Disequilibrium macroeconomics

Disequilibrium macroeconomics is a tradition of research centered on the role of deviation from equilibrium in economics. This approach is also known as non-Walrasian theory, equilibrium with rationing, the non-market clearing approach, and non-tâtonnement theory.^[1] Early work in the area was done by Don Patinkin, Robert W. Clower, and Axel Leijonhufvud. Their work was formalized into general disequilibrium models, which were very influential in the 1970s. American economists had mostly abandoned these models by the late 1970s, but French economists continued work in the tradition and developed fixprice models. Other approaches that focus on the dynamic processes and interactions in economic systems that are constantly changing and do not necessarily settle into a stable state are discussed as non-equilibrium economics.^[2][3]

Macroeconomic disequilibria

In the neoclassical synthesis, equilibrium models were the rule. In these models, rigid wages modeled unemployment at equilibria. These models were challenged by Don Patinkin and later disequilibrium theorists. Patinkin argued that unemployment resulted from disequilibrium.^[4] Patinkin, Robert W. Clower, and Axel Leijonhufvud focused on the role of disequilibrium.^[5] Clower and Leijonhufvud argued that disequilibrium formed a fundamental part of Keynes's theory and deserved greater attention.^[6]

Robert Barro and Herschel Grossman formulated general disequilibrium models,^[7] in which individual markets were locked into prices before there was a general equilibrium. These markets produced "false prices" resulting in disequilibrium.^[8] Soon after the work of Barro and Grossman, disequilibrium models fell out of favor in the United States^[9][10][11] and Barro abandoned Keynesianism and adopted new classical, market-clearing hypotheses.^[12] However, leading American economists continued work with disequilibrium models, for example Franklin M. Fisher at MIT, Richard E. Quandt at Princeton University, and John Roberts at Stanford University.^{[13][14][15][16]}

Disequilibrium and unemployment

Diagram based on Malinvaud's typology of unemployment shows curves for equilibrium in the goods and labor markets given wage and price levels. Walrasian equilibrium is achieved when both markets are at equilibrium. According to Malinvaud the economy is usually in a state of either Keynesian unemployment, with excess supply of goods and labor, or classical unemployment, with excess supply of labor and excess demand for goods.^[17]

While disequilibrium economics had only a supporting role in the US, it had major role in European economics, and indeed a leading role in French-speaking Europe.^[18] In France, Jean-Pascal Bénassy (1975) and Yves Younès (1975) studied macroeconomic models with fixed prices. Disequilibrium economics received greater research as mass unemployment returned to Western Europe in the 1970s.^[19][20][21] Disequilibrium economics also influenced European policy discussions, particularly in France and Belgium.^[20][22][23] European economists such as Edmond Malinvaud and Jacques Drèze expanded on the disequilibrium tradition and worked to explain price rigidity instead of simply assuming it.^[24]

Malinvaud used disequilibrium analysis to develop a theory of unemployment.^[25] He argued that disequilibrium in the labor and goods markets could lead to rationing of goods and labor, leading to unemployment.^[25] Malinvaud adopted a fixprice framework and argued that pricing would be rigid in modern, industrial prices compared to the relatively flexible pricing systems of raw goods that dominate agricultural economies.^[25] In Malinvaud's framework, prices are fixed and only quantities adjust.^[17] Malinvaud considers an equilibrium state in classical and Keynesian unemployment as most likely. He pays less attention to the case of repressed inflation and considers underconsumption/unemployment a theoretical curiosity.^[26] Work in the neoclassical tradition is confined as a special case of Malinvaud's typology, the Walrasian equilibrium. In Malinvaud's theory, reaching the Walrasian equilibrium case is almost impossible to achieve given the nature of industrial pricing.^[26] Malinvaud's work provided different policy prescriptions depending on the state of the economy.^[26] Given Keynesian unemployment, fiscal policy could shift both the labor and goods curves upwards leading to higher wages and prices. With this shift, the Walrasian equilibrium would be closer to the actual economic equilibrium. On the other hand, fiscal policy with an economy in the classical unemployment would only make matters worse. A policy leading to higher prices and lower wages would be recommended instead.^[27]

