The core problem with ‘New Keynesian’ macroeconomics

10 July, 2018 at 11:51 | Posted in Economics | 3 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?

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. Lars, you seem to think that one of ‘the core problems with macroeconomics’ is “The almost quasi-religious insistence that macroeconomics has to have microfoundations”. From a mathematical perspective this seems odd. While mainstream economists pay lip-service to microfoundations, they seem to deny the applicability of any relevant mathematics. I was recently somewhat taken aback to find a reference to Takens embedding theorem on an economic blog. If it is accepted that this has any relevance at all, doesn’t it blow apart the mainstream argument? (I discuss at In other words, the solution to economics problems may not be less attention to microfoundations, but more.

    My understanding of the microfoundations of economics is that there was alleged (e.g. by Greenspan) to be an elite who is motivated and able to escape the implications of Takens’ theorem by innovation or otherwise. This may once have been try, but by 2007 it was clear from game theory (among other sources) that for this to be true the old elites would have to have been in cohoots with the Chinese. But this appeared not to be the case, and the hard fact of the crash would seem to invalidate this. But then again, I am no economist, so maybe I am reading the theory all wrong and ‘microfoundations’ has some obscure (to me) technical meaning. (I naively take it mean that the macro should be logically consistent with the micro.)

    Maybe we should identify some reasonably long-running econometric series as a test case to which to apply Takens’ theory, and see how we get on? From a social science perspective you could give the series to some actual mathematicians and see what conclusions they reach. An experiment!

  2. Dave,
    Can you explain how Taken’s Theorem attributing the “onset of turbulence to the presence of strange attractors” has anything to do with the microfoundations of macro?
    Micro deals with the optimal utilization of resources (against an assumed constaint), setting a unique equilibrium across a range of and in individual markets while macro deals with the level of the utilization of resources (no constraint necessarily necessary) and equilibrium in the level of aggregate output not necessarily at the point of optimal resource utilization.
    I have difficulty understanding how these two perspectives might and should intersect in economic theory.

  3. “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.”
    Radical uncertainty has been solved for markets; Goldman Sachs matched its books and was insured against Mortgage-backed Security defaults in 2008. Linear algebra and other advanced mathematical techniques used in derivative formation hedge any market outcome. The problem in 2008 was that the insurance piece was immature, and broke. You can call that breakage uncertainty, but the only real uncertainty was whether the Fed would make up for the broken insurance piece by printing a lot of money. The only radical uncertainty for big finance firms is psychological: will the Fed backstop us if we screw up?
    Radical uncertainty about supply of physical resources did not cause the 2008 crisis, as the quoted passage implies. Finance firms know how to strip out risk. We are right back to pre-2007 levels of private credit creation, because the insurance piece is supposedly fixed. The only real uncertainty now is, if there is a mistake somewhere else, will the Fed expand its balance sheet to bail out banks again? Why wouldn’t it?

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