Sunday, June 2, 2013

AS-AD: Counting the Ballots

Ah, the blogosphere is a wonderful thing.  I asked for thoughts about the status of AS-AD in the intro macro textbook, and I got a whole bunch.  I really appreciate the response!  Here is my takeaway:

1. There is a lot of love out there for AS-AD.  I didn’t want to get into a debate over its merits (and yes I know Romer’s version, the claim that AS is a kind of Phillips Curve, and so on), but I was curious about whether economists feel positively enough about the model to actually use it in real life (as opposed to the classroom).  The answer is that some do.  That said, I think one could follow policy debates in economics without any exposure to AS-AD: all the main arguments on every side—Keynesian, classical, Post Keynesian, Austrian—can be presented and normally are presented without recourse to the AS-AD format.  There is a bit of AS-ADing on the web; there is little to none, as far as I know, in the corridors of policy.

2. AS-AD’s greatest claim to relevance may be its role in allowing the 1970s experience in the US to be placed in a different box than previous and subsequent episodes of macro distress.  (This is Paul Krugman’s core point.)  I can see the logic of this.  The 1970s was a crucial decade for macrotheory, and if all recessions were like the OPEC-induced variety the real business cycle model would be the only way to go.  By differentiating between “demand-side” and “supply-side” crunches, we can ringfence the 70s.  AS-AD is the easiest way to do this.

3. And what is the alternative?  Surely we don’t want to suggest that a model without prices (like the venerable Keynesian Cross) can fill the bill?  Whatever the detailed merits of AS-AD, at least it allows you to talk about output and prices at the same time.

So have I budged?  Maybe, somewhat.

1. I still think AS-AD is logically flawed.  That’s a different debate, but I think the flaws show up in a widespread perception that the framework isn’t very useful for policy purposes.  Here are two examples: (a) A recurring question is “what should the central bank do?”  Assuming that the CB engages robotically in inflation targeting (the Romer version of the model) isn’t exactly the best starting point for trying to answer it.  (b) The standard model of a shifting short run Phillips Curve (when unemployment is above or below NAIRU) provides a more empirically relevant basis for understanding the relationship between output and inflation than an AS curve.  You can actually measure NAIRU, debate its stability, etc.  That will give you an AS curve too.  But what is the empirical basis for a shift in the AS curve?  That’s about a shift in NAIRU, right?  Am I the only one who notices that the literature that would justify and calibrate such shifts is thin and inconclusive?  (I say this even though I think I have a rough understanding of the factors that might push NAIRU one way or the other.)  A lot has been written on the impact of Obama’s initial stimulus on output and employment, for instance; how much has been written on its impact on NAIRU?

2. It’s true that without AS-AD it’s hard to put the 1970s in a separate box.  How much that matters depends on how you want to respond to the new classical critique that emerged at the same time.  One response is, OK you guys were right, but mostly about this one period, which really was a real business cycle.  That’s not the only option.

3. What the alternative is depends on whether you think you always need a single model to tie everything together.  That function is served by DSGE at the upper reaches of macrotheory.  (Again, the merits of DSGE are not at issue at the moment.)  But DSGE can’t do this job at the intro level.  So do you tell a number of stories that bear on DSGE-ish issues, or do you opt for a simple model whose value is mainly to provide a thread that runs through the intro textbook?  The mantra for textbooks today is simple stories with lots of repetition.  Whether you can get introductory students to wrap their minds around multiple stories that stand in some tension with one another is a practical question.  We’ll see.

7 comments:

rosserjb@jmu.edu said...

Peter,

I am going to differ, partly drawing on stuff I have already said but that you have not noticed or ackknowledge. If one does Keynesian AE in nominal terms, one can simply carry that "equlibrium" level of nominal AE over into the AS-AD space as a rectangle at the AS-AD equilibrium. Policy and other things can shift the AD, and one can handwave in a reasonable SRAS (or go to a vertical AS if one prefers that).

