Lawrence Robert Klein

RUAECO502

NIKITA VIVEKUMAR(3613-C),
MANAS NATEKAR(3657-C) & VIHAAN VADNERE(3625-C)
TYBA ECONOMICS

Contact Information
 Nikita Vivekumar: 91+ 9930840988
[email protected]

 Manas Natekar: 91+ 9657199544

 Vihaan Vadnere : 91+ 9082181539

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Introduction
Lawrence Robert Klein, born on September 14 1920 in Omaha, Nebraska, U.S. died October 20
2013, in Gladwyne, Pennsylvania, American economist whose add developing macro econometric
models for national, regional, and world economies won him the 1980 Nobel Prize in Economic
Sciences.
After graduating from the University of California, Berkeley, in 1942, Klein studied under economist
Paul Samuelson at the Massachusetts Institute of Technology, taking a Ph.D. in 1944. From 1944 to
1947 he was involved in econometric research at the University of Chicago, and from 1948 to 1950
he was on the staff of the National Bureau of Economic Research. Subsequently he was related to the
Survey Research Centre of the University of Michigan (1949–54) and also the Institute of Statistics
at the University of Oxford (1954–58). Klein joined the college of the University of Pennsylvania in
1958 and later became author Professor of Economics and Finance at the university’s Wharton
School (1968–91; later emeritus). Klein was one amongst the pioneers in building macroeconomic
models. one in every of his earliest successes was in forecasting economic conditions at the top of
World War II. Whereas many economists speculated that the war’s end would bring another
depression, Klein predicted that the unsatisfied demand for goods throughout the war, combined with
the purchasing power of returning soldiers, would likely prevent a depression; his prediction was
right.

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Career
After getting his Ph.D. from MIT, he moved on to the Cowles Commission for Research in
Economics, which was then at the University of Chicago. While there he built a model of the U.S.
economy, using Jan Tinbergen’s earlier model as a starting point, to forecast economic conditions
and to estimate the impact of changes in government spending, taxes, and other policies. In 1946 the
conventional wisdom was that the end of World War II would sink the economy into a depression for
a few years. Klein used his model to counter the conventional wisdom. The demand for consumer
goods that had been left unsatisfied during the war, he argued, plus the purchasing power of
returning soldiers, would prevent a depression. Klein was right. Later he predicted correctly that the
end of the Korean War would bring only a mild recession. Klein moved to the University of
Michigan, where he proceeded to build bigger and more complicated models of the U.S. economy.
The Klein-Goldberger model, which he built with then graduate student Arthur Goldberger, dates
from that time. But in 1954, after being denied tenure because he had been a member of the
Communist Party from 1946 to 1947, Klein went to Oxford University. There he built a model of the
British economy.
His research produced a series of increasingly detailed and sophisticated models of economic activity
that were used to forecast fluctuations including national product, exports, investments, and
consumption, and to study the effect on them of changes in taxation, public expenditure, oil price. In
1959, Professor Klein won the prestigious John Bates Clark Medal from the American Economic
Association which was awarded biennially to that American economist under the age of forty who is
adjudged to have made a significant contribution to economic thought and knowledge. Klein was one
of the pioneers in building macro econometric models. In the 1970s the models Klein had inspired
and, in many instances, personally constructed proved inadequate to describe the impact of big
shocks such as the decade’s twin oil price spikes. Academics such as Robert Lucas, another Nobel
laureate, attacked them for failing to acknowledge that individuals also change their spending, saving
and investing behaviour as a result of government action. Yet Klein’s legacy lasted and econometrics
– its models eternally tweaked, fine-tuned and finessed – is still firmly at the centre of academic and
policy making debates.
In 1980, Klein won the Nobel Prize in Economic Sciences for the creation of econometric models
and the application to the analysis of economic fluctuations and economic policies. His Nobel
citation states that few, if any, research workers in the empirical field of economic science have had
so many successors and such a large impact as Lawrence Klein.
Professor Klein was an eminent teacher who not only led the intellectual activity of the Graduate
Group in Economics for more than 20 years but also for many years actively taught undergraduates
in the General Honours Program. While on the faculty, he mentored more graduate students and
directed more doctoral theses per year than any other departmental member. In 1993, Klein created
the Penn Institute for Economic Research (PIER), to foster an environment for research and teaching
that enhances the University's role as one of the leading institutions in the world of the study of
economics. He was extremely generous with his time helping the institute to grow and become an
important part of Penn Economics.

