw. R.W. Clower Papers, Rubenstein Rare Book and Manuscript Library. This letter is undated. Yet it sounds like a report on a discovery: the dual-decision hypothesis. For a discussion of the difficulties experienced by Clower when trying to study the stability properties of his 1965 disequilibrium model, see Plassard (2016, chapter IV). 16 While Patinkin considered that the real-balance effect ensured the stability of the full-employment equilibrium ([1956] 1965: pp. 324-328), Clower was less clear-cut (1965: p. 55). This was because he had identified a scenario of persistent involuntary unemployment (1965: pp. 54-55).
13 By contrast, Barro and Grossman (1976) provided a formal stability analysis. By doing so, they clarified how behaved individuals during the adjustment process and showed that:
Changes in l and y [the levels of employment and production], as well as in W and P [reestablished] general-market-clearing conditions (1976: p. 97).
To demonstrate that Walrasian equilibrium was stable, Barro and Grossman considered a situation of general excess demand (1976: pp. 97-100). Let us account for the stabilization process, starting from a general excess supply case. To this end, I need to identify how vary from one “fixed-price” equilibrium to another. Without specifying the relative speed at which W and P fall, the variation of the real wage is ambiguous. What Barro and Grossman did was to determine subregions (within the space created by the effective market-clearing loci) where increased or decreased (1976: p. 96). This depended on whether the effective excess supply for goods was greater than the effective excess supply for labor (1976: p. 96) – according to (1) and (2), the more the discrepancy between effective demand and supply is large, the more W and P vary rapidly (and conversely).17 Assume that after a shock, the economy situates in a subregion where real wage declines. Since the labor cost is reduced, firms will hire. At the same time, the supply of labor declines. Both because households are lower paid and because their nonwage wealth increases (under the real-balance effect and of rising profits). As a result, price change tends to reduce the gap between demand and supply in the labor market. In the process, the rate of decrease of P declines, which progressively leads the real wage to rise. Under these circumstances, consumption raises while the supply of goods tends to fall. Consequently, output also converges towards its market-clearing level, associated to general-equilibrium values of W, P, and .
3.2 Monetary structure of exchange
When sketching their models, Patinkin ([1956] 1965) and Clower (1965) considered that money constrained rather than facilitated transactions during economic depressions. Such
17 Barro and Grossman indicated that the stability of Walrasian equilibrium was not affected by their “arbitrary” identification of subregions where increased or declined: “had we assumed the dashed line to be upward sloping, W would have initially risen proportionately faster than P, so that would have initially risen, before falling back to ( )∗” (1976: p. 98).
14 an intuition underlined Patinkin’s explanation of how an excess supply in the market for goods was transmitted to the labor market:
When firms planned the inputs of labor described by the [standard] demand curve, they assumed that they would be able to pay for these inputs with the sales proceeds of the resulting outputs. Therefore, when these sales fail to materialize, firms find themselves with their funds tied up in illiquid inventories and hence financially unable to carry out their original plans. Accordingly, […] they now demand a smaller input ([1956] 1965: p. 320)
Firms failed to receive the proceeds they had planned because of the excess supply in the market for goods. Without sufficient access to cash, they could not pay their wage bill. Hence why they revised their production plans and, in turn, generated involuntary unemployment. Inspired by chapter XIII when writing the “Counter-Revolution” article, Clower put efforts towards the elaboration of a disequilibrium model where individuals would behave under cash constraints (Plassard, 2017). Its microfoundations combined the dual-decision hypothesis with the dichotomized budget constraint, presented in “A Reconsideration of the Microfoundations of Monetary Theory” (1967). Due to the dichotomization of “income” and “expenditure” branches, individuals would be forced to get cash to consume and to receive cash in return for their sales. Accordingly, they had to revise their purchasing plans downward when unable to earn a monetary income. That was why the monetary structure of exchange caused disequilibria to spread.
