by Putting sticky-price DSGE lipstick on the RBC pig ‘New Keynesian’ macroeconomists have for years been arguing (e.g. here) about the importance of the New Classical counter-revolution in economics. ‘Helping’ to change the way macroeconomics is done today — with rational expectations, Euler equations, intertemporal optimization and microfoundations — their main critique of New Classical macroeconomics is that it didn’t incorporate price stickiness into the Real Business Cycles models developed by the New Classicals. So — the ‘New Keynesians’ adopted the methodology suggested by the New Classicals and just added price stickiness! But does putting a sticky-price DSGE lipstick on the RBC pig really help? It sure does not! I have elaborated on why in my On the
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Putting sticky-price DSGE lipstick on the RBC pig
‘New Keynesian’ macroeconomists have for years been arguing (e.g. here) about the importance of the New Classical counter-revolution in economics. ‘Helping’ to change the way macroeconomics is done today — with rational expectations, Euler equations, intertemporal optimization and microfoundations — their main critique of New Classical macroeconomics is that it didn’t incorporate price stickiness into the Real Business Cycles models developed by the New Classicals. So — the ‘New Keynesians’ adopted the methodology suggested by the New Classicals and just added price stickiness!
But does putting a sticky-price DSGE lipstick on the RBC pig really help?
It sure does not!
I have elaborated on why in my On the use and misuse of theories and models in mainstream economics, and David Glasner gives some further reasons why a pig with lipstick is still a pig:
The real problem is not that prices are sticky but that trading takes place at disequilibrium prices and there is no mechanism by which to discover what the equilibrium prices are. Modern macroeconomics solves this problem, in its characteristic fashion, by assuming it away by insisting that expectations are “rational.”
Economists have allowed themselves to make this absurd assumption because they are in the habit of thinking that the simple rule of raising price when there is an excess demand and reducing the price when there is an excess supply inevitably causes convergence to equilibrium …
I regard the term “sticky prices” and other similar terms as very unhelpful and misleading; they are a kind of mental crutch that economists are too ready to rely on as a substitute for thinking about what are the actual causes of economic breakdowns, crises, recessions, and depressions. Most of all, they represent an uncritical transfer of partial-equilibrium microeconomic thinking to a problem that requires a system-wide macroeconomic approach. That approach should not ignore microeconomic reasoning, but it has to transcend both partial-equilibrium supply-demand analysis and the mathematics of intertemporal optimisation.