The ‘New Keynesian’ Monetarist fantasy is finally over

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Lars Pålsson Syll
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from Lars Syll

Kenneth Rogoff of Harvard recently argued that fiscal stabilization policy “is far too politicized to substitute consistently for modern independent technocratic central banks.” But instead of considering how this defect might be overcome, Rogoff sees no alternative to continuing with the prevailing monetary-policy regime – despite the overwhelming evidence that central banks are unable to play their assigned role. At least fiscal policy might in principle be up to the task of economic stabilization; there is no chance that central banks will be …

A less skeptical observer than Rogoff would have looked more closely at proposals to strengthen automatic fiscal stabilizers, rather than dismissing them on the grounds that they will have (bad) “incentive effects” and that policymakers will override them on occasion. For example, a fair observer would at least be open to the idea of a public-sector job guarantee of the sort envisaged by the 1978 Humphrey-Hawkins Act in the US, which authorized the federal government to create “reservoirs of public employment” to balance fluctuations in private spending …

To be sure, both the design and implementation of such a job guarantee would give rise to problems. But for both political and economic reasons, one should try to tackle them rather than concluding, as Rogoff does, that, “with monetary policy hampered and fiscal policy the main game in town, we should expect more volatile business cycles.” We have the intelligence to do better than that.

Robert Skidelsky

Great post!

Paul Krugman had a similar post up a couple of years ago on why monetarism has more or less disappeared from economics nowadays. Milton Friedman’s project was, according to Krugman, doomed to failure. The key point for this argument was the following:

On the intellectual side, the “neoclassical synthesis” — of which Friedman-style monetarism was essentially part, despite his occasional efforts to make it seem completely different — was inherently an awkward construct. Economists were urged to build everything from “micro foundations” — which was taken to mean perfect rationality and clearing markets, not realistic descriptions of individual behavior. But to get a macro picture that looked anything like the real world, and which justified monetary activism, you needed to assume that for some reason wages and prices were slow to adjust.

Sounds familiar, doesn’t it? Yes, indeed, that is exactly what Krugman’s ‘New Keynesian’ buddies — Greg Mankiw, Olivier Blanchard, David Romer, Simon Wren-Lewis et consortes — are doing today! So being consistent to his own argument, Krugman has to conclude that their project is ‘doomed to failure.’

Back in 1994 Laurence Ball and Greg Mankiw argued that

although traditionalists are often called ‘New Keynesians,’ this label is a misnomer. They could just as easily be called ‘New Monetarists.’

That is still true today — the macroeconomics of people like Greg Mankiw and Paul Krugman has theoretically and methodologically a lot more to do with Milton Friedman than with John Maynard Keynes. As Skidelsky wrote last year:

The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times. Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved …

Without acknowledgement of uncertainty, saltwater economics is bound to collapse into its freshwater counterpart. New Keynesian “tweaking” will create limited political space for intervention, but not nearly enough to do a proper job.

Robert Skidelsky

Skidelsky’s articles show why we all ought to be sceptical of the pretences and aspirations of Monetarist and  ‘New Keynesian’ macroeconomics. So far it has been impossible to see that they have yielded anything in terms of realist and relevant economic knowledge.

‘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 won’t do. The ‘New Keynesian’ pig is still neither Keynesian nor new.

The rather one-sided emphasis of 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, 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, and 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 neither ontological nor 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.

And then, of course, there is that weird view on unemployment that makes you wonder on which planet those ‘New Keynesians’ live …