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Econometric Modelling from the Perspective of L.R. Klein
The earliest works of L.R. Klein focus on a discussion on the statistical determination of the
investment schedule. In the same period, Klein focused on developing his doctoral thesis The
Keynesian revolution, which was published as a book in 1947. Klein investigates, develops and
explains the central arguments contained in the General Theory of Employment, Interest and Money
demonstrating the validity and the innovation brought to the economic perspective. Klein dedicates
an extensive chapter to the analysis of the main reviews on The General Theory dissecting the
arguments brought by Lerner, Reddaway, Pigou, Knight, Cassel, Hicks, Viner, Hansen or Hawtrey.
He also contributed to several controversies that raged at the time, such as the effects of money
wages on employment, the savings – investment controversy or the liquidity – preference theory of
interest. Another important landmark of Klein’s work from the Chicago years is the book Economic
Fluctuations in the United States, which was published in 1950. In this book, Klein follows in the
footsteps of Tinbergen and succeeds in building comprehensive macroeconomic models which are
also estimated econometrically.
Solow observes that one innovation brought by this model comes from the separate specifications for
inventories of consumer goods and producer goods. Also, Solow pointed out that Klein considers
that residuals in the inventory equations drive changes in the output, and thus builds an output
adjustment function. Solow makes another interesting observation regarding Klein. Klein’s
applications in which the wage rate is expressed as a linear function of unemployment, lagged
unemployment, lagged wage and a time trend, pointing out that this might be the first econometric
Phillips curve. Before Klein, models II and III had been used in a study on the formation of
economic policies he compared three theories on the evolution of employment: the classical, the
Keynesian and the Marxian in order to “identify the necessary and sufficient assumptions that
underlie each theory”. Klein’s perspective is similar to that found in The Keynesian revolution,
reasserting that the main distinctive feature of the Keynesian theory is the low interest-elasticity of
the investment function. De Vroey and Malgrange (2010) point out the fact that, according to Klein,
the difference between a classical and a Keynesian analysis comes from the manner in which the
overdetermination problem is solved. Klein noted that, the classical solution can be defined as the
Pigou effect (Pigou, 1934), which consists in a replacement of the saving-investment equation with
the following one: S( ) () i,Y, M / p = I i,Y
Considering that the current literature had a gap in the study of the rate of change of real fixed
capital, Klein (1951) offers a substantial study on the investment behaviour. In order to investigate
the investment process from an empirical point of view, Klein focuses on two types of investment
sectors: railroad investment and the electric light and power investment, and tries to identify the
factors that influence investments in these sectors. The main conclusions of the study point to the
fact that investments are clearly influenced by the gross operating profits of the preceding year and
that gross investment is influenced by the interest rate.
L.R. Klein targets a more realistic interpretation he develops a theoretical model that characterizes
the logic of the input-output analysis and which eliminates the assumption that each economic sector
can only generate a single output. Klein succeeds in offering a technological interpretation of the
input-output coefficients as structural parameters and concludes that these coefficients depend on the
parameters of the factor demand and supply functions. After the modelling experience gathered
developing the monograph Economic Fluctuations in the United States, L.R. Klein focused on
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another monograph in collaboration with Goldberger that meant the launch of the homonymous
model. The model is based on 15 structural equations accompanied by 10 other identities and
relationships and was estimated by limited information maximum likelihood. Klein considered the
Keynesian system “an extremely useful pedagogic model”, but at the same time “not adequate to
explain observed behaviour” (and highlighted the need for a dynamic model able to characterize
processes over time. Thus, the main challenge in Klein and Goldberger was to metamorphose the
Keynesian theoretical background into an empirical and dynamic model. Klein (focuses on a
methodology that transforms the Keynesian model into an empirical construction. The main
challenge is again the search for a dynamic solution for the static Keynesian system. Klein’s model
consists of a discussion on the efficiency of the estimation process in building econometric models
and tackles several problems related to the use of the conventional least-squares methods.
Klein identified five major distinctive factors: a less aggregative nature, the presence of anticipatory
data, explicit relations between inventories, sales, backlogs, and order flow, the use of the capacity
concept and the clear expression of accounting identities in current prices. The consumer
expenditures split into three categories (durables, nondurables and services) and provides
quantification for the aggregate income as a precursor of consumption. For the investment equations,
Klein divides capita. formations into producers’ plant and equipment residential construction and
inventory investment.
The model also incorporates three equations that relate to the non-wage income components
covering: corporate saving, non-corporate to corporate income and depreciation. Other key building
blocks of the model are: an equation for production functions, specifications for wage, labour force,
orders and backlogs, foreign trade, money and interest, prices and a number of identities. In his
Nobel Lecture of 1980 titled Some Economic Scenarios for the 1980s, Klein discusses a series of
economic trends forecasted through the use of two econometric models: one for the United States
and an aggregate model for the rest of the world based on the Project Link model. For the case of the
USA, the model forecast shows a constant growth pattern around the value of 3%. This tendency is
accompanied by a higher inflation, higher interest costs and an elevated rate of unemployment. For
the rest of the world, Klein detects a tendency of moderate growth and lower inflation for the
industrial market economies. Klein notes that in the case of developing countries the results are
mixed and depend highly on country classification. Klein and Coutiño (1996) considered the crisis
that shook Mexico at the end of 1994. By estimating import and export equations on the basis of data
with monthly frequency belonging to the 1982-1983 period, Klien

