New Keynesianism — a macroeconomic cul-de-sac

28 Sep, 2014 at 15:55 | Posted in Economics | Comments Off on New Keynesianism — a macroeconomic cul-de-sac

Macroeconomic models may be an informative tool for research. But if practitioners of “New Keynesian” macroeconomics do not investigate and make an effort of providing a justification for the credibility of the assumptions on which they erect their building, it will not fulfill its tasks. There is a gap between its aspirations and its accomplishments, and without more supportive evidence to substantiate its claims, critics will continue to consider its ultimate argument as a mixture of rather unhelpful metaphors and metaphysics. Maintaining that economics is a science in the “true knowledge” business, I remain a skeptic of the pretences and aspirations of “New Keynesian” macroeconomics. So far, I cannot really see that it has yielded very much in terms of realistic and relevant economic knowledge.

kKeynes basically argued that it was inadmissible to project history on the future. Consequently an economic policy cannot presuppose that what has worked before, will continue to do so in the future. That macroeconomic models could get hold of correlations between different “variables” was not enough. If they could not get at the causal structure that generated the data, they were not really “identified”. Dynamic stochastic general euilibrium (DSGE) macroeconomists – including “New Keynesians” – has drawn the conclusion that the problem with unstable relations is to construct models with clear microfoundations where forward-looking optimizing individuals and robust, deep, behavioural parameters are seen to be stable even to changes in economic policies. As yours truly has argued in a couple of post (e. g. here and here), this, however, is a dead end.

Here we are getting close to the heart of darkness in “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 – including the economic system. The interaction between animal spirits, trust, confidence, institutions etc., cannot be deduced or reduced to a question answerable on the individual level. Macroeconomic structures and phenomena have to be analyzed also on their own terms. And although one may easily agree with e.g. Paul Krugman’s emphasis on simple models, the simplifications used may have to be simplifications adequate for macroeconomics and not those adequate for microeconomics.

In microeconomics we know that aggregation really presupposes homothetic an identical preferences, something that almost never exist in real economies. The results given by these assumptions are therefore not robust and do not capture the underlying mechanisms at work in any real economy. And models that are critically based on particular and odd assumptions – and are neither robust nor congruent to real world economies – are of questionable value.

Even if economies naturally presuppose individuals, it does not follow that we can infer or explain macroeconomic phenomena solely from knowledge of these individuals. Macroeconomics is to a large extent emergent and cannot be reduced to a simple summation of micro-phenomena. Moreover, even these microfoundations aren’t immutable. The “deep parameters” of “New Keynesian” DSGE models– “tastes” and “technology” – are not really the bedrock of constancy that they believe (pretend) them to be.

So I cannot concur with Paul Krugman, Mike Woodford, Greg Mankiw and other sorta-kinda “New Keynesians” when they more or less try to reduce Keynesian economics to “intertemporal maximization modified with sticky prices and a few other deviations”. ” As John Quiggin so aptly writes:

If there is one thing that distinguished Keynes’ economic analysis from that of his predecessors, it was his rejection of the idea of a unique full employment equilibrium to which a market economy will automatically return when it experiences a shock. Keynes argued that an economy could shift from a full-employment equilibrium to a persistent slump as the result of the interaction between objective macroeconomic variables and the subjective ‘animal spirits’ of investors and other decision-makers. It is this perspective that has been lost in the absorption of New Keynesian macro into the DSGE framework.

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