Tuesday, December 4, 2012

A Review of Roger Farmer's Books

My review of Roger E.A. Farmer's Expectations, Employment and Prices and How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies has finally appeared in the Eastern Economic Journal.

Farmer's ideas are spiritually Keynesian, but he accepts the belief which developed out of the work of Friedman, Lucas and others, that macroeconomic theory should be consistent with microeconomic optimization.  His point of departure from standard DSGE models (both of the Real Business Cycle and New Keynesian varieties) is that he allows for the lack of a unique equilibrium in the labor market.  This opens up a key role for asset values and confidence in determining output, with the policy implication that monetary policy should be directed at stabilizing asset prices.

Expectations is addressed to a professional audience economics book, while How the Economy Works second is written for a general audience.  How the Economy Works also provides a nice overview of how macroeconomics has evolved which would be a good background for laypersons and students about some of the debates within the field.

A subscription is necessary to read the review, which concludes:
The financial crisis and recession have led to considerable hand-wringing and soul-searching by macroeconomists. Caballero [2010, p. 85] argues that “macroeconomic research has been in ‘fine-tuning’ mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in ‘broad-exploration’ mode.” Farmer's work answers that call nicely. It is a synthesis in the best sense of the word, blending Keynesian insight with key subsequent developments such as rational expectations, the permanent income hypothesis and the search model of the labor market. It deserves the attention of macroeconomists, who will find it a healthy challenge to their thinking.

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