Saturday, September 02, 2006

A joke for macroeconomists

The joke is from Greg Mankiw.

A group of macroeconomists are sitting on a panel at a conference discussing developments in the discipline.

In a heated exchange, the New Keynesian says to the Real Business Cyclist: "You guys have put macroeconomics back twenty years with this nonsense!"

The Real Business Cyclist smiles and says "So you DO believe in negative productivity shocks after all."

I am pretty sure that most people don’t get it. So I’ll try to explain.

The fundamental problem in macroeconomics is to understand why recessions happen.

One line of argument is that there is a potential output that the economy can produce, but at any given point in time the economy might produce less than this potential because of some shortfall in demand, and if this ‘output gap’ between actual and potential is too big or too prolonged then we have a recession. Keynes’s general theory gives a story along these lines. In this view of the world, governments can boost demand by cutting taxes, building roads / missile defense systems or just dropping helicopter-loads of money.

Another argument is that the there is a trend output that the economy can produce, and at any given point in time the economy might be either above or below this trend because of variations in the supply, and recessions happen when there are negative productivity shocks. The real business cycle models are along these lines. In this view of the world, it is not immediately clear what the governments could do during a recession.

Since most macroeconomists depend on the government for a living, this view of the world is not very popular among them. Some of them, the New Keynesians, use similar modeling techniques as the RBC types to tell a Keynesian story. These guys say that they don’t believe in negative productivity shocks.

Now that I have explained the joke, I admit to finding it hilarious. I should also note Mankiw’s student’s pointer: I don't know what's more perverse... that I understand the joke or that I find it really funny.