The Closed Economy: The Frisch or Keynes Paradigm?

Abstract

In this chapter we provide, as an introduction into the essential features of our approach to open economy macrodynamics, two different views of the working of modern market economies on the macrolevel,¹ the Neoclassical and the Keynesian approaches which indeed give rise to very different macrodynamic implications,² even on the standard IS-LM-PC textbook level of macrodynamic modelling that includes the Phillips Curve (PC) mechanism. We shall show that basic systematically destabilizing feedback chains in this standard framework are generally simply ignored or — if taken note of — restricted to short discussions of basically comparative static analysis (e.g. on the adverse effects of deflation, Blanchard, 2003, p.408) or solely put into exercises (e.g. on destabilizing price flexibility, Romer, 1996, p.239). By contrast, we will show in this chapter that such destabilizing feedback mechanisms form an integral part of any proper Keynesian IS-LM-PC analysis in periods of inflation, even more than in periods of deflation. The relevance of these can eventually only be decided by an empirical analysis concerning the parameter sizes of the model for certain historical episodes and specific countries.