Seven Schools of Macroeconomic Thought This page intentionally left blank Arne Ryde 8 December 1944–1 April 1968 This page intentionally left blank Seven Schools of Macroeconomic Thought The Arne Ryde Lectures Edmund S.Phelps CLARENDON PRESS · OXFORD GreatClarendonStreet,OxfordOX26DP OxfordUniversityPressisadepartmentoftheUniversityofOxford ItfurtherstheUniversity'sobjectiveofexcellenceinresearch,scholarship, andeducationbypublishingworldwidein OxfordNewYork AucklandBangkokBuenosAiresCapeTownChennai Dar esSalaamDelhiHongKongIstanbulKarachiKolkata KualaLumpurMadridMelbourneMexicoCityMumbaiNairobi SãoPauloShanghaiTaipeiTokyoToronto Oxfordisaregisteredtrademark ofOxfordUniversityPress intheUK andincertainothercountries PublishedintheUnitedStatesby OxfordUniversityPressInc., NewYork ©EdmundS.Phelps1990 Firstpublished1990 Allrightsreserved.Nopartofthispublicationmaybereproduced, storedinaretrievalsystem,or transmitted,inanyform orbyanymeans, withoutthepriorpermissioninwriting ofOxfordUniversityPress, oras expresslypermittedbylaw, or under termsagreedwiththeappropriate reprographicsrightsorganization.Enquiriesconcerningreproduction outsidethescopeoftheaboveshouldbesenttotheRightsDepartment, OxfordUniversityPress,attheaddressabove Youmustnotcirculatethisbookinanyotherbindingorcover andyoumustimposethissameconditiononanyacquirer BritishLibraryCataloguinginPublicationData Phelps, EdmundS.(EdmundStrother) Sevenschoolofmacroeconomicthought— (TheArneRyde lectures) 1.Macroeconomics.Theories. I.TitleII.Series 339.301 ISBN0 19828333 4 LibraryofCongressCataloginginPublicationData Phelps,EdmundS. Sevenschoolsofmacroeconomicthought:theArneRydelectures/ EdmundS.Phelps. Includesbibliographicalreferences. 1. Macroeconomics.I.TitleII.Title:7 schoolsof macroeconomicthought.III.Title:ArneRydelectures. HB172.5.P4581990339–dc2089-49214 ISBN0 19828333 4 The Arne Ryde Foundation Arne Ryde was an exceptionally promising young student on the doctorate programme at the Department of Economics at theUniversityofLund. Hediedafteran automobile accidentin1968 whenonly twenty-threeyears old. In his memory his parents Valborg Ryde and pharmacist Sven Ryde established the Arne Ryde Foundation for the advancement of research at our department. We are most grateful to them. The Foundation has made possible important activities to which our ordinary resources are not applicable. In agreement with Valborg and Sven Ryde, we have decided to use the funds made available by the Foundation to finance major arrangements. We have from 1973 arranged a series of symposia in various fields of theoretical and applied economics. In May 1988 at Snogeholm Castle in Skane Professor Edmund S. Phelps held some lectures entitled ‘Recent Schools in Macroeconomic Theory’, published here as the first issue in a series of Arne Ryde Memorial Lectures. A new issue in the series is planned to appear about every second year. We are indeed glad that Professor Phelps agreed to come to Sweden to give the first Arne Ryde Memorial Lecture. Bjorn Thalberg This page intentionally left blank Preface This smallbookisa versionfor publicationoftheArneRydelectures givenatLund UniversityinMay 1988. Theyare the first in a series of lectures under the sponsorship of the Arne Ryde Foundation. It has been an unusual venture for me in a number of ways. There was, first, its method of total immersion. Though not known for a love of oratory, I found myself talking about macroeconomic theory for eight or nine hours in the space of two days. Happily, the audience of advanced students and assorted scholars managed to remain engaged the whole time, and so did the speaker. This was a gratifying experience. There was another departure. Until then I had always worked on my own ideas. But this enterprise used the studio system, built around the producer. The subject of these lectures was entirelythe idea of Bjorn Thalberg, who as head of the Ryde Foundation instituted the new lecture series. He suggested to me that one could divide macroeconomics these days into a number of schools of thought and that there would be a wide audience for an appraisal of their progress and prospects. The work of defining the schools and evaluatingthem was left to me. This arrangement was conducive to more risk-taking, I suspect, than would have resulted had the whole responsibility for the enterprise rested on me. Theopportunitytoshare my views onpresent-day macroeconomicsseemstome tocome at therightmoment.Some observersconsider macroeconomicstobeina sorrystate,confusedbyrecentexperienceand rivenbymethodological dissension. I agree it is destructive when the more zealous participants wage a crusade to exclude or demote other approaches and other questions. Some of the combatants, in the heat of battle, seem to see themselves in a Western epic between good guys and bad guys, a second Methodenstreit a century after the first. x PREFACE To me, however, it is themost interestingtime in macroeconomics since the rise of micro-macro theory in the 1960s. It is a time in which macroeconomists are again entertaining new hypotheses about the mechanisms governing the economy and reaching out for a new ‘paradigm’—not all reaching in the same direction, of course. To me the recent empirical puzzles and the increased diversity of approaches constitute another demonstration that no school can expect its approach to be right for every place and period. Pluralism is best, and recurrent outbreaks of pluralism are inevitable in any case. I see seven living schools of thought to be of importance in macroeconomic theory today. These are all thriving schools withan activeresearch programme, however numbered theirdays. Some once-important schools from which the profession has moved away have not made it to the grand list. Friends have suggested that the thesis of exactly seven extant schools is an artifice of the imagination, like the seven pillars of wisdom or the seven kinds of ambiguity. I suspect they think that three or four macroeconomic schools would be quite enough. The distinctions I have made were a function of the aspects of macroeconomic theory to which I have been particularly attracted. Much of my interest in macroeconomics has been directed to price-wage setting and to the role ofexpectations, andmakingdistinctionsamongmodelswithrespecttothoseaspectsleadseasilytoalarger numberof schools than are commonly defined. Onedimensionalongwhichwecanclassifyschools ofthoughtpertains tothetreatmentofwagesand prices. Someof the more recent models contain, explicitlyor implicitly, either real-wage rigidity in some sense or real-wage stickiness. The contrasting asynchronicity models possess one or another kind of impediment to the adjustment of nominal wages or prices, whichgives rise to a stickiness in the average wage or price level.(While in any day some wages may bechanging,mostwagesorpricesaretemporarilyunchangingbecauseofthresholdorschedulingeffects.)Finallythere is a great variety of models