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Keynes betrayed

from Lars Syll

To complete the reconciliation of Keynesian economics with general equilibrium theory, Paul Samuelson introduced the neoclassical synthesis in 1955 …

51zdd7pouql-_sx323_bo1204203200_In this view of the world, high unemployment is a temporary phenomenon caused by the slow adjustment of money wages and money prices. In Samuelson’s vision, the economy is Keynesian in the short run, when some wages and prices are sticky. It is classical in the long run when all wages and prices have had time to adjust….

Although Samuelson’s neoclassical synthesis was tidy, it did not have much to do with the vision of the General Theory …

In Keynes’ vision, there is no tendency for the economy to self-correct. Left to itself, a market economy may never recover from a depression and the unemployment rate may remain too high forever. In contrast, in Samuelson’s neoclassical synthesis, unemployment causes money wages and prices to fall. As the money wage and the money price fall, aggregate demand rises and full employment is restored, even if government takes no corrective action. By slipping wage and price adjustment into his theory, Samuelson reintroduced classical ideas by the back door—a sleight of hand that did not go unnoticed by Keynes’ contemporaries in Cambridge, England. Famously, Joan Robinson referred to Samuelson’s approach as ‘bastard Keynesianism.’

The New Keynesian agenda is the child of the neoclassical synthesis and, like the IS-LM model before it, New Keynesian economics inherits the mistakes of the bastard Keynesians. It misses two key Keynesian concepts: (1) there are multiple equilibrium unemployment rates and (2) beliefs are fundamental.

Not that long ago Paul Krugman had a post up on his blog telling us that what he and many others do is “sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point” and that “New Keynesian models are intertemporal maximization modified with sticky prices and a few other deviations.” 

newkeyBeing myself sorta-kinda Keynesian, I side with Farmer and remain a skeptic of the pretences and aspirations of ‘New Keynesian’ macroeconomics.

Where ‘New Keynesian’ economists think that they can rigorously deduce the aggregate effects of (representative) actors with their reductionist microfoundational methodology, they have to put a blind eye on the emergent properties that characterize all open social systems. The interaction between animal spirits, trust, confidence, institutions etc., cannot be deduced or reduced to a question answerable on the individual level.

So, I cannot concur with Krugman – and other sorta-kinda ‘New Keynesians’ – when they try to reduce Keynesian economics to “intertemporal maximization modified with sticky prices and a few other deviations.”

The purported strength of New Classical and ‘New Keynesian’ macroeconomics is that they have firm anchorage in preference-based microeconomics, and especially the decisions taken by inter-temporal utility maximizing ‘forward-looking’ individuals.

To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations – without ever presenting neither ontological nor epistemological justifications for this claim – has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations. It is as if – after having swallowed the sour grapes of the Sonnenschein-Mantel-Debreu-theorem – these economists want to resurrect the omniscient Walrasian auctioneer in the form of all-knowing representative actors equipped with rational expectations and assumed to somehow know the true structure of our model of the world.

And then there is also the fact that ‘New Keynesians’ share the New Classical economists extraterrestial view of unemployment as voluntary.

The ‘New Keynesian’ microfounded dynamic stochastic general equilibrium models do not incorporate such a basic fact of reality as involuntary unemployment. Of course, working with microfounded representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility. In this model world, unemployment is always an optimal choice to changes in the labour market conditions. Hence, unemployment is totally voluntary. To be unemployed is something one optimally chooses to be.

To Keynes it was an obvious and sad fact of the world that not all unemployment is voluntary. But obviously not so to New Classical and ‘New Keynesian’ economists.

  1. December 28, 2016 at 5:27 am

    Farmer argues fixing and preventing financial crises requires economists attune themselves to present-day conditions. Specifically, he asserts that governments need to intervene in asset markets in a manner similar to recent actions of central banks, and principal actors in the international economy need to pursue financial stability. To achieve this stability Farmer proposes that sovereign nations create sovereign wealth funds backed by the present value of future tax revenues. These funds would function like exchange-traded funds currently operate, and in time, would become the backbone for stabilizing financial markets.

    Admiral objective. Two questions. First, what’s to stop the financial gamblers who take the wins and leave we lowly taxpayers to take the losses from plying their trade with these new sovereign wealth funds? And leaving us holding the bag once again? Second, why should the ordinary citizens care about any of the pros or cons of Farmer’s proposals or the opponents he proposes to banish? Will it help them pay their mortgages/rent or feed their kids or find a job? If yes, please show me how that happens.

    • Craig
      December 28, 2016 at 6:45 pm

      Perhaps if we integrated directness, encompassment and reciprocity into monetary and economic policy we could transcend Keynesianism.

  2. robert locke
    December 28, 2016 at 9:02 am

    We went through all of this in the 1950s when I first read about Keynes. Why can’t economics deal with people who lived after Keynes died in 1946. Make it a rule, discuss no economists who is not now alive and discuss him or her within a contemporary context. And then turn your attention to people who are not economists.

  3. patrick newman
    December 28, 2016 at 11:10 am

    This discussion tells me that much economic thinking is far removed from the real world of economies and their dynamics. The concept of equilibrium in the context of present day economies and their prominent global dimensions is virtually meaningless – worse it helps to constrain the role of government in economic management.

  4. December 29, 2016 at 4:12 pm

    “beliefs are fundamental”

    I assume the point here is that you get non-linear feedback loops such as when a stock is valuable because it has momentum and the last group of investors thought it had value?

  5. December 30, 2016 at 6:05 am

    People never make optimal choices. While sometimes humans do want to have such choices, they never do. To make an optimal choice a person would have to have certain and complete knowledge of the current and future status of each variable and relationship of variables involved. This simply is impossible. Also is the pursuit of the study of optimality in economic decision making. That removes equilibrium and the perfect human economic decision maker from economics. So why do many economists continue to pretend this is the basis of economic decision making? My theory is that economics has never really been an independent science. It has always hitchhiked on other sciences, modeling itself after them. First it was 19th century physics. Then cybernetics and mathematics. Then evolution. Keynes offered a connection with history. I don’t know where economics is going from this point forward. I won’t guess which science it will attach itself to next.

    • robert locke
      December 30, 2016 at 11:13 am

      “To make an optimal choice a person would have to have certain and complete knowledge of the current and future status of each variable and relationship of variables involved”

      Not only certain and complete knowledge of the current and future status of each variable but knowledge of what the varables are, since so many are overlooked, unseen, in a new time frame.

      • December 31, 2016 at 12:04 pm

        Robert, thanks for the clarification. That was my intent.

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