Home > Uncategorized > The core problem with ‘New Keynesian’ macroeconomics

The core problem with ‘New Keynesian’ macroeconomics

from Lars Syll

Whereas the Great Depression of the 1930s produced Keynesian economics, and the stagflation of the 1970s produced Milton Friedman’s monetarism, the Great Recession has produced no similar intellectual shift.

This is deeply depressing to young students of economics, who hoped for a suitably challenging response from the profession. Why has there been none?

risk-uncertainty-03-e1508523129420-1024x550Krugman’s answer is typically ingenious: the old macroeconomics was, as the saying goes, “good enough for government work”  … Krugman is a New Keynesian, and his essay was intended to show that the Great Recession vindicated standard New Keynesian models. But there are serious problems with Krugman’s narrative …

The New Keynesian models did not offer a sufficient basis for maintaining Keynesian policies once the economic emergency had been overcome, they were quickly abandoned …

The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times. Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved …

Without acknowledgement of uncertainty, saltwater economics is bound to collapse into its freshwater counterpart. New Keynesian “tweaking” will create limited political space for intervention, but not nearly enough to do a proper job.

Robert Skidelsky

Skidelsky’s article shows why we all ought to be sceptic of the pretences and aspirations of ‘New Keynesian’ macroeconomics. So far it has been impossible to see that it has yielded very much in terms of realist and relevant economic knowledge. And — as if that wasn’t enough — there’s nothing new or Keynesian about it! 

pig‘New Keynesianism’ doesn’t have its roots in Keynes. It has its intellectual roots in Paul Samuelson’s ill-founded ‘neoclassical synthesis’ project, whereby he thought he could save the ‘classical’ view of the market economy as a (long run) self-regulating market clearing equilibrium mechanism, by adding some (short run) frictions and rigidities in the form of sticky wages and prices.

But — putting a sticky-price lipstick on the ‘classical’ pig sure won’t do. The ‘New Keynesian’ pig is still neither Keynesian nor new.

The rather one-sided emphasis of usefulness and its concomitant instrumentalist justification cannot hide that ‘New Keynesians’ cannot give supportive evidence for their considering it fruitful to analyze macroeconomic structures and events as the aggregated result of optimizing representative actors. After having analyzed some of its ontological and epistemological foundations, yours truly cannot but conclude that ‘New Keynesian’ macroeconomics, on the whole, has not delivered anything else than ‘as if’ unreal and irrelevant models.

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 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, of course, there is that weird view on unemployment that makes you wonder on which planet those ‘New Keynesians’ live …

  1. July 12, 2018 at 12:32 am

    Pigs are very intelligent people, and contrary to popular beliefs they drink a lot and are capable of ruling kingdoms, re-writing histories and remaining in power forever. It is the poor, hard-working, silent donkeys, and the tamed naïve, horses that one should have sympathy with. I think. In the end, the silent majority, no matter how hard they work, is so wise that it knows history is repeating itself, and the naïve wild horses that lose their lives without even knowing who betrayed them.

  2. Helen Sakho
    July 12, 2018 at 12:52 am

    All Internal and the External Markets of the TNCs (Labour, resources, all skills and specialisms, etc.) are vast vertically and horizontally and, by definition, extend globally. Any competition amongst them is based on an old Marxist concept with which all are familiar. To each according to need and from each according to ability, except internally or externally. By the same token, the same thing would apply to credit unions!

  3. Craig
    July 12, 2018 at 1:11 am

    The new concept behind modern economic systems needs to change from austere general equilibrium to grace as in the higher disequilibrium of stable, relatively abundant monetary gifting. The temporal universe being in an intensely integrated yet slightly disequilibrated state of continual dynamic, interactive grace as in process and flow, the economy would best capture nature by resonating closely with that reality.

    The present economy and business cycle follows the same curve of a failed satellite orbital insertion. The direct distribution of money to the individual via a universal dividend and a high percentage discount and the discount’s reciprocal rebated gifting back to enterprise will enable the economy to achieve orbital free flow/free fall from so called Keynesian wage rigidities that will be much more stable exactly like a satellite’s successful orbit is, that is perturbed only slightly by atmospheric expansion.

    This is not DSGE tweaking via the indirect, blunt and unworkable tool of interest rate changes, it is the deep, permanent, direct and transformational breakthrough known as a paradigm change.

  4. July 12, 2018 at 1:40 am

    In 2017 Paul Davidson published “Who is afraid of J M K?” In its Index, Uncertainty is completely absent, not to speak of radical one. Rusk management on 4 pages (10-11, 20-21) – about 10 lines combined, all about stock market recession and 2008 Greenspan testimony, which mentioned risk management systems. Keynes and uncertainty – one line on p. 21.

  5. July 12, 2018 at 2:22 am

    “Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved …”

    It is tragic that otherwise intelligent-seeming economists are claiming that a faster collapse of wages to meet supply and demand in the labor market could have somehow made the Great Depression better. They should try thinking before they speak.

    “The almost quasi-religious insistence that macroeconomics has to have microfoundations…”

    I think that this is understating the problem. The real problem is not concerning whether the (assumed correct) microfoundations lead to the macroeconomic ideas in question but rather concerning whether the microfoundations are even correct in their micro contexts. The assuredly are not, as they have made several unrecoverable fallacies, including the assumption that better tools that increase local efficiency (as measured by theoretical ability to handle peak business traffic) are positively correlated with financial efficiency (revenues / wages). Better tools and fewer customers will reliably lead to the same expected results in any right-leaning economic system.

