Keynes v. the ‘old’ classical model

Keynes v. the ‘old’ classical model
Introduction
In order to better understand current controversies within macroeconomics it is
necessary to trace their origin back to the ‘Keynes v. Classics’ debate which
began in the 1930s and has continued in various forms ever since. For example,
during the 1980s the two schools of thought at the centre of the mainstream
debate were represented by the new classical (real) equilibrium business cycle
theorists and the new Keynesian school. The former carry on the tradition of
the classical economists and emphasize the optimizing power of economic
agents acting within a framework of free market forces. The latter ‘believe that
understanding economic fluctuations requires not just studying the intricacies
of general equilibrium, but also appreciating the possibility of market failure on
a grand scale’ (Mankiw, 1989; see Chapters 6 and 7).
Classical economics is that body of thought which existed prior to the
publication of Keynes’s (1936) General Theory. For Keynes the classical
school not only included Adam Smith, David Ricardo and John Stuart Mill,
but also ‘the followers of Ricardo, those, that is to say, who adopted and
perfected the theory of Ricardian economics’ (Keynes, 1936, p. 3). Keynes
was therefore at odds with the conventional history of economic thought
classification, particularly with his inclusion of both Alfred Marshall and
Arthur Cecil Pigou within the classical school. However, given that most of
the theoretical advances which distinguish the neoclassical from the classical
period had been in microeconomic analysis, Keynes perhaps felt justified in
regarding the macroeconomic ideas of the 1776–1936 period, such as they
existed, as being reasonably homogeneous in terms of their broad message.
This placed great faith in the natural market adjustment mechanisms as a
means of maintaining full employment equilibrium.
Before moving on to examine the main strands of macroeconomic thought
associated with the classical economists, the reader should be aware that,
prior to the publication of the General Theory, there was no single unified or
formalized theory of aggregate employment, and substantial differences existed
between economists on the nature and origin of the business cycle (see
Haberler, 1963). The structure of classical macroeconomics mainly emerged
after 1936 and did so largely in response to Keynes’s own theory in order that
comparisons could be made. Here we take the conventional approach of
presenting a somewhat artificial summary of classical macroeconomics, a
body of thought that in reality was extremely complex and diverse (see
O’Brien, 1975).
Although no single classical economist ever held all the ideas presented
below, there are certain strands of thought running through the pre-Keynes
literature which permit us to characterize classical theory as a coherent story
with clearly identifiable building-blocks. To do so will be analytically useful,
even if ‘historically somewhat inaccurate’ (see Ackley, 1966, p. 109). Even
an ‘Aunt Sally’ version of the classical theory can, by comparison, help us
better understand post-1936 developments in macroeconomic theory. We accept
that, whilst the major presentations of the ‘Keynes v. Classics’ debate
consist of ahistorical fictions – especially those of Hicks (1937) and
Leijonhufvud (1968) – and serve as straw men, they aid our understanding by
overtly simplifying both the Keynes and the classics positions.