"Disequilibrium macroeconometrics" was developed by Drèze's, Henri Sneessens (1981) and Jean-Paul Lambert (1988).^[28] A joint paper by Drèze and Sneessens inspired Drèze and Richard Layard to lead the European Unemployment Program, which estimated a common disequilibrium model in ten countries.^[29] The results of that successful effort were to inspire policy recommendations in Europe for several years.^[22][23]

Disequilibrium extensions of Arrow–Debreu general equilibrium theory

In Belgium, Jacques Drèze defined equilibria with price rigidities and quantity constraints and studied their properties, extending the Arrow–Debreu model of general equilibrium theory in mathematical economics. Introduced in his 1975 paper, a "Drèze equilibrium" occurs when supply (demand) is constrained only when prices are downward (upward) rigid, whereas a preselected commodity (e.g. money) is never rationed. Existence is proved for arbitrary bounds on prices. A joint paper with Pierre Dehez established the existence of Drèze equilibria with no rationing of the demand side. Stanford's John Roberts studied supply-constrained equilibria at competitive prices;^[30] similar results were obtained by Jean-Jacques Herings at Tilburg (1987, 1996).^[31] Roberts and Hering proved the existence of a continuum of Drèze equilibria. Then Drèze (113) proved existence of equilibria with arbitrarily severe rationing of supply. Next, in a joint paper with Herings and others (132), the generic existence of a continuum of Pareto-ranked supply-constrained equilibria was established for a standard economy with some fixed prices. The multiplicity of equilibria thus formalises a trade-off between inflation and unemployment, comparable to a Phillips curve. Drèze viewed his approach to macroeconomics as examining the macroeconomic consequences of Arrow–Debreu general equilibrium theory with rationing, an approach complementing the often-announced program of providing microfoundations for macroeconomics.^[20]

Specific economic sectors

Credit markets

Main article: Credit rationing

Disequilibrium credit rationing can occur for one of two reasons. In the presence of usury laws, if the equilibrium interest rate on loans is above the legally allowable rate, the market cannot clear and at the maximum allowable rate the quantity of credit demanded will exceed the quantity of credit supplied.

A more subtle source of credit rationing is that higher interest rates can increase the risk of default by the borrower, making the potential lender reluctant to lend at otherwise attractively high interest rates.

Labour markets

Main article: Labour shortage

Main article: Unemployment

Labour markets are prone to particular sources of price rigidity because the item being transacted is people, and laws or social constraints designed to protect those people may hinder market adjustments. Such constraints include restrictions on who or how many people can be laid off and when (which can affect both the number of layoffs and the number of people hired by firms that are concerned by the restrictions), restrictions on the lowering of wages when a firm experiences a decline in the demand for its product, and long-term labor contracts that pre-specify wages.

Spillovers between markets

Main article: Effective demand

Disequilibrium in one market can affect demand or supply in other markets. Specifically, if an economic agent is constrained in one market, his supply or demand in another market may be changed from its unconstrained form, termed the notional demand, into a modified form known as effective demand. If this occurs systematically for a large number of market participants, market outcomes in the latter market for prices and quantities transacted (themselves either equilibrium or disequilibrium outcomes) will be affected.

Examples include:

• If the supply of mortgage credit to potential homebuyers is rationed, this will decrease the demand for newly built houses.
• If labourers cannot supply all the labor they wish to, they will have constrained income and their demand in the goods market will be lower.
• If employers cannot hire all the labor they wish to, they cannot produce as much output as they wish to, and supply in the market for their good will be diminished.

