Exploring General Equilibrium

by Fischer Black

The general equilibrium approach, Black asserts, can be used to explain most of the economy's behavior. It can explain business cycles and growth without using sticky prices, irrationality, economies of scale, or imperfect competition. It can explain the volatility of consumption, output, sales, investment, and inventories with axiomatic utility and constant-returns-to-scale production. It can explain temporary layoffs, job changes with and without intervening unemployment, and the behavior of vacancies. It can explain lower wages in part-time jobs, wages that increase rapidly with time on the job, and the forces that cause migration from poor to rich countries.
Although the general equilibrium approach cannot be tested in conventional ways, it can be used to generate examples that explain stylized facts - generalized observations from the real world - that have preoccupied macroeconomists for the last decade. Black contrasts his interpretation of these facts with conventional views. Finally, he reviews a substantial body of literature on these topics.

Genres: Economics, Finance

Hardcover

First published July 6, 1995

Reviews

[Max Lybbert · Rating 5 out of 5]

This is a delightful book. Sadly, it was published after Fischer Black died of throat cancer. Myron Scholes was later given the Nobel Prize for his part in developing the Black-Scholes framework for pricing derivatives. The Nobel Prize announcement included a discussion of Black's contributions, along with the statement that the Prize is only given to living people.

I picked up Exploring General Equilibrium because I had read an interview where Eugene F. Fama said, "Fischer was one of the rare people ... who could cause you to think entirely differently about something you’ve been working on. It’s hard to think of anything more valuable when you’re doing research."

The book includes an honest critique of the field as it existed in 1995 and an overview of Black's view of the world: "When we want a single unified theory of almost everything, I like the general equilibrium model. I feel it is consistent with most of what we see in the world: both labor markets and the markets of goods and services; both general and specific aspects of the economy; and both short-run variability and long-run growth" (pg. 3).

Black was venturing outside his area of expertise. Perhaps for this reason, he used words like "I think" and "I feel" often. He made his opinions known, and made it clear they were opinions.

Many of the models in the literature are not general equilibrium models in my sense. Of those that are, most are intermediate in scope: broader than examples, but much narrower than the full general equilibrium model. They are narrower, not for carefully spelled out economic reasons, but for reasons of convenience. I don't know what to do with models like that, especially when the designer says he imposed restrictions to simplify the model or to make it more likely that conventional data will lead us to reject it. The full general equilibrium model is about as simple as a model can be: we need only a few equations to describe it, and each is easy to understand. The restrictions usually strike me as extreme. When we reject a restricted version of the general equilibrium model, we are not rejecting the general equilibrium model itself. So why bother "testing" the restricted version? If we reject it, we will just create another version (pg. 4).

"Estimation" suggests a Bayesian approach to data, while "testing" suggests a classical approach. I prefer estimation, since I think researchers who want to test often choose models that are more specific than the economics require. They talk of adding restrictions for no reason other than making their models easier to reject (pg. 97).

He explained the title of the book early:

I think it's better to "estimate" a model than to test it. ... Best of all, though, is to "explore" a model. This means creating many specific examples of a general model, where each one explains a single stylized fact or perhaps a few features of the world. It means using some of these examples to elucidate microeconomic evidence. ...

"Exploring general equilibrium," then, means generating examples and specific versions of the full general equilibrium model, to explain stylized facts and other data. It means changing examples quickly when they don't fit the facts. It means avoiding formal testing, or even estimation of heavily restricted models. When a general equilibrium model and another kind of model both fit the facts, it means favoring the general equilibrium model (pgs. 4, 5).

Black claimed his model worked well for a healthy economy, but not so much for an unhealthy one. This asymmetry is par for the course. He gave a great discussion of the way various economic concepts fit together, and why he made changes to the standard equilibrium model.