The Missing Motivation in Macroeconomics

Macroeconomics changed between the early 1960s and the late 1970s. The macroeconomics of the early 1960s was avowedly Keynesian. This was manifested in the textbooks of the time, which showed a remarkable unity from the introductory through the graduate levels. John Maynard Keynes appeared, posthumously, on the cover of Time. Even Milton Friedman was famously—although perhaps misleadingly— quoted: “We are all Keynesians now.” A little more than a decade later Robert Lucas and Thomas Sargent (1979) had published “After Keynesian Macroeconomics.” The love-fest was over. The decline of the old-style Keynesian economics was due in part to the simultaneous rise in inflation and unemployment in the late 1960s and early 1970s. That occurrence was impossible to reconcile with the simple nonaccelerationist Phillips curves of the time. But Keynesian economics also declined because of a change in economic methodology. The Keynesians had emphasized the dependence of consumption on disposable income and, similarly, of investment on current profits and current cash flow. They posited a Phillips curve, where nominal—rather than real—wage inflation depended upon the unemployment rate, which was used as an indication of the looseness of the labor market. They based these functions on their own introspection regarding how the various actors in the economy would behave. They also brought some discipline into their judgments by estimating statistical relations. But a new school of thought, based on clas† Presidential Address delivered at the one hundred eighteenth meeting of the American Economic Association, January 6, 2007, Chicago, IL. * Department of Economics, University of California at Berkeley, 549 Evans Hall, Berkeley, CA 94720 (e-mail: akerlof@econ.berkeley.edu). This paper is based on a longterm research program with Rachel Kranton on the implications of identity for economic behavior. Our previous joint papers (Akerlof and Kranton 2000, 2002, 2005) have explored implications outside of macroeconomics of utility functions dependent on people’s notions of what ought to be. Some of this paper—especially Section III (“The Missing Motivation: Norms”) and Section IX (“Economic Methodology”)—has been directly taken from our joint manuscript: The Missing Motivation: Economics Made Human (Akerlof and Kranton 2006). I am especially grateful to Professor Kranton for extending to me the invitation to join this project, after she had the initial insight in the spring of 1996 that concerns regarding identity were missing from economic theory. I have also benefited from conversations with Robert Shiller, with whom I am coauthoring work on behavioral macroeconomics. In addition, I especially wish to thank Robert Akerlof and Janet Yellen for invaluable advice. I also want to thank Roland Benabou, Alan Blinder, Louis Christofides, Stephen Cosslett, Ernst Fehr, David Hirshleifer, Houston McCulloch, John Morgan, George Perry, Antonio Rangel, Paola Sapienza, Robert Solow, Dennis Snower, and Luigi Zingales, and seminar participants at the IMF, the World Bank, Ohio State University, Vanderbilt University, the University of California at Berkeley, the Munich Behavioral Economics Summer Camp, the 2006 Macroeconomics and Individual Decision Making Conference of the NBER and the Federal Reserve Bank of Boston, and at the Social Interactions, Identity, and Well-Being, and Institutions, Organizations, and Growth groups of the CIAR. I am also grateful to Marina Halac for invaluable research assistance and to the Canadian Institute for Advanced Research and to the National Science Foundation under Research Grant SES 04-17871 for invaluable financial support. 1 See, for example, Paul A. Samuelson (1964), Thomas F. Dernburg and Duncan M. McDougall (1967), and Gardner Ackley (1961). The econometric model of Lawrence R. Klein and Arthur S. Goldberger (1955) provides a useful synopsis of the variables that the early Keynesians thought most important for a macroeconomic model, and how they would be included. 2 Time, December 31, 1965. His appearance on the cover was especially remarkable because Time covers are rarely posthumous. Keynes had died in 1946. 3 But in a later disclaimer, Friedman said, almost surely correctly, that he had been quoted out of context. See http://www.libertyhaven.com/thinkers/miltonfriedman/ miltonexkeynesian.html, which quotes Friedman (1968), Dollars and Sense, 15. 4 The treatment of consumption in The General Theory, as we shall see below, was typical of such thinking. Keynes first discusses the dependence of consumption on current income, which he clearly sees as the primary determinant of current consumption; but, in addition, he makes a long list of other factors that will alter the relation between consumption and current income. 5 A good example of this methodology can be seen in Alban W. Phillips’s (1958) mixture of light theory and statistical analysis in his estimation of the relation between wage inflation and unemployment.