Money and the Future of Macroeconomics

A perennial topic in the economics blogosphere is the state of macroeconomics. Since the financial crisis, people (at least the people who take the time to blog) have become increasingly critical of macro.

In the latest issue of the Oxford Review of Economic Policy, the biggest names in the field — Paul Krugman, Joseph Stiglitz, Olivier Blanchard, Ricardo Reis, and more — take up the state of macro from different angles. Compared to the breathy discussion on blogs, the journal-length articles are refreshing for their depth. The articles range from optimistic to downright damning.

One of the most optimistic pieces comes from Randall Wright, the noted monetary economist whose models I’ve previously discussed. In his assessment of macro, Wright makes three main claims:

1. Mainstream macro does a good job explaining real phenomena. A financial crisis does not change that.
2. Understanding financial crises requires incorporating financial factors related to money, credit, banking, and liquidity. Solid microfoundations are critical to achieving that.
3. New-monetarist models incorporate financial considerations with solid microfoundations.

For readers of this blog, Wright’s last two points are the important ones. The second point stresses how macro must get money right to advance. The third point suggests a way forward. Money must be at the heart of macro. As Wright puts it, “The most pressing goal in mainstream macro is to incorporate financial considerations with solid microfoundations.”

By financial considerations, Wright means things like credit and banking. Though Wright doesn’t put it this way, going back to Mises’s The Theory of Money and Creditin 1913 we have known that credit is fundamental to the business cycle. Yet many macro models do not include credit (for a variety of reasons). Wright is calling for a return to Mises’s insight.

By solid microfoundations, Wright means something like banking should not simply be assumed. We cannot simply assume that people demand banking services the way they demand apples. Banking is different. Instead, the models should have banking emerge from the actions of the people in the model. According to Wright, only then can we properly understand the role of banking. We need models of banks, not models with banks. I agree.

The whole journal issue is a must-read for anyone who wants to participate in the state-of-macro debates or just learn a bit more about how macroeconomists understand macroeconomics.

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