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From Disequilibrium to Equilibrium Macroeconomics: Barro and Grossman’S Trade-Off Between Rigor and Realism

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From Disequilibrium to Equilibrium Macroeconomics: Barro and Grossman’S Trade-Off Between Rigor and Realism FROM DISEQUILIBRIUM TO EQUILIBRIUM MACROECONOMICS: BARRO AND GROSSMAN’S TRADe-OFF BETWEEN RIGOR AND REALISM Documents de travail GREDEG GREDEG Working Papers Series Romain Plassard GREDEG WP No. 2019-17 https://ideas.repec.org/s/gre/wpaper.html Les opinions exprimées dans la série des Documents de travail GREDEG sont celles des auteurs et ne reflèlent pas nécessairement celles de l’institution. Les documents n’ont pas été soumis à un rapport formel et sont donc inclus dans cette série pour obtenir des commentaires et encourager la discussion. Les droits sur les documents appartiennent aux auteurs. The views expressed in the GREDEG Working Paper Series are those of the author(s) and do not necessarily reflect those of the institution. The Working Papers have not undergone formal review and approval. Such papers are included in this series to elicit feedback and to encourage debate. Copyright belongs to the author(s). From Disequilibrium to Equilibrium Macroeconomics: Barro 1 and Grossman’s Trade-off between Rigor and Realism Romain Plassard GREDEG Working Paper No. 2019-17 Abstract During the 1970s, Keynesian macroeconomics was challenged by the New Classical Economics of Robert Lucas. This involved a battle between disequilibrium and equilibrium macroeconomics. My article contributes to explain why the equilibrium approach came to dominate. My case study is Robert Barro and Herschel Grossman. In 1971, Barro and Grossman elaborated the basic disequilibrium model. In 1976, they wrote the first book on disequilibrium macroeconomics – i.e., Money, Employment, and Inflation. However, at the end of the 1970s, they came to advocate for equilibrium models à la Lucas (1972, 1975). My article traces how and why. JEL Codes: B21, B22, B23, E1, E3. Keywords: business cycle, non-neutrality of money, disequilibrium macroeconomics, equilibrium macroeconomics. 1 Université Côte d’Azur, CNRS, GREDEG, France. Correspondence may be addressed to Romain Plassard, Groupe de Recherche en Droit, Économie et Gestion, Université Côte d’Azur, 250 rue Albert Einstein, CS 10269, 06905 Sophia Antipolis Cedex, France; e-mail : [email protected]. I would like to thank Paul Dudenhefer, Kevin Hoover, and Roy Weintraub for their comments on earlier drafts of this essay. I am also indebted to the participants of the HOPE seminar of Duke University, to the participants of the 2018 Summer Institute on the History of Economics, and to the participants of the nHice workshop. My final thanks go to the staff of the John Hay Library (Brown University) for their help with the Herschel I. Grossman Papers. 1 1. The reasons to jump on Lucas’s bandwagon The 1970s marked a period of profound change in macroeconomics. After long years of domination, Keynesian macroeconomics was challenged by the New Classical Economics of Robert Lucas (1972, 1975). This involved a battle between two modelling strategies. On one side, macroeconomists considered that market prices varied too slowly to ensure a continuous equilibrium on markets. This led them to model how individuals and markets behaved, under rationing constraints. New classical economists, on the other side, assumed that price variations occurred instantaneously and ensured equilibrium on markets. This led them to model how economies behaved when individuals realized their optimization plans. My article contributes to explain why the equilibrium approach came to dominate the field. My case study is Robert Barro and Herschel I. Grossman. Until the mid-1970s, Barro and Grossman contributed to the development of disequilibrium macroeconomics. In 1971, they elaborated the basic disequilibrium model. In 1976, they wrote the first book on disequilibrium macroeconomics, Money, Employment, and Inflation. However, at the end of the 1970s, Barro and Grossman came to advocate for equilibrium models. In two articles published in 1979, they claimed that Lucas had identified the good approach to macroeconomics (Barro, 1979: pp. 55-56; Grossman, 1979a: p. 68). Why did they privilege equilibrium over disequilibrium macroeconomics? Several explanations may be considered. Opportunism is a possibility. With the ascent of New Classical Economics, Barro and Grossman were likely to publish more and to get better positions if they developed equilibrium models. This might explain why they chose to jump on Lucas’s bandwagon. Such a decision could also have been motivated by politics. Barro and Grossman were against policy activism.2 Coincidence, equilibrium models à la Lucas made strong cases against fiscal and monetary policies. Accordingly, Barro and Grossman might have preferred equilibrium macroeconomics