New Keynesian ‘tweaking’ won’t do the job

22 January, 2018 at 19:44 | Posted in Economics | 5 Comments

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?

tweakKrugman’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!

counterfeit‘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. I agree with Lars’s skepticism re “New Keynsianism”. When I first came across MMT, I immediately saw what MMTers were on about. In contrast, I’m baffled as to what “New Keynsianism” actually consists of.

    Re Skidelsky, I think he goes astray in this passage: “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.”

    What needs to be done “in good times in order to avoid the bad times” has nothing to do with Keynes’s ideas or variations on those ideas, which is presumably what New Keynsianism consists of. What needs to be done is to make sure bank crises like the one we had ten years ago do not happen again. That’s not a problem which Keynes paid much attention to, far as I know.

    • “What needs to be done is to make sure bank crises like the one we had ten years ago do not happen again.”

      We know how to fix bank crises: the Fed becomes a money dealer and value investor, supplying liquidity without capacity limits and providing a floor for “toxic assets” well above the $0 markets settled on.

      The best thing public policy can do is create money for a basic income, and index fully incomes to price rises to address inflationary fears. Then individuals are insulated from banker mistakes.

      • The problem with central banks printing billions and lending it to private banks in trouble and at near zero rates of interest (which is what the Fed did) is that that is a subsidy of private banks. I suggest full reserve banking is a better solution: a system under which it is plain impossible for private banks to fail, and under which bank shareholders carry all the costs of bank mistakes rather than taxpayers carrying the cost.

        • I’m reminded of Mehrling’s recent article at which mentions Henry Simons’s 100% reserve proposal, from the 1930s. But Mehrling concludes:

          “Credit is not a bug, but a feature.”

          My own view is that banks are going to figure out how to manufacture money to help their friends and hurt their enemies (government, because governments tax). Instead of trying to control bankers, I would let them go but also create the best money in the world to insulate individuals from banker-induced crises. The best money is the money banks in crises rely on most of all: the US dollar …

  2. A poignant and well-written post.

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