Macroeconomic Policy: The Elephant in the Room

Alejandro Nadal

International conferences on poverty and the environment come and go. There’s always a big pachyderm in the meeting room. It’s got the words “macroeconomic policy” written on its forehead. Nobody wants to talk about it.

Consider the following. The Millennium Development Goals were debated in many conferences, but nobody spoke about the macroeconomic policy framework needed to achieve them. As if reducing hunger and extreme poverty, generating employment and providing health services and education had nothing to do with fiscal policy, monetary policy and financial deregulation. Aside from some pious words about financing and overseas development assistance, the implicit message was to carry on with the same macroeconomic policies. That could only have been based on faith in the trickle-down potential of neo-liberal globalization.

At UNFCCC-COP events, everyone recognized there are serious issues in terms of financial resources for mitigation and adaptation. Vulnerability and poverty go hand in hand, it is said. But, again, nobody wanted to discuss the relationship between neo-liberal macroeconomic policies and poverty, as if they had no connection. Even the Stern report kept safely away from the thorny issues of macroeconomic policies in developing countries.

Then came the Bad Times. The 2008 crisis led the UN Environment Program (UNEP) to launch its Green Economy Initiative and the Global Green New Deal (GGND). Their objective is to revive the global economy, “boost employment and accelerate the fight against climate change, environmental degradation and poverty.” According to the GGND, the triple crises demand the same kind of initiative as shown by Roosevelt’s New Deal of the 1930s, but “at the global scale and embracing a wider vision.” The punch line is that “re-booting the world economic system” is simply not enough to get us on the road to sustainability.

One would think that macroeconomic policy would be a relevant issue in this context, especially after the reference to FDR’s “New Deal.” Well, the authors appear to think differently: the Global Green New Deal is unconcerned with macroeconomic policies.

What? Monetary and fiscal policies, financial regulation, exchange and interest rates, capital flows, and incomes’ policies, they have nothing to do with environmental and social sustainability?

Let’s assume we keep a monetary policy obsessed with price stabilization, a fiscal policy focused on generating a primary surplus for “responsible debt management”, an open capital account and financial deregulation. On top of this, let’s say we also maintain downward trends for real wages. Clearly, more efficient automobiles and intelligent buildings will not, by themselves, give us at the end of the day a “green global economy.”

Why is macroeconomic policy ignored in so many important conferences? Is it because macroeconomics focuses on the short term and is unconcerned with long term developmental and sustainability issues? This is a real problem, but I think there might be a deeper reason.

Perhaps another explanation is the state in which macroeconomic theory finds itself today. For one thing, many people find it difficult to get around in this messy land where everything is, as Blanchard and Fischer once remarked, in a state of flux. What with getting to know who are the New Keynesians and how they differ from the Keynesians, the Neo-Keynesians and the Post-Keynesians, it can get a bit confusing.

I’ve heard people in progressive circles talk about the interest rate as if the loanable funds of the old Classical school were not only correct, but in fact the only theoretical reference. Similarly, the response to Herman Daly’s call for an environmental macroeconomics came in a series of articles using the venerable IS-LM model (including Daly’s contributions), without realizing that the model’s flaws made it useless, both from a policy and a theoretical perspective. Yes, many think that the IS-LM framework is still alive in central banks. Perhaps, but there are a lot of silly models in central banks and that’s not sufficient reason for us to rely on them. Obviously we need to be more careful on how we think about macroeconomics.

Maybe there is an additional explanation for why the elephant in the room is met with silence. Discussing macroeconomic policies raises awareness about the inner workings of the neo-liberal model and its political economy. Suddenly, the relation between cuts in social expenditures and a primary surplus becomes crystal clear. The rapport between controlling inflation and holding back aggregate demand (all too frequently through repressing real wages) turns out to be self-evident. Pretty soon people are talking about how macroeconomic policy is subordinated to the priorities of financial capital. This morphs the discussion into a political debate, something the establishment dislikes.

Progressive movements need to seize the initiative in defining new avenues for macroeconomic policy. They have done this in debates on agricultural policies, as well as with social and environmental policies. But we still have a long way to go to replace that elephant with a friendly creature.