To confirm the existence of this causal link, it must be shown that the effects of disequilibrium transactions would be different if barter exchange were admitted.18 Patinkin ([1956] 1965) and Clower (1965) did not. Neither did Barro and Grossman (1976). However, Grossman provided such a comparative analysis in his “Comment” (1974) of Leijonhufvud’s article “Effective Demand Failure” (1973). Using the disequilibrium model elaborated with Barro, Grossman showed that:
18 Many disequilibrium theorists worked toward resolving this theoretical problem. Let me mention Jean-Pascal Bénassy, Jean-Michel Grandmont, Axel Leijonhufvud, Guy Laroque, or Yves Younes. For a more exhaustive list, see Allan Drazen’s (1980) survey on disequilibrium macroeconomics.
15 The multiplier effects associated with a non-general-market-clearing combination of wages and prices depend on the monetized structure of exchange (1974: p. 365)
Grossman considered a situation of general excess supply and discussed employment and output variations. First when money served as a medium of exchange, and then when the consumption good played this role. In the first case, cash constraints forced firms and households to curtail their demand for labor and commodities. As a result, the effective demand for labor and commodities determined respectively employment and output levels (1974: p. 365). In the second case, the excess supply in the market for goods no longer forced firms to adjust their demand for labor downward. This was because firms could pay their wage bill and distributed profits in the form of commodities (1974: p. 364). Under these circumstances, the notional demand for labor services and the notional supply of commodities determined employment and output levels (1974: p. 365). This resulted in a contraction of unemployment. But of less magnitude than when money was used as the medium of exchange. Hence why multiplier effects depended on the monetary structure of exchange.
This demonstration concludes the first phase of knowledge-building on disequilibrium models à la Patinkin ([1956] 1965) and Clower (1965). Let me now turn to the second phase. Barro and Grossman’s analyses continue to be used to clarify the properties of Patinkin ([1956] 1965) and Clower (1965)-type macroeconomics. However, the analytical distance between frameworks may increase. Moreover, emphasis is given to issues that were not discussed in Money, Interest, and Prices or in the “Counter-Revolution” article. Barro and Grossman’s (1976) analysis of how rapidly worked monetary policy is a case in point.
3.3 Monetary policy speed
In its basic form, Barro and Grossman’s (1976) model was not appropriate for analyzing the effects of monetary policy. Change in the money supply could take place. But in the absence of assets other than money, its influence on the rate of interest was not taken into account. Thus, one of the main channels through which monetary policy was supposed to affect economic activity was not modelled. To fill this gap, Barro and Grossman (1976) incorporated a financial market into their framework.19 By assumption, economic units exchanged equity shares and treasury bonds against money. The supply of equity shares came from firms; the supply of
19 See chapter 3 “Capital, financial assets, and the rate of return” (1976: pp. 101-153) for a full account of the change introduced by Barro and Grossman.
16 treasury bonds came from the government; and the demand for these two assets resulted from households’ portfolio choice.20 Since there was no uncertainty about their rates of return, households considered equity shares and treasury bonds as perfect substitutes (1976: p. 103). Accordingly, the disequilibrium model included one more exchange ratio, the rate of interest (�), also determined according to the principle of “voluntary” exchange.
On that basis, Barro and Grossman offered a comparative-statics analysis to demonstrate the efficiency of monetary policy (1976: pp. 151-153). Moreover, they “analyze[d] the exact form of the time path of � and � implied by the behavior of � [quantity of money]” (1976: p. 214). What was at stake was whether monetary policy worked slowly, an issue explored by taking into account “various structural lags”. For instance, Barro and Grossman assumed gradual adjustments of money balances (1976: pp. 211-217), of the demand for goods (1976: pp. 217-223), and a gradual clearing of the financial market (1976: pp. 230-237).
