Using Historical Perspective of Keynesian vs.Neoclassical Macro in Teaching Principles
14th Fed Prof Conference 2016
Max Gillman, U. of Missouri-St. Louis
Federal Reserve Bank of St. Louis
3-4 November 2016
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Evolutionary Approach to Teaching MacroPrinciples of Macroeconomics: An Evolutionary Approach; Jan. 2017
Great Depression to Great Recession
Fisher vs. Keynes
Neoclassical vs Keynesian
Lectures including Online FRED.
Homework including EconLowdown Modules.Using State of Art Econ Govt data & Online Modules.Without reliance on Proprietary Online Services.Adjust as FRED, EconLowdown Advance/Evolve.(In FRED We Trust).
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What We Teach Matters: Not Just How
What is an Economic Fallacy?
What is an Economic Fact?
What is a Macroeconomic Principle?
What Math can we use?
Can We Tell the Story of Macro?
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Fallacies: AS-AD derivation.
Keynesian Cross gives AS � AD analysis.
IS-LM gives AS � AD analysis.
Phillips curve gives AS � AD analysis.
Oil Price Theory of Stag�ation gives AS � AD analysis.
David Colander, 1995, "The Stories We Tell:
A Reconsideration of AS/AD Analysis."Journal of Economic Perspectives, 9(3): 169-188.
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Stylized Facts
Normal Real Business Cycle Stylized Facts
Solow Growth Facts of balanced growth path.
Phillips curves during Asset Market Booms & Busts
Bank Collapse Causing Crises of Grt Depress & Grt Rec.
US Lost Decades: 1929-1939 & 2007-2016.
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Macro Principles
S & D for capital depends on Real Interest Rate:
Fisher 1896 Model allows "Ramsey" RBC explanation.
Ramsey (1928) underlies Neoclassical & (New) Keynesian.
Ramsey World AS � AD underlies Dyn. Stoch. Gen Equil.
Ramsey World AS � AD depends on real price of Gds to Labor:1/w .
Ramsey World S&D in Labor market dependson real price of Labor to Goods: w/1.Real Interest Rate constant in Ramsey World
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Math We Can Use
Graphs of Data over time: FRED mainly.
Plus BLS graphs, NIPA Dpt Comm.& OECD tables.
Graphs of Functional Data, in time: Phillips Curve
Can Construct Using FRED data in Excell.
Graphs of Functions between 2 Variables:
eg. Price, Quantity; Output, Input.
Graphs of Functions Shifting:
Comparative Statics Change in one Parameter.
Tables.Equations: Simple Algebra Only
C + I + G = Y = GDP; R = r + π; GDP = GDI .Maybe: wl + rk � δ+ G � T = Y = GDI(A � B + C �D + E = F ).
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Story to be Told
Microeconomic to Macroeconomic Foundations
Comovement & Crises
Cycles & Growth
Policy
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Micro Principles Used in MacroMicroeconomic to Macroeconomic Foundations
PPC, Production Function, Indi¤erence Curve.Diminishing Marg Prod. & Marg Utility; Mrkt Structure.Supply & Demand as function of Relative PriceComparative Statics
Smith, Ricardo, Bentham, Jevons, Menger, Walras,Malthus, Darwin, & MarshallLabor Theory of Value vs Neoclassical Theory of Value
Application: Gasoline Prices & Loss of US World Auto MrktCurrent Dollar Gas Prices vs Real Dollar Gas Prices
Appendices: How Darwin Solved Shape of Production CurvePlus: Graphs & Data; Using FRED; y = a+ bx .
EconLowdown Module: Supply & DemandReview of S&D basics + Comp. Statics
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0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.00.00
0.05
0.10
0.15
0.20
0.25
Input
Output
Figure: General Equilibrium Production Function (Blue) and Utility LevelExpressed as Indi¤erence Curve (Red).
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0 1 2 3 4 50
1
2
3
4
5
Quantity
Relative Price
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Figure: US Gasoline Prices: Actual & Constant 2013 Prices, 1929-2014.
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Figure: US Gasoline Index divided by All Items CPI, 1990:4 - 2016:3.
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Aggregate Output and IncomeMicroeconomic to Macroeconomic Foundations
National Output & Income Accounting
NIPA Tables for GDP & GDI4 Categories of Each GDP & GDIKuznets & Stone; Fisher (price index).Nominal vs Real: Using the Price Index
Production of Output from Input
General Function and GraphRepresentative Agent EconomyCircular Flow: GDP = GDIClassical Dichotomy: Nominal & Real Economy
Application: US Real & Nominal GDP Growth
Appendix: Nominal vs Real Interest Rate: Fisher eqtn.
