Conventional Macro Models and Aggregate Economic Choice

Frequent references to economic analysis as the “theory of choice” notwithstanding, macroeconomists generally take a severely limited view of the degree of choice available to private economic agents. Portrayed as price takers buffeted by the dictates of a policy authority, private agents in conventional macro models directly decide only the quantities of labor, privately-produced goods and nonmonetary financial assets. A fictitious auctioneer announces all wages, prices, and interest rates while an outside policy authority determines the levels of government-produced goods, taxes, and the stock of nominal money. Furthermore because existing models typically prohibit private agents from engaging in transactions until the auctioneer has set all wages and prices at their “market clearing” levels, they cannot explain the existence of involuntary unemployment if wages and prices are free to vary. Consequently several assumptions underlying conventional macro models drastically reduce their ability to explain important aggregate economic phenomena.