They showed that “the existence of structural lags [did] not necessarily imply a lag in the response of � to change in �” (1976: p. 221). In other words, monetary policy could have instantaneous effects on economic activity while some components of aggregate demand reacted slowly to stimuli.21 To explain why, let me focus on one of the cases studied in chapter 6 of Money, Employment and Inflation, “The dynamics of aggregate demand”. By assumption, the economy was in a situation of general excess supply. Accordingly, output and employment levels were determined by the effective demands in the respective markets. Then, throughout the analysis, p remained fixed, and r ensured effective clearing of the financial market (1976: p. 211). Therefore, Barro and Grossman considered only quantity adjustments in the market for goods, and the time path of r was somehow pre-determined. Lastly, Barro and Grossman assumed that households adjusted gradually their money balances and their demand for goods according to target levels (1976: p. 220). Under these circumstances, they claimed that:
the gradual adjustment of money balances causes a more exaggerated response of � to changes in �, which in turn tends to produce a more exaggerated movement in �. At the same time, the gradual adjustment of effective
20 To “rationalize the holding of money and the diversification of wealth between money and earning assets”, Barro and Grossman introduced transactions costs into the analysis (1976: p. 104). Households had to pay a financial service when buying assets. Thus, they would seek to minimize the number of financial transactions. Hence the accumulation of saving in the form of money and assets. 21 Barro and Grossman (1976) acknowledged that Tucker had already obtained this result in two articles: “Dynamic Income Adjustment to Money Supply Change” (1966) and “Credit Rationing, Interest Lags, and Monetary Policy Speed” (1968). See Money, Employment and Inflation (1976: p. 220; p. 232)
17 commodity demand tends to dampen the response of � to any change in �. The net result can be either a greater or lesser response of � to � in the short-run than in the long-run (1976: p. 221).
Due to the gradual adjustment of money balances, an immediate change in the target level of money balances was the condition for individuals to demand the new money put into circulation (1976: p. 215). Such a change would take place if individuals had an incentive to sell assets against money. And the incentive needed to be strong, because of the cost of financial transactions. Hence the “exaggerated” decrease in the rate of interest. From there, aggregate demand and production increased mechanically – according to the principle of “voluntary exchange”, the representative firm kept � equal to � . Accordingly, monetary policy had immediate effects on economic activity. Barro and Grossman only indicated that the magnitude of the rise in production depended on how rapidly households adjusted their demand for goods to the new target level of effective commodity demand.
3.4 Empirical content
Until now, no attention was paid to the empirical content of Barro and Grossman’s disequilibrium model. However, Barro and Grossman were concerned with its capacity to fit the data. They focused on two empirical issues. The relation between real wage and employment variations, and the relation between wage inflation and unemployment rates.
Real wages and employment fluctuations
When addressing the relation between real wages and employment fluctuations, Barro and Grossman referred to two empirical studies. Edwin Kuh’s, in “Unemployment, Production Functions and Effective Demand” (1966), and Ronald Bodkin’s in “Real Wages and Cyclical Variations in Employment: A Re-Examination of the Evidence” (1969).22 In both articles, Kuh and Bodkin reopened the debate over whether real-wages were positively or negatively related to the rate of unemployment. They obtained two results. First, no strong statistical evidence supported the view that employment increased when real-wages decreased. Second, some of the cases studied (e.g., USA during the post-second World War period) showed that real-wages were related negatively and significantly to the rate of unemployment.
22 For an explicit reference to Kuh (1966) and Bodkin (1969), see “A General Disequilibrium Model of Income and Employment” (1971: p. 83). See also Money, Employment, and Inflation (1976: p. 2).
18 Already in the 1971 article, Barro and Grossman highlighted the gap between these two results and the assumptions underlying the “conventional” theory of the firm. In standard models, entrepreneurs’ demand for labor was inversely and uniquely related to the real-wage. Accordingly, “cyclical variations in the quantity of labor demanded and the amount of employment must imply countercyclical variations in real wage rates” (1971: p. 82). By contrast, Barro and Grossman’s model of the labor market could replicate the positive relation between real-wage and employment variations:
To the extent that real wages decline in response to this excess supply, a fall in
real wages toward � will accompany (follow upon) the decline in employment. If, at point � or at some intermediate point between � and �, some action is taken to restore effective commodity demand, excess demand for labor (or at least reduced excess supply) will result. In that case, a rising real wage may accompany the recovery of output an employment. Thus, disequilibrium analysis of the labor market suggests that real wages move procyclically (1971: p. 87).