  6. Frank Salter
    July 12, 2018 at 7:00 am

    “… that macroeconomics has to have microfoundations …” from above should be written as macroeconomics HAS microfoundations BUT they are NOT those found in conventional analysis.

    In “Transient Development” (RWER-81) I show that. for manufacturing, the natural unit of output is labour-time. I demonstrate that integrating productivity produces aggregative output values. This is the underlying reason that aggregated values produce results which are meaningful despite the very different products involved.

  7. Off The Street
    July 12, 2018 at 3:02 pm

    There is BS in economics. As one famous observer of events asked about a decade ago:

    “Did no one see it coming?”

  8. July 12, 2018 at 3:26 pm

    It should be no surprise that math physics has wrestled with this issue of calculating and predicting emergent macro system properties from the starting point of simple atoms and molecules. Predictably there were early successes in statistical mechanics where simple elastically colliding spheres as input yielded emergent macro behavior of known simple fluids. Unfortunately it quickly became obvious that more interesting macro level behaviors like phase change were permanently intractable. For example consider water condensation to form a snow flake. First, condensation by nucleation is inherently described by a mathematic singularity which can only be removed by abandoning the continuum approximation. Doing so opens a huge can of worms involving highly nonlinear molecular interactions. How well do you think this approach came to predicting that all snow flakes would be hexagonal let alone predicting they would all be unique? Or even the temperature where they would start to form?
    I’m pretty sure people are more complex than water molecules to model. This whole notion of deriving emergent system properties from micro models is so preposterous it was long ago abandoned by physicists. Guys like Krugman really need to get out more and have some beers with applied mathematicians in the physical sciences. Maybe he has and didn’t like it when they laughed and threw their shoes at him.

    • Frank Salter
      July 12, 2018 at 6:11 pm

      I would be in total agreement if physics could only be conducted in the manner described in the first paragraph. But as you say, such methods were abandoned long ago in the physical sciences. However, I would like to draw your attention to my comments at July 12, 2018 at 7:00 am.
      The analysis in my paper is from first principles and uses calculus, so it encompasses the entire range of possibilities from the infinitesimal to the macro. It predicts the overall characteristics of manufacturing. The predictions are completely in accord with empirical data. Unnoticed and known relationships are predicted and explained.

  9. Prof Dr James Beckman, Germany
    July 12, 2018 at 3:29 pm

    As one who once had a long conversation with Friedman, the words “let it be” come to mind. (There was also a song of the same name as some may recall.) We can’t predict much–think Brexit, Trump, the refugees being let into Europe by Merkel, the rise of both Isis & a new Turkish Caliphate, IT crushing all economic competition (with US & China being best at it), etc. While many warned of the housing bust to come, it was obvious that Wall Street was too connected to human nature & Washington to bear much risk. Obama did a partial bail-out. The US Fed & other central banks made money easy for those who wanted it. Government did not reconstruct the system which caused the crash. And of course over time we healed as nations, although with some enormous long-term losers. Now isn’t that what our currently dominant economics has directed us to do? And it’s not going to change until politics allows more liberal leaders into power, who then might listen to the thoughts of some of our contributors here, I believe.

  10. Risk Analyst
    July 13, 2018 at 8:57 pm

    So here we have yet another article listing all of the problems with neokeynesian economics. Just add it to the pile. What is really needed is an exploration of what is right with neokeynesian economics. When has such a topic EVER been explored here? Not even once to my experience. So much for diversity and inclusiveness. The same goes for President Trump’s economic policies where according to comments here everything is wrong and a crisis. I have seen otherwise heterodox writers here even change their economics to present neoclassical trade theory to argue against Trump’s policies. It is rather amazing that writers can be so ferociously against someone that they will reverse their own foundations just to resist.

    In an article on what is right with neokeynesian economics there is a lot to be learned by heterodox. For one, clearly marketing is very important as Prof. Beckman points out in the recent discussion, “What Did I Learn From My Students.” You can have great ideas, but few may listen if you cannot sell it. After the Great Financial Crisis, people were so hungry for knowledge that literally the heterodox author Minsky’s books could be found in airport book stores. Heterodox was handed the advantage on a silver platter and what happened? They knocked it away, bing bam boom across the floor. Again, when the topic of income mis-distribution arose, people looked for knowledge and again, bing bam boom. And again, people looked for trade theory to explain the trade deficit and Trump’s point of lost jobs, and yet again the platter was knocked away.

    For the trade issue, look to Dean Baker’s post titled “Six Lies on Trade.” He starts by calling Trump a liar, and ends by calling for him to be shown contempt and ridicule. Why? In between he posts six “lies” and actually Trump would probably agree with Mr. Baker that five of those are wrong. What is this? Where news sources were saying “no” economists would support tariffs, all sorts of heterodox economists did but they were too busy hating Trump to let their economics be known. Keynes most likely would have supported his policy on this, as well as Marx would have if asked how to immediately improve the domestic worker’s lot. And I’ve seen writers here so desperate to not agree with Trump on anything, they bypass the tariff issue by trying to refocus and redefine it into a debate on patents.

    So, I think one of the main reasons for the lack of influence by heterodox is self inflicted. Too many are more interested in some “feel good” hate-fest against Trump and neokeynesian theory rather than getting their message across. I have never seen Krugman calling people liars or Nazis, and yet he is the one on the news and you guys are not. There is a lot that heterodox can learn from neokeynesian economics, such as respect and civility and a bit of marketing.

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