New Macroeconomics Teaching for a New Era:

Instability, Inequality, and Environment

Jonathan M. Harris

http://ase.tufts.edu/gdaeCopyright © 2014 Jonathan M. Harris

Teaching Macroeconomics: Missing Perspectives

Current mainstream texts (e.g. Mankiw, Principles of Economics) lack treatment of:

• Instability (assume classical long-run full-employment)• Inequality (no empirical assessment of increasing inequality,

no treatment of macro effects)• Environment/Resource limits (only brief mention) • Infrastructure and Social Investment (very limited treatment)

Limitations and biased policy implications arise from assumptions of Aggregate Supply/Aggregate Demand model

Source: Mankiw, Principles of Economics, 5th ed., Chapter 33

The assumption of a fixed Long-Run Aggregate Supply curve means that government policy is ineffective, affecting only the price level in the long run.

Is AS/AD salvageable?

• Inherent inconsistency in AS/AD as presented in standard texts (with price level equilibrium).

• Continued dominance because it appears to work (at least for short-term results) but intellectual incoherence (as per Colander critique) and New Classical bias.

• Dynamic approach (using inflation) is more intellectually consistent, and reflects more Keynesian perspective.

A New Approach to Teaching Macroeconomics

• Dynamic approach to AS/AD • Recognition of inherent instability• Active government policy responses• Importance of distribution and inequality• Consideration of resource and environmental

limits

Output (Y )

Infl

atio

n r

ate

(π )

Aggregate Supply (AS)

Maximum Capacity

Y*

Unemployment

Wage-Price Spiral

The Aggregate Supply CurveAs the economy approaches its maximum capacity, inflation levels tend to rise as excessive demand for workers, goods and services, and production inputs pushes up wages and prices.

Source: Goodwin et al., Macroeconomics in Context, 2nd ed., Chapter 13

Output (Y )

Infla

tion

rate

(π

) AS

Y*

AD1

AD0

E1

E0

Unemployment

Expansionary Fiscal Policy in Response to a RecessionAn expansion of government spending, as well as a program of tax cuts, shifts the AD curve to the right.

Source: Goodwin et al., Macroeconomics in Context, 2nd ed., Chapter 13

Factors affecting AD, AS

• Slope of AD based on real wealth, real money supply and trade effects, plus Fed response rule.

• Position of AD: instability of investment, variability of consumption based on income distribution and debt, fiscal and monetary policy, trade in open economy

• Position of AS: technology, natural resource and environmental constraints, institutions, infrastructure investment

Implications of dynamic AS/AD

• All of the factors affecting positions of AS and AD are the proper domain of economic analysis and policy; cannot simply rely on “efficient markets”.

• There is no “equlibrium price level” for the macro economy, and factors such as money illusion and rational expectations are not needed to explain shifts in macro equilibrium.

• Different equilibria, disequilibria, and varied growth paths exist. Inherent instability may affect investment, macro equilibrium (as per Keynes).

Brunei

United Arab Emirates

United States

India

China

Bahrain

Saudi Arabia

Kazakhstan

Gabon

Sweden Switzerland

Norway

CO2 emissions are correlated with GDP, but different growth paths exist, including low-carbon paths.

GDP AND CO2 Emissions

Top 10 Percent

Top 1 Percent

Inequality in the U.S. has risen to levels not seen since the 1920s, with macroeconomic consequences including increased debt and more

unstable aggregate demand.

INCOME SHARES OF TOP 10% AND TOP 1%

GD

P a

nd

GP

I P

er C

apit

a (2

000

US

$)

Gross Domestic Product

Genuine Progress Indicator

GDP AND THE GENUINE PROGRESS INDICATOR

Increasing GDP does not necessarily mean increasing well-being; other indicators may be needed.

2005 2010 2015 2020 2025 2030 20350

50

100

150

200

250

300In

dex

(200

5=10

0)

Year

GDP/Capita

GHGUnemploymentPovertyDebt to GDP

PROJECTIONS FOR STABILIZED GDP/LIMITS TO GROWTH

Indefinite growth is not essential for macro stability. A macroeconomic model for Canada shows that GDP/capita can be stabilized while improving social indicators and lowering environmental impacts.