Here was the scenario considered by Barro and Grossman (1971). Initially, a decline in commodity demand forced entrepreneurs to revise their demand for labor downward. This resulted in a situation of involuntary unemployment. Given the excess supply in the labor market, real-wages declined. Just before real-wages reached the level which cleared the labor market, the government implemented a fiscal policy. The resulting increase in aggregate demand led entrepreneurs to hire more. Given the low level of real-wages, entrepreneurs might be constrained in the labor market. Barro and Grossman concluded that a rise in real-wages followed upon a rise in employment, and vice versa.
Wage Inflation and unemployment rate
When addressing the relation between wage inflation and unemployment rate, Barro and Grossman (1976) considered one empirical study. Alban William Phillips’, in “The relationship between unemployment and the rate of change of money wage rates in the United Kingdom, 1862-1957” (1958). According to Barro and Grossman, Phillips established two empirical regularities which characterized the experience of most developed countries until the end of the 1950s. First, on average, the higher the unemployment rate the lower the rate of wage inflation. Conversely, the lower the unemployment rate the higher the rate of wage inflation. Moreover, the unemployment rate was positive when the rate of inflation was zero. Second, when wage inflation started increasing, unemployment rate increased over a short period of
19 time and eventually decreased. Conversely, when wage inflation started decreasing, unemployment rate decreased over a period of time and eventually increased. This resulted in what Barro and Grossman described as a “counterclockwise cycle” around the average relation between unemployment and wage inflation (1976: p. 201). On top of these two empirical regularities, Barro and Grossman observed the phenomenon of “stagflation” (1976: p. 206). It was related to a change in the cyclical pattern of unemployment and wage inflation. While analyzing data from the U.S. Bureau of Labor Statistics (1973), Barro and Grossman realized that when wage inflation accelerated, unemployment could decrease for a short period of time. Conversely, when wages started decreasing, unemployment could increase for a short-period of time. But eventually, an acceleration of the wage inflation led to a rise in the unemployment rate, and vice versa. This resulted in a “clockwise cycle” around the average relation between unemployment and wage inflation (1976: p. 201).
In Chapter 5 of Money, Employment, and Inflation (1976), Barro and Grossman showed that their disequilibrium model could account for these three empirical observations. The condition was to make some change to its basic version:
Section 5.2 developed a basic model of the average inverse relation between � 1 �� 1 �� and ( �)( ��). Equation (5.2), � �� = � �, and equation (5.9), � = �(�), summarized this model. Section 5.4 introduced partial adjustment into the relation between � and �. This modification generated
� equation (5.16), = � [�(�) − �], as a generalization of (5.9). With � less � than infinite, the model, summarized by equations (5.2) and (5.16), predicted a counterclockwise cyclical pattern. Section 5.5 introduced adaptive expectations 1 �� into the relation between ( �)( ��) and �. This modification generated ( ) equation (5.21), = � (� � + ), as a generalization of equation
(5.2). With � greater than zero, the model summarized by equations (5.9) and (5.21), predicted a clockwise cyclical pattern (1976: p. 209).
Barro and Grossman’s analysis started with the wage adjustment relation (1976: p. 189). Wages were supposed to vary according to the effective excess demand for labor (�). They increased when the effective excess demand for labor increased, and vice versa. Equivalently, wages decreased when the effective excess supply of labor increased, and conversely. This resulted in
20 an inverse relation between wage variations and unemployment. However, its features “[were] counter to empirical evidence” (1971: p. 192). Zero wage inflation was associated to zero unemployment. Moreover, there was an inverse relation between wage variations and unemployment only when wages declined (1971: p. 192). Hence the need to change the basic framework. Barro and Grossman made three modifications. They introduced heterogeneity into labor services, considered that the unemployment rate reacted with a lag to change in �, and introduced expectations into the wage adjustment relation. The first modification allowed to generate Phillip’s average relation between unemployment and wage inflation. Coupled with the gradual adjustment of the unemployment rate, the model also generated Phillips’ second empirical regularity. Lastly, a disequilibrium model involving heterogeneous labor services and inflationary expectations could portray “clockwise cycle” around the average relation between unemployment and wage inflation.
