Comment

Abstract

Recently, I had a dream where I was trying to explain supply and demand to an audience of intransigent economists.How could I say that demand curves sloped downward, they asked, when for so many goods, a simple plot of quantity demanded against price showed the opposite? How could these curves be useful concepts when, even by the most generous account, their parameters shifted from year to year? I knew the answers. The incorrect slope of demand was no surprise; a plot of quantities against prices would reveal the demand curve only if the variation was caused by supply shocks. And yes, supply and demand didmove around from year to year, but this did not invalidate the concepts. If I am selling oil, I can predict that a sudden decline in supply (embargo) will increase the price, I can predict that a new source of supply (fracking) will decrease the price, and I can predict that a decline in demand (fuel efficiency) will decrease the price. All of this is useful information. The dream audience was unmoved. But upon waking up, I was relieved to find myself in a world where economists are not so silly. We understand that supply and demand is a useful framework, even if there is an identification problem and even if there is no consensus on the parameters for a particular market. In fact, we persist even in the face of more profound theoretical complications, like imperfect competition or increasing returns. Then I started reading commentary on the Phillips curve and economists started seeming awfully silly again. Somehow, a weak reducedform relationship in the aggregate data has led many people to deny the Phillips curve as a structural relationship. In the face of this criticism, McLeay and Tenreyro’s paper is a vitally important rejoinder.