by Solow’s Nobel Prize lecture One of the achievements of growth theory was to relate equilibrium growth to asset pricing under tranquil conditions. The hard part of disequilibrium growth is that we do not have — and it may be impossible to have — a really good theory of asset valuation under turbulent conditions … One important tendency in contemporary macroeconomic theory evades this problem in an elegant but (to me) ultimately implausible way. The idea is to imagine that the economy is populated by a single immortal consumer, or a number of identical immortal consumers. The immortality itself is not a problem: each consumer could be replaced by a dynasty, each member of which treats her successors as extensions of herself. But no short-sightedness can
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Solow’s Nobel Prize lecture
One of the achievements of growth theory was to relate equilibrium growth to asset pricing under tranquil conditions. The hard part of disequilibrium growth is that we do not have — and it may be impossible to have — a really good theory of asset valuation under turbulent conditions …
One important tendency in contemporary macroeconomic theory evades this problem in an elegant but (to me) ultimately implausible way. The idea is to imagine that the economy is populated by a single immortal consumer, or a number of identical immortal consumers. The immortality itself is not a problem: each consumer could be replaced by a dynasty, each member of which treats her successors as extensions of herself. But no short-sightedness can be allowed. This consumer does not obey any simple short-run saving function, nor even a stylized Modigliani life-cycle rule of thumb. Instead she, or the dynasty, is supposed to solve an infinite-time utility-maximization problem. That strikes me as far-fetched, but not so awful that one would not want to know where the assumption leads.
The next step is harder to swallow in conjunction with the first. For this consumer every firm is just a transparent instrumentality, an intermediary, a device for carrying out intertemporal optimization subject only to technological constraints and initial endowments. Thus any kind of market failure is ruled out from the beginning, by assumption. There are no strategic complementarities, no coordination failures, no prisoners’ dilemmas.
The end result is a construction in which the whole economy is assumed to be solving a Ramsey optimal-growth problem through time, disturbed only by stationary stochastic shocks to tastes and technology. To these the economy adapts optimally. Inseparable from this habit of thought is the automatic presumption that observed paths are equilibrium paths. So we are asked to regard the construction I have just described as a model of the actual capitalist world. What we used to call business cycles – or at least booms and recessions are now to be interpreted as optimal blips in optimal paths in response to random fluctuations in productivity and the desire for leisure.
I find none of this convincing. The markets for goods and for labor look to me like imperfect pieces of social machinery with important institutional peculiarities. They do not seem to behave at all like transparent and frictionless mechanisms for converting the consumption and leisure desires of households into production and employment decisions. I can not imagine shocks to taste and technology large enough on a quarterly or annual time scale to be responsible for the ups and downs of the business cycle.