Macroeconomic Priorities

Macroeconomics was born as a distinct Ž eld in the 1940’s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades. There remain important gains in welfare from better Ž scal policies, but I argue that these are gains from providing people with better incentives to work and to save, not from better Ž ne-tuning of spending  ows. Taking U.S. performance over the past 50 years as a benchmark, the potential for welfare gains from better long-run, supply-side policies exceeds by far the potential from further improvements in short-run demand management. My plan is to review the theory and evidence leading to this conclusion. Section I outlines the general logic of quantitativewelfare analysis, in which policy comparisons are reduced to differences perceived and valued by individuals. It also provides a brief review of some examples—examples that will be familiar to many—of changes in long-run monetary and Ž scal policies that consumers would view as equivalent to increases of 5–15 percent in their overall consumption levels. Section II describes a thought-experiment in which a single consumer is magically relieved of all consumption variability about trend. How much average consumption would he be willing to give up in return? About one-half of onetenth of a percent, I calculate. I will defend this estimate as giving the right order of magnitude of the potential gain to society from improved stabilization policies, but to do this, many questions need to be addressed. How much of aggregate consumption variability should be viewed as pathological? How much can or should be removed by monetary and Ž scal means? Section III reviews evidence bearing on these questions. Section IV considers attitudes toward risk: How much do people dislike consumption uncertainty? How much would they pay to have it reduced? We also know that business-cycle risk is not evenly distributed or easily diversiŽ ed, so welfare cost estimates that ignore this fact may badly understate the costs of  uctuations. Section V reviews recently developed models that let us explore this possibility systematically. These are hard questions, and deŽ nitive answers are too much to ask for. But I argue in the end that, based on what we know now, it is unrealistic to hope for gains larger than a tenth of a percent from better countercyclical policies.