An Assessment of New Keynesian Economics
How successful have new Keynesian economists been in their quest to develop
coherent microfoundations for sticky price models? Barro’s (1989a)
main conclusion regarding new Keynesian economics (for which he uses the
acronym NUKE) was that, although some of these ideas may prove to be
useful as elements in real business cycle models, NUKE models have ‘not
been successful in rehabilitating the Keynesian approach’. In sharp contrast,
Mankiw and Romer (1991, p. 15) concluded that ‘The new classical argument
that the Keynesian assumption of nominal rigidities was incapable of
being given theoretical foundations has been refuted.’
Keynesian economics has displayed a remarkable resilience during the
past 30 years, given the strength of the theoretical counter-revolutions launched
against its essential doctrines, particularly during the period 1968–82. This
resilience can be attributed to the capacity of Keynesian analysis to adapt to
both theoretical innovations and new empirical findings (see Shaw, 1988;
Lindbeck, 1998; Gali, 2002). Not only has Keynesian economics proved
capable of absorbing the natural rate hypothesis and expectations-augmented
Phillips curve; it has also managed to accommodate the rational expectations
hypothesis and build on the insights and methodology of the real business
cycle school (Ireland, 2004). This fundamental metamorphosis continues,
with new Keynesian theorists rebuilding and refining the foundations of
Keynesian economics in line with modern developments in microeconomic
and macroeconomic theory. By emphasizing a variety of imperfections in the
labour, product and capital markets, new Keynesian economics is viewed by
its advocates as an ‘exciting’ and ‘dynamic research programme’ (Stiglitz,
1992). To the critics, new Keynesians have achieved little more than reintroduce
‘old wine in new bottles’.
In his assessment of new Keynesian economics, Lindbeck (1998) argues
that the current ‘sophisticated structure of macroeconomic theory’ has arisen
through numerous contributions from many different strands of economic
analysis. As this process continues and involves the closer integration of real
business cycle analysis with new Keynesian frictions, ‘traditional labels’ on
macroeconomic theories, such as new Keynesian, new classical and real
business cycle, will ‘probably become increasingly irrelevant’.
In his Nobel Memorial Lecture, ‘Behavioural Macroeconomics and Macroeconomic
Behaviour’, Akerlof (2002) provides a significant critique of new
classical models and a spirited defence of Keynesian economics broadly
defined. Akerlof argues that the behavioural assumptions of the new classical
models are so ‘primitive’ that they lead to an outright denial of several
important macroeconomic phenomena. These include denying ‘the existence
of involuntary unemployment’, denying that monetary policy, even if anticipated,
does impact on real variables such as output and employment, and
ignoring the fact that deflation fails to accelerate when unemployment and
output are above their natural rates, as predicted by new classical models.
Akerlof agrees with Lucas that the orthodox Keynesian models of the neoclassical
synthesis era were in need of coherent microfoundations. However,
the orthodox neoclassical microfoundations adopted by the new classical
school ignored, and continue largely to ignore, the tremendous progress that
has been made by economists in modelling the impact of asymmetric information,
imperfect competition and adopting assumptions ‘grounded in
psychological and sociological observation’. Akerlof believes that future
progress in macroeconomics depends on building a ‘behavioural macroeconomics’
in the spirit of Keynes (see also Stiglitz, 2000, 2002). It remains to
be seen if a ‘Keynesian economics’ will proceed in the direction recommended
by Akerlof.
How successful have new Keynesian economists been in their quest to develop
coherent microfoundations for sticky price models? Barro’s (1989a)
main conclusion regarding new Keynesian economics (for which he uses the
acronym NUKE) was that, although some of these ideas may prove to be
useful as elements in real business cycle models, NUKE models have ‘not
been successful in rehabilitating the Keynesian approach’. In sharp contrast,
Mankiw and Romer (1991, p. 15) concluded that ‘The new classical argument
that the Keynesian assumption of nominal rigidities was incapable of
being given theoretical foundations has been refuted.’
Keynesian economics has displayed a remarkable resilience during the
past 30 years, given the strength of the theoretical counter-revolutions launched
against its essential doctrines, particularly during the period 1968–82. This
resilience can be attributed to the capacity of Keynesian analysis to adapt to
both theoretical innovations and new empirical findings (see Shaw, 1988;
Lindbeck, 1998; Gali, 2002). Not only has Keynesian economics proved
capable of absorbing the natural rate hypothesis and expectations-augmented
Phillips curve; it has also managed to accommodate the rational expectations
hypothesis and build on the insights and methodology of the real business
cycle school (Ireland, 2004). This fundamental metamorphosis continues,
with new Keynesian theorists rebuilding and refining the foundations of
Keynesian economics in line with modern developments in microeconomic
and macroeconomic theory. By emphasizing a variety of imperfections in the
labour, product and capital markets, new Keynesian economics is viewed by
its advocates as an ‘exciting’ and ‘dynamic research programme’ (Stiglitz,
1992). To the critics, new Keynesians have achieved little more than reintroduce
‘old wine in new bottles’.
In his assessment of new Keynesian economics, Lindbeck (1998) argues
that the current ‘sophisticated structure of macroeconomic theory’ has arisen
through numerous contributions from many different strands of economic
analysis. As this process continues and involves the closer integration of real
business cycle analysis with new Keynesian frictions, ‘traditional labels’ on
macroeconomic theories, such as new Keynesian, new classical and real
business cycle, will ‘probably become increasingly irrelevant’.
In his Nobel Memorial Lecture, ‘Behavioural Macroeconomics and Macroeconomic
Behaviour’, Akerlof (2002) provides a significant critique of new
classical models and a spirited defence of Keynesian economics broadly
defined. Akerlof argues that the behavioural assumptions of the new classical
models are so ‘primitive’ that they lead to an outright denial of several
important macroeconomic phenomena. These include denying ‘the existence
of involuntary unemployment’, denying that monetary policy, even if anticipated,
does impact on real variables such as output and employment, and
ignoring the fact that deflation fails to accelerate when unemployment and
output are above their natural rates, as predicted by new classical models.
Akerlof agrees with Lucas that the orthodox Keynesian models of the neoclassical
synthesis era were in need of coherent microfoundations. However,
the orthodox neoclassical microfoundations adopted by the new classical
school ignored, and continue largely to ignore, the tremendous progress that
has been made by economists in modelling the impact of asymmetric information,
imperfect competition and adopting assumptions ‘grounded in
psychological and sociological observation’. Akerlof believes that future
progress in macroeconomics depends on building a ‘behavioural macroeconomics’
in the spirit of Keynes (see also Stiglitz, 2000, 2002). It remains to
be seen if a ‘Keynesian economics’ will proceed in the direction recommended
by Akerlof.
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