As one who taught intro from late 70s on, I note that Romer's argument is nothing new. The old Samuelson textbook a la 10th edition very clearly treated what we now call "supply shocks" as showing up in the form of shifts of the Phillips Curve, however one treated expectations. So, this is nothing new. I am fairly certain that it was the widely used Baumol and Blinder textbook that first introduced the AS-AD framework explicitly.

As for NAIRU, I do not see anybody talking about it now. Obama's policies did anything to it? How? If you are assuming NAIRU, then you are assuming some location of the PC that is vertical. But, there has never been a logical link between it, Friedman's natural rate of unemployment, or anything else other than a vertical PC that I know of, although lots of people handwaved these into coinciding. There is no reason whatsoever to think that some level of unemployment that the economy might "naturally" go to over some run coincides with a NAIRU, if such a beast even exists at all.

Oh, and there are certainly other times besides the 1970s when supply side shocks have been relevant and of interest, notably the late 90s when Greenspan figured out that real growth had increased and, if you prefer, NAIRU and the expectations-adjusted Phillips Curve had shifted, meaning he could get away with continuing to lower interest rates without inflation accelerating, which he successfully did.

Oh, and while RBC DSGE is supposedly rigorously supply-side, it is useless in handling oil price shocks, the most common form of negative supply side shocks, other than as a giant hand wave of an exogenous productivity shock, although what is going on is something happening through the price level of inputs, not actual production technology.

rosserjb@jmu.edu said...

Oh, and just for the record, according to Dave Colander, the only intro textbook that ever did what I suggest, to do Keynes-AE nominally and then link it to AS-AD, was Dolan, which did not sell all that well.

Peter Dorman said...

Hi Barkley. AS-AD really gets people going, I find. I'm not supposed to be arguing it here, so in theory I shouldn't respond, but....

To identify the AE equilibrium with the AS-AD equilibrium is not a point in favor of the latter, at least not that I can see.

I agree with your point that there is no automatic tendency for an economy to settle at NAIRU, nor is it even clear that NAIRU is stable. I brought up NAIRU only to make the point that the AS curve is a P curve assuming a given NAIRU, so if you are shifting the AS curve you are implicitly shifting NAIRU. That should be understood as a problem for AS-AD.

Incidentally, it seems that Paul Krugman is arguing for an equilibrium NAIRU in the post that replies to me. This is the meaning of a vertical LRAS curve, isn't it? (To be clear, you can have a vertical LR PC without any equilibrium connotation, but not so the vertical LRAS.)

rosserjb@jmu.edu said...

That is certainly a way of interpreting it and is how most textbooks interpret, including Krugman's I believe. The belief that the natural rate equals the NAIRU equals the position of the LRAS is deeply entrenched in the textbooks, even more strongly at the intermediate undergrad level, I believe, however questionable it is.

Maybe linking Keynesian AE to AS-AD does not help the latter, but I prefer that to this Waldmannian IS curve linked to Taylor Rule stuff, although that at least does have the rate of inflation on the darned vertical axis.

Edward Lambert said...

Here is an alternative to the AS-AD model which is in the development stage. It has the dynamics of the Phillips curve, various price levels and more. Feel free to scrutinize...

http://effectivedemand.typepad.com/ed/2013/06/proof-of-effective-demand-incorporating-unemployment-and-nairu.html

http://effectivedemand.typepad.com/ed/2013/05/aggregate-supply-effective-demand-model-points-of-price-dynamics.html

Edward Lambert said...

In response to the NAIRU comments above... If you look at this version of based on Effective demand and aggregate supply, you will see the dynamics of the NAIRU and the LRAS curve. This is a new development in economics that is appearing this weekend.

http://effectivedemand.typepad.com/ed/2013/06/proof-of-effective-demand-incorporating-unemployment-and-nairu.html

João Marcus said...

"It’s true that without AS-AD it’s hard to put the 1970s in a separate box. How much that matters depends on how you want to respond to the new classical critique that emerged at the same time. One response is, OK you guys were right, but mostly about this one period, which really was a real business cycle. That’s not the only option."
I don´t think it was a RBC at all.
http://thefaintofheart.wordpress.com/2012/08/25/the-origins-of-the-great-inflation/