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Abstract
The imperfect coordination of expectations and actions is a central theme running through Keynes’s General Theory. Incorporating this theme into mainstream macroeconomics, however, has proved to be a difficult endeavour. In particular, attempts to accommodate coordination failures within Dynamic Stochastic General Equilibrium (DSGE) models through multiple equilibria and “dynamic” indeterminacy, while promising in the 1990s, were gradually abandoned in the 2000s. Since then, the “New Keynesian” framework has come to dominate macroeconomic modelling. And since the coordination of agents is not at issue in this latter framework, mainstream macroeconomics has seemed to leave the coordination theme out of its focus, if not its scope. In this paper, we challenge this perception and argue that the coordination theme is actually alive and well. We especially present two recent research programmes which, while belonging to the DSGE paradigm, give pride of place to coordination failures and share a common objective: providing, within the class of DSGE models, an alternative to the New Keynesian framework that would involve the most important ideas emerging from Keynes’s General Theory.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Notes
1 A reference to this paper, in its Federal Reserve Bank of Cleveland W.P. version (2001), is included in Smets and Wouters (Citation2003).
2 Throughout the paper, we use the terms ‘imperfect coordination,’ ‘lack of coordination,’ and ‘coordination failures’ interchangeably. The term ‘imperfect coordination,’ though less usual, is now widely used in the recent literature.
3 It is worth mentioning here that, since the mid-2010s, Jess Benhabib and his co-authors have also investigated the implications of ‘sentiment shocks.’ However, we will not consider this work in the present paper since it does not introduce beauty contest games and sentiment shocks into quantitative models: Benhabib and his associates therefore do not aim at restating central Keynesian conclusions within the current mainstream in macroeconomics.
4 See the presentation given by Farmer (2014). A more complete formalisation of the essentials of the General Theory in terms of a temporary general equilibrium model, alternative to the present one (based on the RBC model), is suggested by Dos Santos Ferreira (Citation2014).
5 This is Equation (2) in Farmer (Citation2020), the corresponding current utility function being specified in footnote 10 (p. 681). Log-linearity is assumed for convenience, but it expresses the peculiar property that income and substitution effects cancel each other out. More generally, constant elasticity of substitution with separability in consumpton and leisure (or labour) is usually assumed (as in Dos Santos Ferreira and Dufourt Citation2006, Farmer Citation2013 or Angeletos, Collard, and Dellas Citation2018, just to refer to articles examined in this paper).
6 See Benhabib and Farmer (Citation1999) and Lloyd-Braga, Modesto, and Seegmuller (Citation2014) for a synthetic view of this literature.
7 The two terms are used interchangeably by Farmer (see Farmer Citation2020, p. 6867, n. 17).
8 According to Farmer, this latter function “is a new fundamental that determines wealth, and should be accorded the same methodological status as technology shocks and preference shocks in conventional DSGE models” (2016b, p. 84).
9 To the best of our knowledge, it seems that there were no reactions from the mainstream to Farmer’s concept of belief function. It would be interesting to investigate whether Farmer’s argument could be reproduced with the standard approach to rational expectations. This is however a theoretical rather than a historical issue, and not a straightforward one. Beliefs should be seen as part of the “relevant economic theory” the predictions of which depend upon them through their influence on agents’ decisions, conferring anyhow an equilibrium, self-fulfilling, status to rational expectations.
10 The goods produced in the different industries become at the economy level a composite good by applying a Cobb-Douglas aggregator.
11 Entry is free because there are no sunk costs associated with a preliminary decision to enter and because the game is symmetric, offering equal opportunities to all players. Equilibria are however asymmetric relative to the two categories of active and inactive firms (there is no equal treatment of all the players at equilibrium).
12 The terms ‘dispersed’ and ‘heterogeneous’ will be used interchangeably in the rest of the text.
13 For instance, second-order expectations are agent i‘s expectations about the average expectation of the fundamental; third-order expectations are agent i‘s expectations about the average expectation of the average expectation of the fundamental; and so on.
14 The importance of higher-order expectations has been initially raised by Phelps (Citation1983) and Townsend (Citation1983), but it had already been foreshadowed by Keynes: “It is not a case of choosing those [faces] which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees” (Keynes Citation1936, 156).
15 The strength of strategic complementarities is also what differentiates beauty contest games from ‘global games.’ In beauty contest games, dispersed information is combined with weak strategic complementarities, while in global games dispersed information is combined with strong strategic complementarities. Beauty contest games thus feature equilibrium uniqueness, while global games feature multiple equilibria and indeterminacy. See Angeletos and Lian (Citation2016) for a survey of the global games literature.
16 This negative response of employment, at odds with the predictions of the standard – perfect information – RBC model, was initially stressed by Jordi Galí (Citation1999).
17 A positive shock on TFP, indeed, induces an increase in aggregate output in the standard RBC model. Since individual islands believe that the other islands are acting upon the expectation that such a positive shock has occurred, they are naturally led to expect an increase in aggregate output.