Partisan politics, divided government, and the economy

1995 ChoiceReviews  
This book is an expanded version of the Churchill Lectures delivered at the University of Cambridge in 1993. It deals with the question of the modelling of time in economic theory. Diamond's point of departure is that it is necessary to model time explicitly in order to be able to judge the consistency of atemporal equilibrium models, as used for exposition and practical purposes. The book consists of two lectures each comprising two chapters. The first lecture investigates the role of time
more » ... he role of time within the single industry context, in the first chapter with competitive pricing and in the second with non-competitive pricing. Marshall's period analysis, distinguishing temporary, short-and long-period equilibria, is the starting point. In the second lecture attention is focussed on the incorporation of time in economy-wide models. Hicks' IS/LM-model now serves as a frame of reference. Two interpretations of Marshall's period analysis are possible. First, it is a means to disentangle complex adjustment processes by studying each process independently of the other processes: movements to a short-run equilibrium by adjustments in the variable inputs and movements to a long-run equilibrium by changing fixed inputs. Second, the shortrun equilibrium is considered an equilibrium which is reached within a short period of time after a disturbance has occurred, while the long-run equilibrium is considered an equilibrium which is reached after a long period of time. In the latter interpretation the long run can be regarded as a sequence of short-run equilibria. Diamond rejects period analysis in both its interpretations: the former because not analyzing equilibrium means neglecting the feedback elements of the adjustment process, the latter because studying short-and long-run equilibria separately implies ignoring the interactions between short-and longrun adjustments. The alternative Diamond offers does not only differ from Marshall's period analysis in that time is taken into consideration explicitly -by distinguishing between flows (entry of and exit from the market) and stocks of firms -but also in that Marshall's assumption of the representative firm is dropped. Entry is assumed to depend on sunk costs and the discounted value of future profits, while exit is modelled according to a Poisson process. Diamond focusses on the IS/LM model instead of the Arrow-Debreu model as the point of departure of his macroeconomic analysis because in the latter theory the coordination of trade is timeless and perfect so that the problem of income determination -indicated by Diamond as the problem of the command over purchasing power -is non-existent. The focus of attention is instead on the formation of relative prices, whereas in the IS/LM analysis it is on trade and income determination. Diamond lists quite a number of problems inherent in the atemporal IS/LM model, such as the period over which income is calculated, the period over which income is calculated in relation to the transactions demand for money, possibly different periods with respect to the income and cash-in-ad- Economist 144, 497-524, 1996. De
doi:10.5860/choice.33-1186 fatcat:tepizrceezdrja34lk64vlrgzq