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New-Keynesian Economics Today: the Empire Strikes Back Author(S): Brian Snowdon and Howard Vane Source: the American Economist, Vol New-Keynesian Economics Today: The Empire Strikes Back Author(s): Brian Snowdon and Howard Vane Source: The American Economist, Vol. 39, No. 1 (Spring, 1995), pp. 48-65 Published by: Sage Publications, Inc. Stable URL: https://www.jstor.org/stable/25604023 Accessed: 16-06-2019 14:59 UTC JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at https://about.jstor.org/terms Sage Publications, Inc. is collaborating with JSTOR to digitize, preserve and extend access to The American Economist This content downloaded from 189.6.25.92 on Sun, 16 Jun 2019 14:59:19 UTC All use subject to https://about.jstor.org/terms NEW-KEYNESIAN ECONOMICS TODAY: THE EMPIRE STRIKES BACK by Brian Snowdon* and Howard Vane** "... there is no single doctrine taken to be a scientific truth without the diametrically opposed view being similarly upheld by authors of high repute ... in other fields of science these conflicts usually come to an end ... It is only in the field of economics that the state of war seems to persist and remain permanent."1 Knut Wicksell Introduction tion of Keynes's General Theory macroecono mists have been broadly split between those who In a recent 'Symposium on Keynesian Eco nomics Today' (Journal of Economic Per spec believe that the price mechanism, unaided by the tives, Winter 1993) David Romer, James Tobin, visible hand of government, is capable of Robert King, Bruce Greenwald and Joseph stabilizing a capitalist market economy which is subject to periodic shocks and those, like Tobin, Stiglitz offered a variety of perspectives with respect to the current resurgence of Keynesian who doubt the capacity of the system to ideas which has characterized the macroeconom self-equilibrate at a satisfactory level of employ ics literature during the last decade. In his ment. The synthesis of Keynesian and neoclas introduction to the symposium Gregory Mankiw sical analysis which formed the basis of a noted that the '. literature that bears the name consensus in the 1950s and 60s appeared to have Keynesian is broad and it does not offer a single achieved an uneasy reconciliation between these vision of how the economy behaves.' However, two competing views. The theoretical debate as a leading new Keynesian he did not present relating to the consistency of macroeconomic his own views in the symposium. In February equilibrium with an excess supply of labour 1993 we interviewed Gregory Mankiw at appeared to have been won by supporters of the Harvard University2 and here we present his invisible hand view, but as a practical matter it perspective of the current state of macroeconom was accepted that the self-righting properties of ics in general and what he has called the the market were too weak and needed the 'Reincarnation of Keynesian Economics' helping hand of fiscal and monetary policies in (Mankiw, 1992a). order to achieve and maintain the primary stated We first briefly review the background to the objective of full employment. Keynesians of all current debate before presenting Mankiw's persuasions accepted the possibility of wide assessment of some of the important issues in spread and frequent 'effective' demand failures modern macroeconomics. In conclusion we together with prolonged involuntary unemploy compare the varieties of Keynesian vision ment. Nevertheless, apart from a small but presented by some recent contributors to this highly vocal anti-neoclassical group of heretics debate. centered at Cambridge University, the majority of Keynesians were also adherents, and seminal contributors, to the neoclassical paradigm (Paul Breakdown of the Consensus Samuelson and Robert Solow are the most In 1977 James Tobin, the United States' most obvious examples). This schizophrenia could distinguished 'old' Keynesian economist asked not last. the question 'How dead is Keynes?' (see Tobin, During the 1960s the synthesis became 1977). That Tobin was even asking this question increasingly associated with an acceptance of a highlights the turmoil which had begun to stable long-run trade-off between inflation and plague macroeconomics in the early 1970s and unemployment. With the breakdown of the has continued ever since. Following the publica Phillips curve in the late 1960s/early 1970s it * Principal Lecturer in Economics at the University of Northumbria, Newcastle upon Tyne. ** Reader in Economics at Liverpool John Moores University. 