EconLowdown Module: GDP & Pizza
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Macro Divergence from MicroMicroeconomic to Macroeconomic Foundations
Great Depression: Facts (FRED)
Real GDP, Unemployment, In�ation, Currency/Deposits.Govt Spending including Defense and not.Comparison to Great Recession Facts.
Bifurcation of Macro Theory
Neoclassical Approach: Fisher, Hayek Debt-De�ation.Keynes�s Approach: 1930 Cross, Thry of Bus Cycle.National Accounting and Keynesian CrossPro�t � I - S; Excess Savings Spent by Govt.Add Keynes 1936 Consumption FunctionStabilization Policy Arises.
Applic: Grt Depression using Keynes Cross.
Append: Keynes�s Price Theory vs. Marshall�s.
EconLowdown Module: Great Depression 1 & 2.
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Figure: US Currency to Demand Deposit Ratio, 1923-1939.
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Busines Cycles, Crises & GrowthComovement & Crises
Facts of Cycle and Growth Trends (FRED)
Shares of GDP & GDI over Cycle
RBC Theory & Growth Theory & Crisis Theory
Friedman & Schwartz (1963) vs Kydland & Prescott (1982)
Applic: Equity Premium Puzzle.Append: Structural Transformation by Sector;
Why Doesn�t Capital Flow from Rich to Poor Neighborhoods?
EconLowdown Module: Unemployment.
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Figure: US 1930-2014, Growth Rate of Both Real Personal ConsumptionExpenditure (Red) and Real GDP (Blue) Minus 3.5% (trend growth rate).
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Money, Banking & PolicyComovement & Crises
Public Bank & Private Bank Money
Monetary Aggregates (FRED).Govt�s Central Bank: the Fed;Bank Panics Leading to Fed.Institutions & Mrkts.
Theory of Money Demand & Fisher.
Quantity Theory, In�ation Targeting, Taylor Rule.Temp & Permanent Liquidity E¤ects, & Wicksell.
Applic: Ex-Post US Real Interest Rates.
Append: Historical Money, In�ation & Debt;Fiscal Theory of the Price Level.
EconLowdown Module: Capital Markets.& Monetary Policy.
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Crises and In�ationComovement & Crises
Facts: WWI, WWII, Korean War & In�ation
Vietnam war In�ation: a period of "Peacetime".Granger Causality of Oil Prices by Money & In�ationKillian & coauthors on monetary causes of Oil prices.
Oil Price Shock Theory of Stag�ation: Mankiw (2015)
AS-AD with nominal prices vs Relative Prices.Monetary hypothesis of "OPEC Oil Shocks".In�ation Tax & Long run Growth.Phillips Curves: Theory, Evidence & Debt-De�ations.
Applic: Grt Depres. Turning Pt with �33 Banking Act & FDICAppend: US Banking Acts 1930�s and 2008.EconLowdown Module: Great In�ation, Grt Depres. 3 & 4.
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Figure: Real WTI Oil Prices, from Jan. 1947 to Dec. 1973: WTI US$ per barreldivided by US CPI index, in 1982 Constant Dollars.
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Figure: Real Oil Prices in 1982 US Dollars, 1947 -2016.
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InflationGrowth Relationship, OECD, Inflation <50%
0
1
2
3
4
5
6
7
8
9
1 9 19 29 39 49
Inflat ion
Gro
wth
growth
IVs
Spline
Figure: E¤ect of in�ation on real GDP Growth rate, OECD developed countrysample set; panel data estimation.
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Phillips Curves: During Bank Productivity ChangeAnd Corresponding Stock Market Change: Debt-De�ation & Credit-In�at.
Figure: Phillips Curve During US Stock Market Crash and the Great Recession
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July 2008-May 2009 Stock Crash with Bank Crash
Figure: S&P 500 Index During Great Recession.
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May 29-May 33: US Great Depression
Figure: US Phillips Curve During Great Depression
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Grt Depres. Stock Market Crash with Bank Crash
Figure: Dow Jones Industrial Average Percentage Change in Great Depression
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1960s "FAMOUS" Phillips Curve
Figure: Phillips Curve from 1959:1 to 1969:12
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Dawn of Multinational Corp & Global Finance: Bnk Prod.Boom
Figure: Dow Jones Industrial Average during the 1960�s.
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Savings, Investment & InterestCycles & Growth
Facts: Income Flow on Wealth; Savings & Investment data.Keynesian Analysis of Capital Market
IS: Supply shifts out by more than Demand, when Y " ;"Excess Savings" & Downward sloping IS.LM: D shifts out by more than S ; LM slopes up.Horizontal Lines on Solow Growth path: general case.Policy: Govt Spending & Money increases Good.