offer extrapolations that suggest a milder contraction and a fast recovery in the following year. Klein
(2003) examines the flow-of-funds accounts given its role in the determination of interest rates
across maturities and debt qualities. Klein offers an analysis that can cast some light on the dynamics
of relevant mortgage rates, dynamics useful in the understanding of capital formation in the real
estate sector. In the article Measurement of a shift in the world’s centre of economic gravity,
published in 2009, Klein starts from the general idea that the 21st century brought a shift in
economic strength from Northern America and Western Europe to Asia and the Pacific area. Klein
estimates the economic predominance position of Asia and other possible shifts that could lead to
new centres of economic concentration. By studying aspects like economic activity, national
economic accounts, demographic variables, education, health, life expectancy and the energy output,
Klein concludes that new growth centres had emerged in the Asia-Pacific area during the last decade.

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Klein’s interest in the Asian economies was not launched by this paper, but date back to previous
studies such as the work in Klein and Palanivel (2001) consists in a thorough analysis of India’s
development strategies and discusses its economic performance and its perspectives. In the final
section of the paper Klein develop a forecast scenario for the following five years using a model
consisting of nine blocks of equations. The first five blocks characterize a sector of the economy
(agriculture, manufacturing, infrastructure, services and public administration) while the others deal
with consumption, monetary sector, trade and balance of payments and, finally, macro aggregates
and identities. The model predicts that in certain conditions suggested by Klein, India’s economy can
achieve a higher growth pace with a decent inflation rate. Another interesting observation is that
India’s trade to GDP ratio increased in the analysed period, but not to the same extent as in other
developing countries, such as China. In a 2010 paper, Klein and Özmucur investigate the potential
role of consumer and business surveys in economic forecasting. Klein use a benchmark AR (12)
model and a series of ten other models based on indices constructed from answers deriving from
survey questions. Klein and Özmucur conclude that surveys are able to improve forecasting
performance by “adding explanatory power of a model based on only past values of manufacturing
growth”. Klein, Kushnirsky, and Maksymenk perform a macroeconomic study on Ukraine’s
economic growth. They build two structural modelling approaches, a high frequency model based on
monthly observations and low frequency model that assumes annual observations. Their forecast on
ten endogenous macroeconomic variables for Ukraine (GDP, capital stock, labour force,
employment, household final consumption expenditure, private investment, exports of goods and
services, imports of goods and services, wages and the official exchange rate) reveals a mild growth
for all of them, except for employment and export in the 2011-2015 period.
The achievements of L. R. Klein represent an innovative, pioneering and singular contribution to
econometrics and macroeconomics. His work on large-scale economic model construction changed
both the academic perspectives and political decision making on a global scale.