48 THE AMERICAN ECONOMIST This content downloaded from 189.6.25.92 on Sun, 16 Jun 2019 14:59:19 UTC All use subject to https://about.jstor.org/terms became apparent that the microeconomic under ground rules relating to optimizing behaviour pinnings of the supply side of Keynesian models have been set by new classical economists who were fundamentally flawed. The impact of the insist that no self-respecting model should first OPEC oil shock in 1973 made this even contain agents who fail to '. exhaust trades more apparent. As a result Keynesianism was that are to the perceived mutual advantage of rejected by a growing number of academic exchanging parties' (Barro, 1979). In the economists during the 1970s, especially in the language of Robert Lucas, any acceptable theory USA, who were increasingly attracted to the must not allow $100 bills to be left lying on the work of the emerging new classical school led pavement. Incorporating acceptable microfoun and inspired by Robert Lucas who for many is dations into macro models has been and remains '. the leading macro mountaineer of our the principle task facing new Keynesian econo generation' (see Parkin, 1992). Lucas's incorpo mists. ration of John Muth's rational expectations hypothesis into a market clearing setting acted The 'Reincarnation' of like a siren song to the younger generation of graduate economists (see Lucas, 1972, 1973). Keynesian Economics By 1978 Lucas and Sargent were contemplating New Keynesian economics, conceived in the life 'After Keynesian Macroeconomics'. Soon late 1970s, sprang to life in the 1980s. Since the after Lucas went so far as to claim that '. essential feature of Keynesian macroeconomics people even take offense if referred to as is the absence of continuous market clearing, the Keynesians. At research seminars, people don't new Keynesian developments during the past take Keynesian theorizing seriously anymore; decade have been primarily concerned with the the audience starts to whisper and giggle to one '. search for rigorous and convincing models another.'3 In a similar vein, a leading 'younger of wage and/or price stickiness based on generation' Keynesian, Alan Blinder, confirmed maximizing behaviour and rational expectations' that by 1980 '. it was hard to find an (see Gordon, 1990). In contrast to the new American academic macroeconomist under the classical monetary surprise and real business age of 40 who professed to be a Keynesian' (see cycle models where price taking rational indi Blinder, 1988). Lucas's obituary of Keynesian viduals make voluntary choices with respect to economics can now be seen to have been quantities, new Keynesian models contain price premature. However his critiques highlighted making, demand taking, risk-averse firms who the tensions which existed within economics operate in an imperfectly competitive, uncertain between a flexiprice neoclassical micro world world riddled with imperfect information, trans dominated by the fundamental theories of Adam action costs and asymmetric information (see Smith and Leon Walras, and a Keynesian Mankiw and Romer, 1991). New Keynesiaii superstructure where arbitrary assumptions relat economics seeks to understand and explain the ing to nominal price and wage rigidities were the causes of the imperfections in product, labour norm. This conflict was in need of resolution as and capital markets and to show how these the conventional practice of separating micro imperfections have macroeconomic conse from macro analysis was no longer tenable. The quences. In short 'New Keynesianism throws new classical solution to this 'crisis' was to bucket fulls of grit into the smooth-running adapt macroeconomic theory to neoclassical neoclassical paradigms' (Leslie, 1993). This microeconomics. As Kevin Hoover (1992) has agenda has led to research into the causes and noted the new classical research programme consequences of: '. seeks not only to revivify classical modes 1. Nominal wage stickiness (see Fischer, of equilibrium analysis, but also to secure the 1977; Taylor, 1979; Laing, 1993); euthanasia of macroeconomics'. In contrast the 2. Nominal price stickiness (see Mankiw, new Keynesian approach has been to set about 1985; Akerlof and Yellen, 1985; Romer, building new microfoundations for Keynesian 1993); macroeconomics which nevertheless remain 3. Real rigidities (see Yellen, 1984; Sha faithful to the axioms of utility and profit piro and Stiglitz, 1984; Lindbeck and maximization by individual agents. These Snower, 1986; Phelps, 1994); Vol. 39, No. 1 (Spring 1995) 49 This content downloaded from 189.6.25.92 on Sun, 16 Jun 2019 14:59:19 UTC All use subject to https://about.jstor.org/terms 4. Co-ordination failures (see Diamond, cally or acyclically. Furthermore, new Keyne 1982; Cooper and John, 1988; Ball and sians argue that price rigidities do not imply Romer, 1991). gross departures from rationality given the Although new Keynesian theory is still at a existence of 'near rational behaviour' and 'menu rudimentary stage and there are various strands costs' (see Akerlof and Yellen, 1985; and to this diverse school, one of the leading Mankiw, 1985). In new Keynesian models the advocates, Gregory Mankiw (1992a) has re reason why firms lay off workers during a cently claimed that '. .the new classical recession is not because labour costs are too challenge has been met.
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