See also

• Non-equilibrium economics
• Post-Keynesian economics
• Cash-in-advance constraint
• Involuntary unemployment
• Credit rationing
• Labour shortage
• Effective demand

Notes

1. Backhouse & Boianovsky 2012, p. 8.
2. Katzner, Donald W. (2003). "Equilibrium and Non-equilibrium". In King, J.E. (ed.). The Elgar Companion to Post Keynesian Economics. Cheltenham, UK: Edward Elgar. pp. 126–131.
3. Berger, Sebastian (2009). The Foundations of Non-Equilibrium Economics: The Principle of Circular Cumulative Causation. Routledge.
4. Beaud & Dostaler 1997, p. 122.
5. Beaud & Dostaler 1997, pp. 121–123.
6. Tsoulfidis 2010, p. 288.
7. Barro, Robert J.; Grossman, Herschel I. (1971). "A General Disequilibrium Model of Income and Employment". American Economic Review. 61 (1): 82–93.
8. De Vroey 2002, p. 383.
9. Hoover 2003, p. 419.
10. Mankiw 1990.
11. Snowdon & Vane 2005, p. 72.
12. Barro 1979.
13. F. M. Fisher. Disequilibrium Foundations of Equilibrium Economics. New York: Cambridge University Press. Econometric Society Monographs. 1983.
14. Richard E. Quandt wrote several books on disequilibrium economics:

    • (with Stephen M. Goldfeld), Nonlinear Methods in Econometrics, North Holland Publishing Co., (1972).
    • The Econometrics of Disequilibrium, Blackwell Publishing Co., Oxford (1988).
15. Quandt, Richard E.; Rosen, Harvey S. (1988). The conflict between equilibrium and disequilibrium theories: The case of the U.S. labor market. Kalamazoo, Michigan: Upjohn Institute.
16. Luc Bauwens, Michel Lubrano, Jean-François Richard. 1999. Bayesian Inference in Dynamic Econometric Models. Oxford University Press.
17. Tsoulfidis 2010, p. 294.
18. Quandt & Rosen (1988, p. 5) wrote

    The debate between protagonists of the equilibrium paradigm and the disequilibrium paradigm has a strong ideological flavor. Proponents of one view frequently think that the alternative view is worthless or downright silly. A few years ago, one of us gave several seminars on the question of how one would test the null hypothesis that [potential data is generated] from an equilibrium as opposed to a disequilibrium specification. On some occasions (mostly in the U.S.), five minutes into the seminar it would be interrupted with the remark, 'What you are trying to do is silly, because everybody knows that prices always clear markets and therefore there is nothing to test.' At other times (mostly in Europe) the interruption took the form, 'What you are trying to do is silly, because everybody knows that prices never clear markets and therefore there is nothing to test.'

19. Jacques H. Drèze. 1987. "Underemployment Equilibria: From Theory to Econometrics and Policy" [First Congress of the European Economic Association, Presidential Address] European Economic Review, 31: 9—34. Reprinted in Drèze 1993: Underemployment Equilibria: Essays in Theory, Econometrics and Policy, Cambridge University Press, Cambridge, 1991.
20. "From uncertainty to macroeconomics and back: an interview with Jacques Drèze", Pierre Dehez and Omar Licandro. Macroeconomic Dynamics, 9, 2005, 429–461.
21. The rise of European unemployment prompted several books by Edmond Malinvaud:

