How ‘New Keynesian’ economics betrays Keynes

10 Jul, 2017 at 16:15 | Posted in Economics | 2 Comments

Unless you have a PhD in economics, you probably think it uncontroversial to argue that we should be concerned about the unemployment rate. Those of you who have lost a job, or who have struggled to find a job on leaving school, college, or a university, are well aware that unemployment is a painful and dehumanizing experience. You may be surprised to learn that, for the past thirty-five years, the models used by academic economists and central bankers to understand how the economy works have not included unemployment as a separate category. In almost every macroeconomic seminar I attended, from 1980 through 2007, it was accepted that all unemployment is voluntary.

Roger Farmer

‘New Keynesian’ and New Classical microfounded DSGE models do not incorporate such a basic fact of reality as involuntary unemployment. Of course, working with microfounded representative agent models, this should — as argued in my paper Micro vs. macro — 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 a sad fact of the world that not all unemployment is voluntary. But obviously not so to New Classical and ‘New Keynesian’ economists.