To conclude, while studying the dynamic properties of their disequilibrium model, Barro and Grossman (1976) showed how rich the research line opened in Chapter XIII and in the “Counter-Revolution” (1965) article was. Both from a theoretical and a more empirical perspective. That said, Barro and Grossman also identified the flaws of their disequilibrium model (1976: pp. 4-6). Next section questions its capacity to explain satisfactorily the dynamic of actual economies.
4. Flaws
Patinkin ([1956] 1965), Clower (1965), and Barro & Grossman’s (1976) approach to disequilibrium dynamics was deficient. First, their adjustment rule reflected no one’s optimizing behavior. Second, the process of exchange was centralized. Third, the intertemporal dimension was either ignored or insignificant. These flaws called into question the capacity of their models to portray the dynamic of actual economies. To explain why, emphasis is given to arguments formulated by Barro and Grossman (1976), by Howitt (1977) in his review of Money, Employment, and Inflation, or by Clower and Leijonhufvud.
4.1 Ad hoc adjustment process
Unlike effective supply and demand functions, the law of supply and demand was not deduced from agents’ optimizing behavior. Barro and Grossman made this point in the introduction of Money, Employment, and Inflation:
21 Although the discussion stresses the implication of exchange at wages and prices which are not consistent with general market clearing, we provide no choice- theoretic analysis of the market-clearing process itself. In other words, we do not analyze the adjustment of wages and prices as part of the maximizing behavior of firms and households. Consequently, we do not really explain the failure of markets to clear, and our analyses of wage and price dynamics are based on ad hoc adjustment equations (1976: p. 6).
The law of supply and demand was an adjustment rule fixed exogenously. This posed two “embarrassing” problems (1976: p. 6). On the one hand, no rational argument justified why market prices varied slowly. Accordingly, Barro and Grossman’s project to provide microfoundations to macroeconomics remained incomplete. On the other hand, the results of their dynamic analyses had to be read with care. This was because they depended on an “ad hoc” specification of the dynamic process. This caution was all the more important since effective excess demands may not reflect properly individuals’ behavior. Howitt (1977) made this point in his review of Money, Employment, and Inflation. He argued that “under conditions of excess supply in the labor market, [Barro and Grossman] assumed that the effective supply of labor [was] the same as if at the same real wage there were excess demand for labor, which [amounted] to a highly implausible independence of labor force participation rates from unemployment rates” (1977: p. 125). As a result, “it was not clear that prices ought to respond to the effective excess demands that the authors [defined]” (1977: p. 124).
4.2 Unrealistic process of exchange
The need to provide realistic microfoundations to macroeconomics prompted Barro and Grossman’s research program. As a reminder, Grossman (1968) observed that in the real-world, prices varied slowly and individuals not always succeeded in selling or buying what they desired given exchange ratios (p. 5). Hence the need to depart from the perfect price flexibility assumption underlying tâtonnement economics. Instead, Barro and Grossman assumed perfect quantity flexibility. As a result, their disequilibrium model was based on an unrealistic technology of exchange:
As we have formulated the analysis, the convergence to output and employment levels � and � would be instantaneous. [This] assumes a simultaneous determination of the actual transactions carried out in both markets by each economic unit and of the effective demands of each economic unit in both
22 markets. Realistically however, households would not obtain information about actual transactions in the labor market until the firms had expressed their demands, while the firms would not obtain information about actual transactions in the commodity market until the household had expressed their demands. Furthermore, the profit income of households would not be determined until both � and � were determined. The actual effective demands which determine output and employment according to the [principle of voluntary exchange] could only emerge in practice from a recursive interaction (1976: p. 58).
In reality, individuals made decisions and then transactions occurred. Due to this sequence, individuals would start formulating their plans with a minimum level of information about their constraints on markets. Several sequences would be necessary before firms and households identified the levels of output and employment which ensured the consistency of their plans – i.e., a balance budget equal to zero for all individuals. Barro and Grossman concluded that “in practice”, a “fixed-price” equilibrium could emerge only after a “recursive” process. Yet, they did not model it. Instead, Barro and Grossman (1976) assumed perfect quantity flexibility. This reduced the “recursive” process into an instantaneous interaction and so, ruled out any exchange which did not ensure the coordination of individuals’ plans. Consequently, their sequence of “fixed-price” equilibria offered a distorted picture of market dynamics.
