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Keynesian, New Keynesian and New Classical Economics
Author(s): B. Greenwald and J. E. Stiglitz
Source: Oxford Economic Papers, New Series, Vol. 39, No. 1 (Mar., 1987), pp. 119-133
Published by: Oxford University Press
Stable URL: http://www.jstor.org/stable/2663132 .
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Oxford Economic Papers 39 (1987),
119-132
KEYNESIAN, NEW KEYNESIAN AND
NEW CLASSICAL ECONOMICS
B.
By GREENWALD and J. E. STIGLITZ'
1. Introduction
more than two there have
FOR centuries, been two opposing views of the
One its and
capitalist economy. stresses the with which
virtues, efficiency
information between consumers
prices carry and and allocate
producers,
The
resources. other the of the market and
spotlights shortcomings system,
its of massive of
particularly episodes and labour.
unemployment capital
of the first
Adherents group treat
usually unemployment as a temporary
that market forces will cure if
aberration left to themselves. The New
Economists have further. in
Classical gone They interpret changes employ-
ment levels as rational to in
agents' relative
responses perceived changes
in for took
prices: workers 1932, example, more leisure because
relative
wages looked low. They liken to a
unemployed capital spare
it tyre-spare
for those few times when is
held To the critics of
capacity needed.
really
such views are unscientific
capitalism, dangerous, nonsense, misleading
into in the of
governments acquiescing social and costs
grave private high
reconciled these views of He
unemployment. Keynes conflicting capitalism.
confronted the unemployment and that limited
problem, argued govern-
could solve it.
ment intervention Once was the
unemployment removed,
vision of the efficient market could
classical be restored. dubbed
Samuelson
this the Neoclassical
Synthesis.
The Neoclassical was taken as an of faith. Fundamental
Synthesis article
of
about the failures the market such as the causes of
questions system,
and the that
periodic depressions unemployment accompanied them, were
avoided. Keynesian economics created in the that
schizophrenia way
economics was taught: macroeconomic in which
Adam invisible courses, students were
to Smith's hand and
introduced the fundamental
theorems
of welfare were followed macroeconomic
economics, by courses,
focusing
of the
on the failures market and the role of in
economy government
them. Two Microeconomists criticized
correcting sub-disciplines developed.
for their lack of
macroeconomists rigour and theoretical foundations.
Macroeconomists microeconomists for the unrealism and
castigated inap-
of their
propriateness theories. Dissatisfaction with Keynesian
economics
was also based on the want of explanation for some of its central
assumptions, particularly the of and
concerning sluggishness prices wages.
did and not fall in recessions? didn't
Why wages prices enough Why firms
that wanted to sell more lower their A of a of
simply prices? quarter century
failed to
research provide answers to these This
convincing questions. state
not for
of affairs could continue long.
from the National Science
1Financial Foundation and the Hoover Institution
support The is
authors wish to thank
Peter Sinclair for on
gratefully acknowledged. comments an earlier
draft of this
paper.
Oxford Press 1987
(? University
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NEW KEYNESIAN ECONOMICS
120
in the two
There were two ways which sub-disciplines could be recon-
could be to and the
nected. Macrotheory adapted microtheory; converse.
Economics took the first Its
New Classical approach. advocates aimed to
the behaviour of the from the
derive dynamic, aggregative economy basic
principles of rational, maximizing firms and individuals. The School
the of for
recognized importance dynamics understanding macro-behaviour,
and the central role of in
expectations shaping those dynamics. It focused
on the of rational
attention, then, consequences expectation formation, and
it is this aspect of their work which has given the School its alternative
Rational School.2
name, the Expectations
The other seeks to to For
approach adapt
microtheory macrotheory. the
can to it as
one refer the
want of a better New Economics.
term, Keynesian
of credit
The phenomena unemployment, and business
rationing cycles are
with standard
inconsistent macroeconomic
theory. New Keynesian Econom-
to a that can account for
ics aims develop microtheory them. There are
strands
different to New
numerous Keynesian Economics, taken in its
broadest possible sense. One major element is the study of imperfect
and
information incomplete markets.