Fisherian Neoclass. 2-period Model of Sav & Invest.Business Cycle Explanation: just 2 joint Comparative Statics.TFP increase, and y0 endowment increase.Get Keynes (1936) only graph with y0 endowment increase.
Applic: Present Discounted Value.Append: Savings & Investment data on same basis (FRED).EconLowdown Module: Time Value of Money; & Soar toSavings.
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29 30 31 32 33 34 35 36 37 381.00
1.05
1.10
1.15
k Capital Investment, Savings
(1+r)/1
Figure: Shift Back in Supply and Upwards in Demand for Capital (Black), from aProductivity Increase Relative to Baseline (Red): Capital Investment (andSavings) Unchanged, but Interest Rate Higher.
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31 32 33 34 35 361.00
1.02
1.04
1.06
1.08
k Capital
(1+r)/1
Figure: An Increase in Current Income Endowment Shifts out the Supply ofCapital (Black Curve) and Lowers the Real Interest Rate.
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31 32 33 34 35 36 371.00
1.02
1.04
1.06
1.08
1.10
1.12
1.14
K1 Capital
1+r
Figure: Capital Market with 5% Increase in Goods Productivity and IncomeEndowment (Black) versus Baseline (Red).
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AS-AD & Business CyclesCycles & Growth
Facts
Monetary Prices Versus Relative PricesCapital to Goods Price & Debt-De�ationStylized Facts Of Cycles
Theory: Ramsey�s World with AS-AD
Ramsey Markets for Output, Labor and CapitalRBC Analysis: Goods & Time Endowment Changes
Application: Crisis from Fixed WageAppendix: Crisis from Bank Productivity Crash.EconLowdown Module: "The Great Depression 5".
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Figure: US Nominal Price of Goods (CPI) Divided by the Nominal Wage Rate(average weekly wage and salary, full time, 16 and over): P/W , 1979 to 2015
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Figure: Annual Growth Rate of Real Wage Rate and Trend-Adjusted Real GDP,US 1965:6-2014.
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Figure: Annual Average Growth Rates of US Civilian Labor Force ParticipationRate, 1957:7-2015.14, (Blue) and Normalized Real GDP (Red).
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0.14 0.16 0.18 0.20 0.22 0.24 0.26 0.28 0.30 0.320
5
10
15
Aggregate Output y
1/w
Figure: Business Cycle Expansion in Goods Market: AS � AD Equilibrium with5% Increase (in Black) in Both Productivity A and Time T as Compared to theOriginal (in Red).
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0.44 0.46 0.48 0.50 0.52 0.54 0.56 0.58 0.60 0.620.08
0.10
0.12
0.14
0.16
0.18
0.20
0.22
Labor Employment
w
Figure: Business Cycle Expansion: Labor Market has a Shift out in Demand(Black) and Pivoting of Supply (Black) as Compared to Original (Red).
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0 1 2 3 4 5
0.05
0.06
0.07
0.08
0.09
0.10
Capital Stock k
Real Interest Rate r
Figure: Capital Market Shows Shift Out of Demand for Capital (Black Curve)When both Factor Productivity A and Time Endowments T Increase by 5%relative to the Original Example Equilibrium (Red Curve).
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0.30 0.35 0.40 0.45 0.50 0.55 0.600.08
0.10
0.12
0.14
0.16
0.18
0.20
Labor Employment
w
Excess Supply
Figure: Excess Labor Supply with a Fixed Wage During Contraction (in Black)relative to the original example equilibrium (in Red).
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Growth, Progress and AS-ADCycles & Growth
Stylized Growth Rate Facts
Solow & Solow Plus Growth Facts
Theory: Growth Puzzle that Solow Solved
A Comparative Static Productivity IncreaseAS-AD with Solow GrowthSolow Growth from Ramsey WorldAS-AD with Continual Technological Progress
Application: Trend Down in TimeAppendix: Growth with Human CapitalEconLowdown Module ""Economic Growth".
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Figure: US Years of Education by Birth Cohort
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0.14 0.16 0.18 0.20 0.22 0.24 0.26 0.28 0.30 0.320
5
10
15
Aggregate Output y
1/w
Figure: AS � AD Equilibrium with Goods Productivity Increase (in Black) asCompared to the Original (in Red).
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0.3 0.4 0.5 0.6 0.70.05
0.10
0.15
0.20
0.25
0.30
Labor Employment
w
Figure: Increase in Productivity (Black Curves) Raises w and Leaves EmploymentUnchanged.