14 Responses to “Macroeconomic Policy: The Elephant in the Room”

  1. Kevin P. Gallagher says:

    Very, very well put Alejandro. Coming from Mexico, you know this only too well. Mexico’s (low) inflation targeting and tight fiscal policy made the Mexican peso persistently overvalued to the dollar–especially relative to competitors like China, South Korea, and Malaysia. Add a privatized then deregulated banking sector that made credit too expensive for domestic firms. Add the North American Free Trade Agreement that imposed draconian restrictions on policies for industrial competitiveness. Sum all that and you get slow growth, the environmental costs of which are 10 percent of GDP. You get persistent poverty and one of the most unequal countries in the world. A green new deal that tried to operate in such an environment would be doomed to fail.

  2. Sandwichman says:

    A macroeconomic model is only as good as its assumptions. But there are certain assumptions that we know are false that you must make and there are other assumptions that we know are true that you may not make for a macroeconomic model to be tractable. The question then becomes, “what do you want? truth or tractability?”

  3. The tension between a downward trend in real wages during a time of increasing productivity results from raw political power, no ifs ands or buts. And it’s true that price stability is not something to seek automatically, across the entire economy, some prices obviously need to be rationalized with hefty increases, still, maintaining the function of currency as a store of value over time is something justice requires us to pay attention to.

  4. I think the problem with most macro models used for policy is that there is a surprising acceptance of the notion of a natural rate of unemployment. That’s why the role for fiscal policy is limited to recessions, and monetary policy is only used to keep inflationary expectations under check. And that’s also why Blanchard’s rethinking of macroeconomic policy ( is limited to increasing the inflation targeting. It’s a bit incredible that this proverbial black cat in the dark room that nobody has ever seen dominates macro policy.

  5. I would say relevance rather than truth. And neoclassical models have always posed a harsh trade off between relevance and tractability, but that is not necessarily the case. Macroeconomic models with effective demand and no natural rate are relevant and can be very tractable. I don’t buy the idea that you must choose.

  6. Some assumptions and abstractions are essential, but all too frequently they serve to block out things that go against our beloved fixed ideas. A good example of models that are both irrelevant and (perilously) close to intractability: new-Keynesian dynamic stochastic general equilibrium models. These models assume away aggregation problems and explosive trajectories. There is very little room in them for any interesting macroeconomic problem. Perhaps that explains their popularity.

  7. Right on, Alejandro,

    The IS-LM framework of reference is attempted abstraction of thermodynamic reality into the realm of commerce (there are many reasons for avoiding statistical representation thermodynamic reality, one is admitting that knowledge of a precise state is impossible). It is illogical to study abstract reductions of demand and supply when the decision to be made involves something like a just wage or transfer of natural resources to an income generation account because of theoretical graph intersections, the latter being a decision which may remove a life form from its right to continued existence.

  8. Ilene Grabel says:

    Another issue is that some important ideas that macroeconomists hold to be true are not empirically supported. These ideas function as ideologies rather than as empirically verifiable and/or internally consistent theories. An example of this is the universal embrace by neo-liberals of independent central banks. The majority of the economics profession assumes that independent central banks promote low inflation, which is assumed to be an essential goal for developing countries. But empirical evidence shows that (a.) independent central banks in developing countries are not consistently associated with low levels of inflation, and (b.) more importantly, that wringing inflation out of developing economies should not be the main goal of macroeconomic policy since inflation reduces economic growth only when it rises above moderate levels (which varying studies define as being in the range of 20% to up to 40%).

  9. anon says:

    Indulging macroeconomic fantasies is well and good for rich countries, but for starving nations, honestly, a pure micro approach is better because you can’t put food on the table with a naked sham.

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  13. Pretty soon people are talking about how macroeconomic policy is subordinated to the priorities of financial capital. This morphs the discussion into a political debate, something the establishment dislikes.

  14. Karen says:

    Sadly, we are watching our nation suffer due to a triumph of right wing ideology over thoughtful decision making.