Academic journal article
By Akerlof, George A.
American Economist , Vol. 47, No. 1
Think about Richard Scarry's Cars and Trucks and Things That Go. (1) Think about what that book would have looked like in sequential decades of the last century had Richard Scarry been alive in each of them to delight and amuse children and parents. Each subsequent decade has seen the development of ever more specialized vehicles. We started with the model-T Ford. We now have more models of backhoe loaders than even the most precocious four-year old can identify.
What relevance does this have for economics? In the late 1960s there was a shift in the job description of economic theorists. Prior to that time microeconomic theory was mainly concerned with analyzing the purely competitive, general equilibrium model based upon profit maximization by firms and utility maximization by consumers. The macroeconomics of the day, the so-called neoclassical synthesis, appended a fixed money wage to such a general equilibrium system. "Sticky money wages" explained departures from full employment and business cycle fluctuations. Since that time, both micro and macroeconomics have developed a Scarry-ful book of models designed to incorporate into economic theory a whole variety of realistic behaviors. For example, "The Market for 'Lemons'" explored how markets with asymmetric information operate. Buyers and sellers commonly possess different, not identical information. My paper examined the pathologies that may develop under these more realistic conditions.
For me, the study of asymmetric information was a very first step toward the realization of a dream. That dream was the development of a behavioral macroeconomics in the original spirit of Keynes' General Theory. Macroeconomics would then no longer suffer from the ad hockery of the neoclassical synthesis, which had overridden the emphasis in The General Theory on the role of psychological and sociological factors, such as cognitive bias, reciprocity, fairness, herding, and social status. My dream was to strengthen macroeconomic theory by incorporating assumptions honed to the observation of such behavior. A team of people have participated in the realization of this dream. Kurt Vonnegut would call this team a kerass, "a group of people who are unknowingly working together toward some common goal fostered by a larger cosmic influence." (2) In this lecture I shall describe some of the behavioral models developed by this kerass to provide plausible explanations for macroeconomic phenomena which are central to Ke ynesian economics.
For the sake of background, let me take you back a bit in time to review some history of macroeconomic thought. In the late 1960s the New Classical economists saw the same weaknesses in the micro-foundations of macroeconomics that have motivated me. They hated its lack of rigor. And they sacked it. They then held a celebratory bonfire, with an article entitled "After Keynesian Macroeconomics." (3) The new version of macroeconomics that they produced became standard in the 1970s. Following its neoclassical synthesis predecessor, New Classical macroeconomics was based on the competitive, general equilibrium model. But it differed in being much more zealous in insisting that all decisions--consumption and labor supply by households, output, employment and pricing decisions by producers, and the wage bargains between both workers and firms--be consistent with maximizing behavior. (4) New Classical macroeconomics therefore gave up the assumption of sticky money wages. To account for unemployment and economic fluct uations, New Classical economists relied first on imperfect information and later on technology shocks.
The new theory was a step forward in at least one respect: price and wage decisions were now based upon explicit microfoundations. But the behavioral assumptions were so primitive that the model faced extreme difficulty in accounting for at least six macroeconomic phenomena. In some cases, logical inconsistency with key assumptions of the new classical model led to outright denials of the phenomena in question; in other cases, the explanations offered were merely tortuous. …