Source: Peter Victor, Managing Without Growth, 2008.

Greening Macroeconomics

• Revised National Income Accounts• “Green Keynesian” policies of Social

Investment for Full Employment• Carbon Tax, Resource Taxes• Limits to Growth

Examples of “Green” Macro Policy: U.S.• $787 billion dollar stimulus package included about $71 billion for

specifically “green” investments, plus $20 billion in “green” tax incentives.

• Energy efficiency in Federal buildings and DoD facilities -- $8.7 billion• Smart-grid infrastructure investment -- $11 billion• Energy and conservation grants to state and local governments -- $6.3 billion• Weatherization assistance -- $5 billion• Energy efficiency and renewable energy research -- 2.5 billion• Advanced battery manufacturing -- $2 billion• Loan guarantees for wind and solar projects -- $6 billion• Public transit and high-speed rail -- 17.7 billion• Environmental cleanup -- $14.6 billion• Environmental research -- $6.6 billion

Aggressive Federal policy action including “green” investments “probably averted what could have been called Great Depression 2.0 . . . without the government’s response, GDP in 2010 would be about 11.5% lower, payroll employment would be less by some 8 ½ million jobs, and the nation would now be experiencing deflation.” (Blinder and Zandi, “How the Great Recession was Brought to an End”, 2010).

Examples of “Green” Macro Policy: Portugal

• Portugal government-led transition from fossil fuels towards renewable power, with the percentage of renewable supply in Portugal’s grid up from 17 percent in 2005 to 45 percent in 2010.

• $22 billion investment in modernizing electrical grid and developing wind and hydropower facilities.

• Portugal will recoup some of its investment through European Union carbon credits, and will save about $2.3 billion a year on avoided natural gas imports.

“Portugal Gives Itself a Clean-Energy Makeover,” New York Times August 10, 2010.

Policies for Full Employment

• Increased hiring in public sector: teachers, police, construction, transit and park workers, etc.

• Major energy efficiency and renewables investment, partly public and partly incentivized private investment

• Large-scale building retrofit publicly financed but carried out by private contractors

• Increased public R&D expenditures with accompanying higher education investment (“Sputnik” precedent)

• Investment in public transit and infrastructure, public health, education, environmental conservation and regeneration

Policies For Climate Stabilization

• Carbon tax or equivalent (cap & trade with auction) • Recycle revenues of ≥ $150 billion for energy efficiency,

renewables, progressive rebates• R&D investment ($3-12 billion) focuses on efficiency and

renewables• Infrastructure investment – hi-speed rail, public transit, green

buildings, solar and wind power• Efficiency standards for plants, vehicles, machinery, buildings• Preferential credit or subsidy for energy efficiency

investments

What about Deficits and Debt?• Krugman: “Suppose that government uses borrowed money to buy

useful things like infrastructure. The true social cost will be very low, because the spending will put resources that would otherwise be unemployed to work [and allow private debtors to pay down their debt] … the argument that debt can’t cure debt is just wrong.”

• Europe’s problems now arise from unwillingness to use European Central Bank to finance debt, allowing indebted players to recover. Instead, “austerity” policies make debt harder to manage and threaten major defaults and financial catastrophe.

• U.S. focus on debt reduction prevents further stimulus spending, threatens to derail weak recovery (like 1937).

• All based on what Keynes called “the Treasury view” or Herbert Hoover economics: balance the budget during recession.

Sources: Krugman, “Mr. Keynes and the Moderns”, 2011.

Conclusion

• Breaking with standard macro models and returning to a more “Keynesian” dynamic model allows instructors to address modern problems of instability, inequality, and environment.

• This approach does not necessarily prescribe what’s right in terms of policy, but opens up the possibility of constructive activist macro policy to address crucial issues.

Other relevant publications from Tufts University Global Development and Environment Institute