because it strengthened their political views. Last but not least, Barro and Grossman’s decision may be due to some sort of superiority of equilibrium 2 During a conference “On the Stability of Contemporary Economic System” (1975), Grossman claimed that “if we could somehow devise a system where monetary creation [was] stabilized, we could then have a stabilized rate of inflation. That [seemed] to be the practical lesson to learn. The immediate policy prescription which [followed] from that [was] to remove monetary and fiscal policy from the discretion of government and to transfer the power to some highly level of constitutional authority, which would stabilize monetary and fiscal behavior” (1975: p. 457). Barro was on the same page (1979: p. 57). 2 vis-à-vis disequilibrium macroeconomics – e.g., the strength of its microfoundations, its capacity to assess economic policy or its internal consistency. These explanations are probably not mutually exclusive.3 However, my article does not intend to grasp Barro and Grossman’s decision in all its complexity. Its goal is to discuss the validity of one explanation. I am interested in determining whether, and to what extent, they preferred equilibrium macroeconomics because it offered a better framework than disequilibrium macroeconomics. This simplifies the historical analysis. No need, for instance, to explain the relationship between the choice of models and politics. Besides, it allows to address the relevance of the standard narrative in the history of macroeconomics. When macroeconomists trace the history of their field, they insist on the progress made since the 1970s (Mankiw, 1990; Blanchard, 2000; Woodford, 2003). The history of macroeconomics is thus depicted as a process in which macroeconomists replace one approach by another, because it does a better job.4 Does this logic apply to Barro and Grossman’s case? So far, historians have privileged that explanation. According to Roger Backhouse and Mauro Boianovsky (2013), Barro and Grossman failed to complete their disequilibrium program of microfoundations. This would explain why they stopped investigating disequilibrium macroeconomics. The same argument was formulated by Michel de Vroey, in his History of Macroeconomics. From Keynes to Lucas and Beyond (2016). The problem with these historical analyses is twofold. They don’t explain why Barro and Grossman were seduced by equilibrium macroeconomics. Then and more importantly, none of the three historians reconstructed the path that led Barro and Grossman to privilege equilibrium over disequilibrium macroeconomics. By contrast, I trace how and why Barro and Grossman came to advocate for equilibrium macroeconomics. To do so, I make an extensive use of the archival documents left by Grossman, at Brown University. Then, I portray the intellectual context in which Barro and Grossman were involved. Last but not least, I focus on the way Barro and Grossman built and 3 According to Barro (1979), equilibrium macroeconomics offered a better framework than disequilibrium macroeconomics. This was because unlike disequilibrium macroeconomics, equilibrium macroeconomics was based on sound microfoundations (p. 56). Then, Barro stressed that “the non-market-clearing approach [made] government policy activism much too easy to justify” (p. 56). Finally, when Barro advocated for equilibrium macroeconomics, he was Lucas’s colleague at the University of Chicago. Jumping on his bandwagon could thus have been viewed as a career accelerator. Under these circumstances, it is likely that Barro’s decision was motivated by strategic, politic, and scientific reasons. The same might apply for Grossman. 4 For instance, Michael Woodford (2003) claimed that the equilibrium discipline was adopted because it offered a better basis for evaluating economic policies (pp. 11-12). 3 used models. Several questions are addressed. What was their method when modeling economies? Did Barro and Grossman have the same goals when using disequilibrium and equilibrium models? What were their criteria to choose between the disequilibrium and the equilibrium approaches to macroeconomics? From the beginning of the 1970s, Barro and Grossman’s goal was to model the business cycle. Their method was to start from the Walrasian framework, to introduce a friction, and to discuss the qualitative properties of the resulting model. Early on, they considered two frictions: price stickiness and incomplete information about market prices. This led Barro and Grossman to elaborate disequilibrium and equilibrium models. By exploring their properties, their ambition was to determine what was the best framework for analyzing the business cycle. The ranking process was based on “rigor” and “realism” criteria. Grossman clarified its logic in “Employment Fluctuations and Risks,” an unpublished document written in the 1970s: Existing models in which behavior
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