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0.23 0.24 0.25 0.26 0.27 0.285
6
7
8
9
10
Aggregate Output y
1/w
Figure: AS � AD Equilibria Over Time With 2% Exogenous Growth Example;Moving From Red to Black Curves over 4 years.
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0.590 0.595 0.600 0.605 0.610
0.135
0.140
0.145
0.150
0.155
0.160
Labor
Wage Rate w
Figure: Labor Market with 2% Exogenous Growth and Rising Real Wage,Constant Employment, Over Time.
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Policy as Social InsurancePolicy
Facts: British and American "Welfare States"Theory: Moral Hazard Danger of Social Insurance
Inequality and ConsumptionPermanent Income ConsumptionRamsey World�s Keynesian CrossSpanning Keynesian & Friedman ConsumptionSocial Insurance Examples
Application: FDIC Post-2010 Dodd-FrankAppendix: Taxes, Public Goods, InsuranceEconLowdown Modules "Government Budgets" & "FiscalPolicy".
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0 1 2 3
0.7
0.8
0.9
1.0
Y
C/Y = (a/Y)+ b
Figure: Consumption as a Fraction of Income: in the Keynesian Theory ofConsumption C = a+ bY .
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0.0 0.5 1.0 1.5 2.00.0
0.5
1.0
1.5
2.0
y_Perm
c/(y_Perm) = a
Figure: Consumption as a Fraction of Permanent Income: Ramsey-FriedmanTheory
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"Ramsey Cross"
0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.10 0.11 0.120.00
0.02
0.04
0.06
0.08
0.10
0.12
w Full Income
c
Figure: Ramsey Consumption Theory and Busines Cycles: Increase in A.Gillman (Federal Reserve Bank of St. Louis) With FRED and EconLowdown 3-4 November 2016 51 / 62
The Great Recession and Lost DecadePolicy
Facts: Fed "Bailout" of US Bank System?Theory: Bagehot�s law of �nancial e¢ ciency
Tax on Capital Markets, Welfare Loss,Financial "Repression"Seeking Yield": Capital Market DistortionGovernment Capital FloodingInternationally Ine¢ cient Bank SubsidizationDeconstructing 3-Equation Keynesian Bank Model
Application: Normalizing PolicyAppendix: Being Earnest on BankingEconLowdown Module "The Great Depression 6".
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Figure: Great Recession and Post 9/11 Negative Real Interest Rates (Green) vs.FFR (Blue) and CPI in�ation at a monthly frequency (Red).
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Fed Caused Lost Decade?Purple line (Total Assets) - (MBS) follows Red (Excess Reserves)
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Fed�s Assets Minus MBS & Excess Res.= 0
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Interest on Excess Reserves Forces Down Real Interest Rt.
Figure: Loan Ratio (Blue) & Real Int.Rt (Red)Gillman (Federal Reserve Bank of St. Louis) With FRED and EconLowdown 3-4 November 2016 56 / 62
Figure: Loan to Demand Deposit Ratios: Consumer Loans Ratio in Red;Commercial and Industrial Loans Ratio in Blue.
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When E¤ective Ceiling Imposed On Real Interest Rate
31 32 33 34 35 361.00
1.02
1.04
1.06
1.08
K1 Capital
1+r
Excess Demand For Capital
Figure: Savings and Investment: Aggregate Supply and Demand for Capital kWith Real Interest Rate Ceiling
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Fed�s Shift out of Supply of Capital through the OpenMarket Purchases of US Treasury or Treasury backedSecurities: Creating the Bank System�s Excess Reserves ."Excess Reserves" That Fed Supplied Buying Treas Debt
31 32 33 34 35 36 37 381.00
1.02
1.04
1.06
1.08
K1 Capital
1+r
Excess Reserves
Figure:Gillman (Federal Reserve Bank of St. Louis) With FRED and EconLowdown 3-4 November 2016 59 / 62
Capital Tax Wedge on Priv Invest. with High r forInvestmentLow r for Savings: Dead Weight Triangle Loss of Welfare
31 32 33 34 35 36 37 381.00
1.02
1.04
1.06
1.08
K1 Capital
1+r
Excess Reserves
Figure: "Deadweight Loss Triangle"Gillman (Federal Reserve Bank of St. Louis) With FRED and EconLowdown 3-4 November 2016 60 / 62
View of Wedge in Gen Equil CCAPMBrown Indi¤ Curve CUTS Prod Funct at Low Diversi�cation Level
0.0 0.2 0.4 0.6 0.8 1.00.00
0.05
0.10
0.15
0.20
0.25
Capital at Risk
Capital Yield
Figure: Optimal Portfolio Diversi�cation between Market Portfolio (Tangency)and "Risk-free" Government Debt.
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