Abstract
The Great Depression molded macroeconomic theory and policy for a long time, the impact of this shattering experience was far-reaching and, in many ways, it can still be felt today. The economics of Keynes, as well as the variety of Keynesian tendencies, was instrumental to the birth of macroeconomics and for the paradigmatic change in the analysis of whole economies after 1936. A major influence in the decline of Keynesian ideas in later years ought to be attributed to broader social, philosophical and methodological debates. Critics of Keynes’s ideas were not silent after 1936, but only when Monetarism appeared on the scene in full force did a significant opposition to Keynes and Keynesianism make itself heard. According to Milton Friedman’s famous 1968 manifesto, economic performance was determined by fundamental economic forces that no government action could improve. Hence, ‘hands off the economy’ was the best recipe for government policy. The latter conclusion had been promoted by Hayek before Friedman, and the two cooperated often. The rise of NCM to a hegemonic position of influence, was clearly reinforced by their proposals for grounding macroeconomics on microfoundations. Hence, the decline of Keynesianism was, to a significant extent, the result of a triumphing methodological transformation in the mode of thinking about the whole economy which paved the path to the radical alteration in macroeconomics. The self-perception of NCM was that they managed to transform macroeconomics from being based on value judgments and a-priori views, motivated by policy preferences and ideological biases, to a sub-field of economics that was genuinely scientific. The New Keynesians (NK), who used the same methodology as the rest of NCM but inserted specific conditions that made the use of policy welfare increasing, turned out to be the most influential tendency within NCM in the 2000s. Although, like the other NCM tendencies, they did not predict the 2008 crisis and were very ill-prepared for what followed. The dramatic changes in macroeconomics since the Great Depression show how the sub-field reached its dismal state by 2008, when a possible second Great Depression hung in the air.
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Notes
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[Blanchard’s note] “Others, I know, disagree with this optimistic assessment (for example, Solow 2008). To check whether I was totally delusional, I organized a session at the 2008 American Economic Association meetings on the theme ‘Convergence in Macro’. … I read the papers as indeed suggesting substantial but not full convergence; the readers can judge for themselves.” The convergence was to the ‘Toy Model;’ see below.
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“The current financial crisis makes it clear that the arbitrage approach to the determination of the term structure of interest rates and asset prices implicit in the basic NK model falls short of the mark: Financial institutions matter, and shocks to their capital or liquidity position appear to have potentially large macroeconomic effects” (p. 218).
- 4.
See Vines, D., & Wills, S. (2018), “The Rebuilding Macroeconomic Theory Project: An Analytical Assessment” [Introduction to a special issue Rebuilding Macroeconomic Theory], Oxford Review of Economic Policy, vol. 34, pp. 1–42.
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Wren-Lewis summarized Blanchard’s argument: “[T]here should be two types of model: DSGE models, which he called theory models, and models that were much closer to the data, which he called policy models” (p. 55). Wren-Lewis quoted Blanchard as stating:
“DSGE modelers should accept the fact that theoretical models cannot, and thus should not, fit reality closely. The models should capture what we believe are the macro-essential characteristics of the behaviour of firms and people, and not try to capture all relevant dynamics. Only then can they serve their purpose, remain simple enough, and provide a platform for theoretical discussions.
Policy modelers should accept the fact that equations that truly fit the data can have only a loose theoretical justification. In that, the early macroeconomic models had it right …” (pp. 55–56).
The essence of this paper is also in Blanchard (2018).
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For the details of his framework, see Stiglitz’s “Appendix: Core Models for Macroeconomic Policy” (pp. 92–101).
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For a recent review, see Dal Pont Legrand, M. (2022), “Some Reflections on Financial Instability in Macro Agents-Based Models: Genealogy and objectives,” Chap. 12, pp. 207–226, in Financial Markets in Perspective: Lessons from Economic History and History of Economic Thought, Arnon, A., Rosselli, A. and Marcuzzo, C. (eds.), Heidelberg: Springer-Verlag. For a recent review of the post 2008 changes in NK modeling, see Trautwein, H-M. (2022), “Financial Instability and Frictions: Can DSGE Models Finally Address the Critical Issues?”, in Financial Markets in Perspective: Lessons from Economic History and the History of Economic Thought, Arnon, A., Marcuzzo, C, and Rosselli, A. (eds), Chap. 13, pp. 227–248, Berlin: Springer Nature.
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In the project, there are many more contributions; some addressing key policy issues, like David F. Hendry and John N. J. Muellbauer who in their contribution “The Future of Macroeconomics: Macro Theory and Models at the Bank of England” outlined possible proposals for doing policy analysis after the crisis, thus, addressing criticisms raised about NK DSGE model. For a more sympathetic opinion in assessing NCM after the crisis, see, for example, Linde (2018) in the above project and Gali (2018) in the Journal of Economic Perspectives.
- 9.
Colander, D., Goldberg, M., Haas, A., Juselius, K., Kirman, A., Lux, T., & Sloth, B. (2009). “The Financial Crisis and the Systemic Failure of the Economics Profession,” Critical Review, vol. 21, pp. 249–267.
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See Colander, 2010, pp. 422–423.
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N. Emrah Aydinonat, the editor of the symposium, wrote in the “Introduction,” “Dani Rodrik’s (2015) Economics Rules presents a rare opportunity for economists and philosophers of economics to engage in a mutually beneficial exchange that could improve our understanding of the power and limits of economics, and the rights and wrongs of the dismal science.” (2018, p. 211).
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[Rodrik’s note] The quote is from Keynes’s letter to Harrod on July 4, 1938; [AA - One can find the letter in Keynes, J. M. (1973b), The General Theory and After: Part II, Defence and Development, D. Moggridge (Ed.), vol. 14, pp. 296–7 in The Collected Writings of John Maynard Keynes. A second letter on the subject was sent on July 17, 1938. The letters were discussed often over the last twenty years; for an early discussion, see Sardoni (1989–90), “Chapter 18 of the General Theory: Its Methodological Importance.”]
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Intriguingly, Rodrik added, had he known Keynes’s position while writing the book, he probably would not have written it: “Had I been familiar with this quote from Keynes before I wrote the book, I might have chosen not to spend the effort!” (p. 277).
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Rodrik was referring to a famous blog written by Paul Romer.
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“… The new classical models … were developed because the conventional Keynesian model was not very helpful in the face of the supply shocks of the 1970s. … Once the crisis struck, they were largely irrelevant to a world with deficient aggregate demand. … The right conclusion is that the features of the economy they emphasized—rational forward-looking behavior in the context of well-functioning labor and financial markets—became less important when the context was transformed” (279).
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“Macroeconomics changed between the early 1960s and the late 1970s. The macroeconomics of the early 1960s was avowedly Keynesian. … The decline of the old-style Keynesian economics was due in part to the simultaneous rise in inflation and unemployment in the late 1960s and early 1970s. That occurrence was impossible to reconcile with the simple non accelerationist Phillips curves of the time. But Keynesian economics also declined because of a change in economic methodology” (Akerlof (2007), p. 5).
- 17.
Akerlof, G. A. (2007). The New Case for Keynesianism. Challenge [published in the July–August issue], 50, pp. 5–16.
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Arnon, A. (2022). Epilogue: The Road of Macroeconomics Away from Keynesian Economics. In: Debates in Macroeconomics from the Great Depression to the Long Recession. Springer Studies in the History of Economic Thought. Springer, Cham. https://doi.org/10.1007/978-3-030-97703-0_15
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