This aims to a broad outline of this of the
paper present aspect New
Keynesian Economics, and to show how it resembles and differs from
traditional Economics. himself
Keynesian Keynes had a novel, and mark-
vision of how the
edly non-neoclassical economy worked. Keynes used
to describe the behaviour of
picturesque language entrepreneurs: they were
moved "animal But when economics came to be
by spirits". Keynesian
in of a in
and the form model of
codified, presented simple (as chapter 18
and of
the Hicks
the General such as and
Theory, expositions others, (1937)
of
Klein (1948)), earlier modes back. We that
thinking crept contend this
so well in of his brilliant
vision, captured many passages, provides greater
of and business than do the
understanding unemployment cycles formal
models.3
Keynesian
2. Some
important Keynesian insights
of we of
Four Keynes' many insights as essential to the
regard explanation
and business fluctuations.
unemployment These are:
2The leading proponents
of the New Classical
Economics,
Barro, Lucas, Sargent
Wallace, and
have consistently based their
models
upon
rational
expectations.
But their
doctrines derive not from central
rational
expectations but
per
se, from the old classical
that assumption
markets clear. It is this
always last that leads
assumption to the
directly conclusions
(involuntary) cannot that
unemployment exist, and that macro
stabilization
policy be
may
ineffective. and well
Neary Stiglitz have
(1983) shown
that with rational
expectations
and
rigidities, price
government
policy
is even more
effective than
under
myopic
expectations:
are multipliers
even and Buiter
larger; and
(1981) Taylor
(1985)
provide
numerous other
examples
rational not where
expectations
do imply
policy
impotence.
3 Leijonhufvud a not dissimilar
(1968)
expresses view, in terms of
although his
between Keynesian and distinction
of Economics the Economics of Keynes, we would wish to classify
chapter 18 the General as
Theory an
early of the
example former.
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B. GREENWALD AND J. E. STIGLITZ 121
1. A general theory must account for the persistence of unemployment
2. A general theory must account for the in unemployment
3. and investment must be fluctuations
Savings carefully distinguished
4. Disturbances in demand, not supply, underlie the cyclical behaviour of
macroeconomic
aggregates.
The
2.1. persistence of unemployment
Keynes attributed the persistence of unemployment to the failure of
to with to labour the
sufficient clear at
wages adjust speed markets, while
same time in of the
stressing, chapter 19 General Theory, that greater
in need An
flexibility money wage rates not exert stabilizing effects.
that rates are frozen is to Price
assumption money wage integral the Fixed
Barro and Grossman But this
School, exemplified, among others, by (1971).
fell in
premise fails to square with evidence (money wage rates by one third
the Great Slump in the United States), and cries out for theoretical
conclusions
In do not absolute
justification. fact, Keynesian require rigidity
All needed is market
in rates. that is that fail to fall to
money wage wages
clearing levels. As we shall see below, efficiency wage models offer a
of for the critical that
set contention
compelling explanations Keynesian
for
the markets labour.
to clear
rates fail
wage
2.2. The in
fluctuations unemployment
second
Turning to the issue, the fluctuations in unemployment, we face
is of do
two questions. What the source shocks which cause them? Why
in fail to their effects?
changes prices dampen The shocks that generate
macroeconomic fluctuations are if to the
rarely, ever, wholly exogenous
economic system. Evidence suggests that they often take the form of
in demand for and in
changes the investment, particular for inventories. Yet
if production functions are concave, and recessions are characterized by
low real interest
relatively wage and/or rates, intertemporal production
occur.
should Inventories should limit
serve to not
smoothing fluctuations,
stressed in
exacerbate them. Keynes rightly the role of investment macro-
fluctuations. But he attributed in
economic the changes investment to
animal to in His is less than
spirits, unexplained changes expectations. story
complete.
To for in in
account fluctuations unemployment, Keynes invoked changes
the demand for but he also had to and in
investment; say why prices,
interest failed to to offset them. In the
particular rates, change by enough
he that nominal little if
General interest rates would fall
Theory, argued
demand were interest-elastic. it is
One here is that
money highly difficulty
rates
not interest rates that should for real
real, nominal, matter investment;
take account of the rate of inflation. In the of the 1930s
price fact, slump
rates
real interest rose somewhat.
and There must also
saw be
prices fall, if with in the Treatise
doubts
(vented by Keynes himself, greater emphasis
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