    • "Theory of Unemployment Reconsidered", 1977.
    • Malinvaud and Fitoussi, editors, Unemployment in Western Countries.
    • "Profitability and Unemployment", 1980.
    • "Théorie macroéconomique", 2 volumes, 1981-2.
    • "Mass Unemployment", 1984
22. • Drèze, Jacques H.; Malinvaud, Edmond. 1994. 'Growth and employment: The scope for a European initiative', European Economic Review 38, 3—4: 489—504.
    • Drèze, Jacques, E. Malinvaud, P. De Grauwe, L. Gevers, A. Italianer, O. Lefebvre, M. Marchand, H. Sneesens, A. Steinherr, Paul Champsaur, J.-M. Charpin, J.-P. Fitoussi & G. Laroque (1994) "Growth and employment: the scope for a European initiative". European Economy, Reports and Studies 1, 75–106.
23. Unemployment: Macroeconomic Performance and the Labour Market, Richard Layard, S. Nickell and R. Jackman) Oxford University Press, 2nd ed., 2005.
24. Beaud & Dostaler 1997, p. 123.
25. Tsoulfidis 2010, p. 293.
26. Tsoulfidis 2010, p. 295.
27. Tsoulfidis 2010, p. 296.
28. • Sneessens, Henri B. 1981. Theory and Estimation of Macroeconomic Rationing Models. Springer-Verlag Lecture Notes in Economics and Mathematical Systems, Volume 191.
    • Lambert, Jean-Paul. 1988. Disequilibrium Macroeconomic Models: Theory and Estimation of Rationing Models Using Business Survey Data. Cambridge UP.
29. Jacques H. Drèze, Charles R. Bean, JP Lambert. 1990. Europe's Unemployment Problem. MIT Press. This book has chapter-versions of the following refereed articles:

    • Henri R. Sneessens and Jacques H. Drèze. 1986. "A Discussion of Belgian unemployment, combining traditional concepts and disequilibrium econometrics." Economica 53: S89—S119. [Supplement: Charles Bean, Richard Layard, and Stephen Nickell, eds. 1986. The Rise in Unemployment. Blackwell]
    • Jacques H. Drèze and Charles Bean. 1990. "European unemployment: Lessons from a multicountry econometric study." Scandinavian Journal of Economics Vol 92, No. 2: 135—165 [Bertil Holmlund and Garl-Gustaf Löfgren, eds. Unemployment and Wage Determination in Europe. Blackwell. 3—33. In Dréze 1993.]
30. Roberts, J. (1987). "An equilibrium model with involuntary unemployment at flexible, competitive prices and wages". American Economic Review. 77: 856–74.
31. • Herings, J. J. (1996), Static and Dynamic Aspects of General Disequilibrium Theory, Kluwer.

References

• Backhouse, Roger; Boianovsky, Mauro (2012). Transforming modern macroeconomics : exploring disequilibrium microfoundations, 1956–2003. New York: Cambridge University Press. ISBN 978-1-107-02319-2.
• Barro, R. J. (1979). "Second Thoughts on Keynesian Economics". The American Economic Review. 69 (2): 54–59. JSTOR 1801616.
• Beaud, Michel; Dostaler, Gilles (1997). Economic Thought since Keynes. New York: Routledge. ISBN 978-0-415-16454-2.
• De Vroey, Michel (2002). "Involuntary unemployment in Keynesian economics". In Snowdon, Brian; Vane, Howard (eds.). An Encyclopedia of Macroeconomics. Northampton, Massachusetts: Edward Elgar Publishing. pp. 381–385. ISBN 978-1-84542-180-9.
• Hoover, Kevin D. (2003). "A History of Postwar Monetary Economics and Macroeconomics". In Samuels, Warren J.; Biddle, Jeff E.; Davis, John B. (eds.). A Companion to the History of Economic Thought. Malden, Massachusetts: Blackwell Publishing. pp. 411–427. ISBN 978-0-631-22573-7.
• Mankiw, N. Gregory (December 1990). "A Quick Refresher Course in Macroeconomics". Journal of Economic Literature. 28 (4): 1645–1660. doi:10.3386/w3256. JSTOR 2727441.
• Snowdon, Brian; Vane, Howard (2005). Modern Macroeconomics. Cheltenham, UK: Edward Elgar. ISBN 978-1-84542-208-0.
• Tsoulfidis, Lefteris (2010). Competing schools of economic thought. London: Springer. ISBN 978-3-540-92692-4.