The Missing Motivations in Macroeconomics

"The Missing Motivation in Macroeconomics" was written by George A. Akerlof in 2005.

Background

At the end of the 1970's, Keynesian economics was on the decline because of an occurence of increased inflation and increased unemployment. These occurring simultaneously had seemed impossible under the idea of a simple (non-accelerationist) Phillips Curve. However, economic views were also changing because world views were changing.

Many felt that the simple ideas used in Keynesian economics, increased inflation means decreased unemployment, were too simple. These economist believed that macroeconomic relations should be derived from economic principles: behavior of profit maximizing firms and utility maximizing consumers. These thoughts had a significant impact on macroeconomics because they did not reproduce the standard macroeconomic models. They produced five neutrality results:

• Independence of Consumption and Current Income

The standard theory tells us that only under special conditions does consumption depends on wealth.

• Modigliani-Miller Theorem

A firm's investment strategy being totally dependent on its liquidity position.

• Natural Rate Theory

Changes in fiscal/monetary mix will be neutral in their effects on long-term unemployment.

• Inability to Stabilize Output in the Presence of Rational Expectations

A systematic response to the business cycle will have no effect on macroeconomic stability.

• Ricardian Equivalence

In some special situations, a consumer who receives a lump sum transfer (like a Social Security payment) will not spend any extra money.

The purpose of this article is to understand people's preferences including the norms that reveal how they feel they, and others, should and should not behave. Although this is generally an idea in sociology, economists look at statistical relations to understand people's judgments.

The Missing Motivation: Norms

Each neutrality is based on the idea that decision makers are also utility maximizers, the functions have been narrowly described. The functions of decision makers depend only on real outcomes. According to Vilifredo Pareto people have opinions how they and others should (and should not) behave, and they lose utility if they or others fail to meet these behavioral standards. "Such notions are central motivation in sociology, but they are absent from economists' representations of utility." These views are called norms.

Daniel Kahneman and Amos Tversky have results that show people being unwilling to take bets with favorable odds because they are loss averse. These people have utility functions that are convex rather than concave. The thought is that people have a mental frame that makes them reluctant to lose. They believe that they should not take losses. If one fails to behave this way, he or she will lose utility.

Additionally, the Miligram experiment allows sociological norm-based theory to work together with behavioral economics. The focus is now on mental frames instead of in terms of preferences.

The Five Neutrality Results

• Ricardian Equivalence

• Dependence of Consumption on Wealth, not Income

• The Modigliani-Miller Theorem

• Natural Rate Theory

• Rational Expectations

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