The foundations want a different castle.īob’s “islands” paper is famous, yes, for a complete model of how unexpected money might move output in the short run and not just raise inflation. But building foundations under an existing castle doesn’t work. Economists recognized this weakness, and a vast and now thankfully forgotten literature tried fruitlessly to find “micro foundations” for Keynesian economics. Today’s consumption depended on today’s income, having nothing to do with whether people expected the future to look better or worse. Most importantly, macroeconomics treated each year as a completely separate economy. One wrote down equations for quantities rather than people, for example that “consumption” depended on “income,” and investment on interest rates.
Macroeconomics, exemplified by the ISLM tradition, inhabited a different planet. But it was devoted to proving the existence of equilibrium with more and more general assumptions, and never got around to calculating that equilibrium and what it might say about recessions and government policies. I took a lot of general equilibrium classes as a PhD student - Berkeley, home of Gerard Debreu was strong in the field. Set this in motion and see where it all settles down what prices and quantities result.īut for macroeconomic issues, this approach was sterile. Then it similarly described how companies behave and how government behaves. Microeconomic models, and “general equilibrium” as that term was used at the time, wrote down how people behave - how they decide what to buy, how hard to work, whether to save, etc. You can’t keep track of everything in even the most beautiful prose. Economics is all about “models,” complete toy economies that we construct via equations and in computer programs. Macroeconomics until 1970 was sharply different from regular microeconomics. It was really the “general equilibrium” revolution. The “rational expectations” revolution that brought down Keynesianism in the 1970s was really much larger than that.
Here I describe a little bit of his intellectual influence, in a form that is I hope accessible to average people. My first post described a few anecdotes about what a warm person Bob Lucas was, and such a great colleague.
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