Neither Patinkin ([1956] 1965) nor Clower (1965a) assumed perfect quantity flexibility. But just like Barro and Grossman (1976), they sought to analyze how actual economies behaved in models minimizing change to Walras’ technology of exchange. The question is whether it was a relevant research strategy. In the mid-1970s, Clower and Leijonhufvud realized that it was not:
We don’t as yet have an acceptable paradigm for analyzing price-quantity behavior in decentralized markets. Most of the work that has been done thus far on disequilibrium trading behavior starts with a Walrasian auctioneer who merely adds to his traditional price-adjustment jobs the additional task of conveying current information to transactors about their sales and purchases at current (not necessarily market-clearing) prices […] My own attempt to provide some kind of general foundation for disequilibrium analysis started within the Walrasian framework and got me nowhere. Grossman and others (Tucker at C.E.A, Crouch at Santa Barbara, and Frevert at Kansas) have tried to make
23 something of this beginning – the dual-decision hypothesis – but I am not impressed by that work. All of this seems to me to attempt to squeeze into a Walrasian paradigm phenomena that don’t belong there.23
Now, at long last, I know it in my bones – and realize that my defense to date of having taken a Walrasian price-theory approach in my [1968] book won’t do. It’s a good reason up to a point, but necessarily leaves damaging blind spots (which become traps for the unwary – Grossman et al.).24
Clower and Leijonhufvud came to conclude that whatever the change made to the Walrasian framework (e.g., rejection of the tâtonnement hypothesis and introduction of income constraints), the resulting model would remain inappropriate for analyzing actual economies. This was because Walrasian-type macroeconomics portrayed centralized economies, not decentralized economies. Barro and Grossman’s (1976) disequilibrium model was a case in point. For instance, Barro and Grossman (1976) ruled out the information problems that occurred in decentralized systems. In their model, individuals did not have to make decision with few information about the constraints they will face on markets. Market “agents” provided individuals information about prices and their levels of rationing. Besides, Barro and Grossman considered that market “agents” ensured at no cost and without delay the coordination of economic activities. A role that no institution (either banks or traders) performs in actual economies.
4.3 Inter-temporality without uncertainty
When discussing the dynamic of involuntary unemployment, Patinkin ([1956] 1965) and Clower (1965) abstracted from intertemporal choice. In their models, individuals made decision without looking beyond their current economic situations. They were not supposed to expect future market prices, future quantity constraints, or the change in key variables such as the stock of capital. This resulted in a deficient analysis of market dynamics. Notably because Patinkin and Clower considered that disequilibrium situations could last long, as was the case during the Great Depression.
23 Letter from Clower to Bernt Stigum (06/29/1970). R.W. Clower Papers, Box 1, Rubenstein Rare Book and Manuscript Library. 24 Letter from Leijonhufvud to Clower (07/10/1973). Axel Leijonhufvud Papers, Box 1, Rubenstein Rare Book and Manuscript Library.
24 In contrast to Patinkin ([1956] 1965) and Clower (1965), Barro and Grossman (1976) introduced intertemporal choice into their disequilibrium analysis. They assumed that individuals expected market prices and their levels of rationing. To be more specific, Barro and Grossman (1976) separated the planning horizon of economic units into a constrained and an unconstrained sub-period. Moreover, they assumed that firms and households expected market prices to be fixed over time. Accordingly, Barro and Grossman did not consider any probabilistic distribution on the evolution of market prices and of quantity constraints. Rather, expectations “were held with certainty” in their disequilibrium model (1976: p. 4).
