From: david@cats.ucsc.edu (David Michael Wright)
Newsgroups: sci.econ
Subject: Re: Inflation
Date: 10 Jan 1993 08:30:24 GMT
Organization: University of California; Santa Cruz
NNTP-Posting-Host: si.ucsc.edu


In article <1993Jan6.234601.23658@samba.oit.unc.edu> Robert.Vienneau@launchpad.unc.edu (Robert Vienneau) writes:

|...Academic economists, for the most part, have been blind and deaf to the
|GT. They created an equilibrium IS-LM model that ignores both the labor
|market and prices.

I think this is changing as we speak. Recent articles in the American
Economic Review, the QJE, and Mankiw and Romer's new book
"New-Keynesian Economics" have been reviving some of the more
interesting ideas of the GT, and I think Diamond (1982) was one of the
first to get multiple equilibriam driven by changes in expectations of
future investment. (and consumption for that matter).

However, the simplified IS-LM model, while missing the more
interesting parts of the GT, none the less makes plain the differences
between the Classical and Keynesian Schools that existed at that time.
The question centerd on whether reducing interest rates, by
themselves, was enough to stimulate the economy, or whether a stimulus
to something called "aggregate demand" was neccessary. The IS-LM
model rests on fixed money wages or sticky prices, whereas the GT
assumed that it was not neccessary to make this assumption, as you
point out. I don't think Keynes did not make clear how if you drop
this assumption the model does not fall apart, and so we had to wait
for Diamond and others.

|If none of this is the GT, what is? The key point is that it is about a
|"monetary production economy" in which the future is uncertain and the
|particpants know this. If you do not what Keynes meant by "uncertainty,"
|you do not understand the GT. The key texts are the
|_Treatise_on_Probability_ (which I have not read), chapter 12 of the GT,
|and his 1937 response to reviewers, especially the second half. in
|Keynes sense, uncertainty cannot be modelled by a single probability
|distribution or by models that generate ergodic stochastic processes.
|And the difference is not captured by the distinction between Bayesian
|and classical probability. For example, new classicals models are not
|about agents reacting to Keynesian uncertainty. Robert Lucas is totally
|cognizant of this fact.

I really don't understand the problem here. Take an economy driven by
rational expectations with a given random distribution with known
varience and mean:--a common assumption. Now, on average, people will
make the correct amount of investment and consumption, that is, the
plans of all agents will be consistent. But, in any given period, it
will not be the case, there will be an error. If we make the frequency
of this variable fairly long, then we get flucuations in output that
corrospond to Keynesian business cycles, to some degree, and you have
the same "type" of uncertainity that Lucas and conventional economists
use to model the economy. I see no real problem. Now, there might be a
problem with policy implementation: why would the government err less
than the private agents? And so policy may be impotent as the New
Classical might suggest, but we can always assume assymetric
information if need be. 

-- 
"There is nothing in the marginal conditions that     
    distinguish a mountain from a mole hill"            
                      Kenneth Boulding                             

					All comments  are mine---(David Wright) 
						david@cats.ucsc.edu.