by ‘New Keynesian’ macroeconomics — worse than useless I have tried to document how the practitioners of the self-proclaimed ‘science of monetary policy’ have gone out of their way to salvage their paradigm—after the inflationary surge of 2021-2023 made it clear that the New Keynesian emperor was not wearing any clothes. All their elaborate tools and instruments, including the output gap, the unemployment gap, the New Keynesian Phillips curve and forward-looking inflation expectations, were found lacking, incapable of giving timely signals of the re-emergence of high inflation. To be fair, most economists, not just the New Keynesian ones, were caught unprepared—but for Keynesian economists, for instance, it was relatively straightforward to empirically
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‘New Keynesian’ macroeconomics — worse than useless
I have tried to document how the practitioners of the self-proclaimed ‘science of monetary policy’ have gone out of their way to salvage their paradigm—after the inflationary surge of 2021-2023 made it clear that the New Keynesian emperor was not wearing any clothes. All their elaborate tools and instruments, including the output gap, the unemployment gap, the New Keynesian Phillips curve and forward-looking inflation expectations, were found lacking, incapable of giving timely signals of the re-emergence of high inflation. To be fair, most economists, not just the New Keynesian ones, were caught unprepared—but for Keynesian economists, for instance, it was relatively straightforward to empirically account for the (unexpected) surge in inflation within their existing paradigm …
New Keynesian economists do not have this luxury of a macro model that is relevant to the real world. And that is why they have to put in so much effort to steadfastly align their paradigm to real-world events. A paradox remains unresolved, however. The New Keynesians routinely accuse economists working on alternative paradigms of being incoherent dilettantes whose arguments rely on ad-hoc assumptions and policy-variant model parameters. But if the present paper has one takeaway lesson, it is this: the New Keynesians manage to maintain their paradigm only by adding further epicycles to its analytical core that are justified by ‘Just So’ stories.
The pot is thus calling the kettle black. But so far, they are still getting away with it. However, it is safe to predict that the New Keynesian core will break down under the ever-expanding weight of the added epicycles. The sooner this happens, the better. After all, the impenetrability of this continuously expanding New Keynesian paradigm is maddening—one must feel great sympathy for King Alfonso X of Castille (1221-1284), who, when shown the minutiae of the Ptolemaic system, is said to have remarked that “if the Almighty had consulted him on the matter, he would have recommended something a little simpler… “
Servaas Storm’s well-argued article underscores the necessity of being sceptical of the pretences and aspirations of ‘New Keynesian’ macroeconomics. So far it has been impossible to see that it has yielded very much in terms of realist and relevant economic knowledge. And — as if that wasn’t enough — there’s nothing new or Keynesian about it!
‘New Keynesianism’ doesn’t have its roots in Keynes. It has its intellectual roots in Paul Samuelson’s ill-founded ‘neoclassical synthesis’ project, whereby he thought he could save the ‘classical’ view of the market economy as a (long run) self-regulating market clearing equilibrium mechanism, by adding some (short run) frictions and rigidities in the form of sticky wages and prices.
But — putting a sticky-price lipstick on the ‘classical’ pig sure will not do. The ‘New Keynesian’ pig is still neither Keynesian nor new.
The rather one-sided emphasis on usefulness and its concomitant instrumentalist justification cannot hide that ‘New Keynesians’ cannot give supportive evidence for their considering it fruitful to analyze macroeconomic structures and events as the aggregated result of optimizing representative actors. After having analyzed some of its ontological and epistemological foundations, yours truly cannot but conclude that ‘New Keynesian’ macroeconomics — on the whole, and not only regarding its repaired DSGE models — has not delivered anything else than ‘as if’ unreal and irrelevant models.
The purported strength of New Classical and ‘New Keynesian’ macroeconomics is that they have firm anchorage in preference-based microeconomics, especially the decisions taken by inter-temporal utility maximizing ‘forward-looking’ individuals.
To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations — without ever presenting either ontological or epistemological justifications for this claim — has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations. It is as if these economists want to resurrect the omniscient Walrasian auctioneer in the form of all-knowing representative actors equipped with rational expectations and assumed to somehow know the true structure of our model of the world.