Despite addressing expectations, Barro and Grossman did not refer to intertemporal choice when analyzing the stability properties of their disequilibrium model. This suggests that their approach to intertemporal choice was inappropriate for analyzing the dynamic of markets. At least one problem can be stressed. Barro and Grossman (1976) abstracted from uncertainty and so, did not take into account the effects of speculation. In their disequilibrium model, individuals did not bother about future price variations or about their capacity to buy or sell at a reasonable price. Hence doubts about its capacity to portray the dynamic of actual economies.
Conclusion
My paper aimed to show that Barro and Grossman developed a dynamic disequilibrium program of microfoundations. Given their role in the emergence of “fixed-price” equilibrium macroeconomics, this raised three difficulties: to prove that they had a dynamic approach to disequilibrium economics; to determine how they modeled the dynamic of non-clearing markets; and to discuss the scope of their model. Two documents were central to the resolution of these difficulties. “Market Disequilibrium in a Macro-Economic Context” (1968), and Money, Employment, and Inflation (1976).
Just like Patinkin ([1956] 1965) and Clower (1965) or Hahn and Negishi (1962), Barro and Grossman considered that disequilibrium phenomena occurred during the market-clearing process. Thus, the challenge was to model the operation of economic activities throughout the adjustment of markets. At first, a synthesis between Patinkin, Clower, and Hahn and Negishi’s models was considered. But eventually, Barro and Grossman elaborated a model à la Patinkin ([1956] 1965) and Clower (1965). They considered the behavior of aggregates, in a competitive environment; they assumed that market “agents” performed the coordination of individuals’ plans and synchronized transactions; and they substituted “effective” excess demands for
25 “notional” excess demands in the price adjustment mechanism. On that basis, Barro and Grossman addressed theoretical and more empirical issues. They showed that Walrasian equilibrium was stable, that multiplier effects depended on the monetary structure of exchange, and that monetary policy had instantaneous effects on economic activity. On the more empirical side, Barro and Grossman replicated a negative relationship between the real-wage and the rate of unemployment. Besides, they replicated Phillips’ statistical regularities and stagflation. All this showed how rich the modeling strategy initiated by Patinkin ([1956] 1965) and Clower (1965) was. Yet at the same time, Barro and Grossman also identified the flaws of their model. They stressed that the adjustment rule was not based on microfoundations. This forced to read their results with care and to admit that their microfoundational program was incomplete. Then, Barro and Grossman pointed out that their technology of exchange model was too centralized to be realistic. An argument formulated by Clower and Leijonhufvud to explain why Walrasian- type macroeconomics could not explain how actual economies behaved. Lastly, intertemporal choice was either ignored or unimportant in Patinkin ([1956] 1965), Clower (1965), and Barro and Grossman’s (1976) models. This led to put aside salient features of actual economies. Notably the effects of speculation. Hence another reason why their approach to disequilibrium dynamics remained unsatisfactory.
During the 1970s, several “fixed-price” theorists intended to fill these gaps. In his doctoral dissertation, Disequilibrium Theory, Bénassy (1973) argued that “the traditional assumption of prices moving in response to excess demand [was] not very satisfying”. Therefore, he planned to “study more realistic models where firms [would] control the price of some markets” (1973: abstract). This resulted in a dynamic disequilibrium model where the exchange process was decentralized and the price adjustment mechanism reflected firms’ optimizing behavior. It was developed in “Regulation of the Wage-Profit Conflict and the Unemployment-Inflation Dilemma in a Dynamic Disequilibrium Model” (1976) and in “Cost and Demand Inflation Revisited: A Neo-Keynesian Approach” (1978). Other “fixed-price” theorists addressed intertemporal choice without neglecting uncertainty, in dynamic models. For instance, John Muellbauer and Richard Portes (1978), Volker Bohm (1980), or Pierre Dehez (1980) formalized firms’ decision to accumulate or reduce stocks of goods, depending on their expectations about future demand constraints. Besides, Edmond Malinvaud (1980) focused on how firms determined their productive capacity in the future, depending on expected demand. All this indicates that like Barro and Grossman, most “fixed-price” theorists neither
26 abandoned nor marginalized Patinkin ([1956] 1965) and Clower’s (1965) dynamic disequilibrium program of microfoundations.
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