Microeconomics And Macroeconomics Fluctuations

I have been engaged for some twenty year in research on the macroeconomic implications of individual inertia. Are aggregate outcomes impacted by the discontinuous nature of much microeconomic behavior? My analysis of this question dates back to my Ph.D. thesis at Yale University, from which the following article was derived.

The Variability of Aggregate Demand with S,s Inventory Policies, Econometrica, 1985, 1395-1410.

A current application of these ideas in an equilibrium setting is detailed in the following paper.

Durable Goods Cycles, with John Leahy, NBER Working Paper 6987, 1999.

This line of work has had its greatest impact when translated to the pricing arena, where the form of the inertia turns out to be very important. I have focused in particular on "state dependent" price stickiness, in which costs of adjustment imply that it is optimal to adjust only when the state of the economy has changed sufficiently. This form of inertia is very different than classical time dependent price stickiness, in which the interval between price adjustments is pre-set. Here are the articles that formalize some of these differences:

Menu Costs and the Neutrality of Money, with Daniel Spulber, Quarterly Journal of Economics, 1987, 703-726

State Dependent Pricing and the Dynamics of Money and Output, with John Leahy, Quarterly Journal of Economics, 1991, 683-708

Over the course of the years, John Leahy and I became convinced that the most important implications of microeconomic frictions for the aggregate economy would be based on informational linkages. If individuals are inert, much of their private information remains invisible, getting released only when they overcome their inertia and change behavior. This means that others will learn in a discrete fashion from the actions of others, and they may in turn be prompted to overcome their own inertia. The following papers deal with this issue of inertia and the pattern of information transmission.

Sectoral Shocks, Learning, and Aggregate Fluctuations, with John Leahy, Review of Economic Studies, 1993, 777-794

Business as Usual, Market Crashes, and Wisdom After the Fact, with John Leahy, American Economic Review, 1994. 548-565.

We applied our ideas to a policy question, noting that inertia makes the policy maker's job far more difficult, since the state of the economy may remain hidden.

Monetary Policy as a Process of Search, with John Leahy, American Economic Review 1996, 192-196

I believe that the ideas sketched out in the above papers capture an important set of truths. Yet it is not currently an active area of research. Fortunately or unfortunately, there is little interest these days in microeconomic models that may explain real economic fluctuations in the advanced economies. The reason is simple: there have not been major business cycle fluctuations for at least a decade. Various economies have obvious problems, but these seem more structural than cyclical. This is a period in which the existing models seem to be working very well, despite their unconvincing microeconomic foundations. I suspect that one day all this will change, and that we will again need to look in more depth at foundational issues. In the meantime, I have moved on to other areas in which the need for increased understanding remains readily apparent.