Academic journal article Economic Inquiry

Armen Alchian's Contribution to Macroeconomics

Academic journal article Economic Inquiry

Armen Alchian's Contribution to Macroeconomics

Article excerpt

I. INTRODUCTION

This essay examines Alchian's contribution to the theory and practice of macroeconomics. We have the task of reviewing Alchian's contributions in an area that represents only a tiny fraction of his body of work. Citations to his work on the theory of the firm greatly outnumber those on money and inflation. Nevertheless, we find that many of the major developments in macroeconomics in the last two decades follow paths that were pointed out in the late 1950s and early 1960s by Armen Alchian, much of it in collaboration with Reuben Kessel. Alchian's ideas about macroeconomics were developed in a fertile environment at UCLA in conversations with colleagues such as Karl Brunner and Jack Hirshleifer, as well as with graduate students such as Allan Meltzer and Rachael and Ted Balbach.

A signature of Alchian's work was his great ability to clarify the issues. He was careful to distinguish the effects of money versus real shocks, of anticipated versus unanticipated inflation, and to work through the impact of an event to the general equilibrium consequences. He understood that real-world problems such as incomplete information might explain apparently noneconomic behavior, but unlike many macroeconomists of that time, he did not abandon microeconomic principles when explaining nominal/real interactions. Alchian's views were a clear contrast to those of prominent macroeconomists of the day who argued that aggregate monetary policies could not be used to stabilize the price level at full employment because of asymmetric rigidities in markets that prevented the downward adjustment of any nominal price as part of the process of adjusting relative prices.(1)

The conventional wisdom of the day led to policies that ultimately caused two decades of accelerating and costly inflation. Both the rational expectations revolution and developments in modeling the microfoundations of business cycles were a reaction to this experience and to the apparent failure of standard macroeconomic analysis. Alchian's 1970 work on the effect of private information was one of the original articles in this microfoundation literature. Although he used a narrative approach rather than the highly structured mathematical models available to researchers today, Alchian was more than two decades ahead of the real business cycle economists in asking researchers to explore economic explanations fully before adopting explanations based on market failure, money illusion, and irrational behavior.

This paper is organized in four parts. The first part describes Alchian's work involving the fundamental role of money in society. King and Plosser [1986, 93] wrote, "But in the explosion of formal modeling of monetary economies in the postwar period, Brunner and Meltzer (1971) and Alchian (1977) stand nearly alone in stressing ... the idea that monetary arrangements economize on the information production that would otherwise be necessary to mitigate problems of moral hazard in the exchange of commodities."

The second part discusses Alchian and Klein's work on the measurement of inflation. This measurement problem appears to be more obvious when inflation is low and the variance of price indexes is dominated by real factors. This work was generally neglected at the time it was written, perhaps because inflation accelerated so rapidly that the real factors became less important. Now that inflation has declined to moderate levels, the measurement problems are resurfacing.

The third part of the paper documents Alchian's insight into the problems and intellectual developments that followed the erratic inflation policies of the U.S. government in the 1960s and 1970s. In a 1962 Journal of Political Economy article, he and Reuben Kessel set forth a description of the events that occur as an economy shifts from one steady-state inflation regime to another. This work revealed an understanding of the importance of credibility for the policymaker that was missing from much of the writing about macro policymaking in the subsequent three decades. …

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