A series of developments occurred that shook the neoclassical synthesis in the 1970s as the advent of stagflation and the work of monetarists like Milton Friedman cast doubt on neo-Keynesian conceptions of monetary theory. The conditions of the period proved the impossibility of maintaining sustainable growth and low level of inflation via the measures suggested by the school.[6] The result would be a series of new ideas to bring tools to macroeconomic analysis that would be capable of explaining the economic events of the 1970s. Subsequent new Keynesian and new classical economists strived to provide macroeconomics with microeconomic foundations, incorporating traditionally Keynesian and neoclassical characteristics respectively. These schools eventually came to form a "new neoclassical synthesis", analogous to the neoclassical one,[6][7] that currently underpins the mainstream of macroeconomic theory.[8][9][10]
Main contributors
John Maynard Keynes provided the framework for synthesizing a host of economic ideas present between 1900 and 1940 and that synthesis bears his name, known as Keynesian economics. The first generation of neo-Keynesians was focused on unifying the ideas into workable paradigms, combining them with ideas from classical economics and the writings of Alfred Marshall. Paul Samuelson started the program of neoclassical synthesis, outlining two main objects of study:
Static theories: equilibrium is described as a result of actions of rational price-taking agents;
Dynamic theories: price adjustments toward equilibrium after shocks realization, with prices moving in the direction of excess demand functions proportionally to the functions' magnitudes.[7]
Much of neo-Keynesian economic theory was developed by leaders of economic profession, such as John Hicks, Maurice Allais, Franco Modigliani, Paul Samuelson, Alvin Hansen, Lawrence Klein, James Tobin and Don Patinkin.[11] The process began soon after the publication of Keynes' General Theory with the IS-LM model (investment saving–liquidity preference money supply) first presented by John Hicks in a 1937 article.[12] It continued with adaptations of the supply and demand model of markets to Keynesian theory. It represents incentives and costs as playing a pervasive role in shaping decision making. An immediate example of this is the consumer theory of individual demand, which isolates how prices (as costs) and income affect quantity demanded.
The term "neoclassical synthesis" appears to be coined by Paul Samuelson in his influential textbook Economics.[6] According to Samuelson, the neoclassical synthesis should have become a new general economic theory, that could unite positive aspects of previous economic research and become a consensus, over which all members of the economic community believed that the active fiscal and monetary interventions can be used for stabilizing economy and ensuring full employment.[7] Following him, the market economy, based on the reasons described by J. Keynes, cannot provide full employment on its own. But if monetary and fiscal policy is used to tackle underemployment, it will put the economy on a trajectory that applies the principles of classical equilibrium analysis to explain relative prices and resource allocation.[13] The broader neo-Keynesian intellectual program would eventually produce monetarism and other versions of Keynesian macroeconomics in the 1960s.
Main provisions
Firms and individuals are considered as largely rational, and their behavior can be studied by standard microeconomic methods.[6]
Animal spirits still matter; they are perceived as the main source of movements in aggregate demand through investment.[6]
Prices and wages do not adjust quickly to clear markets; thus, markets cannot be considered as competitive.[6]
There is no automatic labor market equilibrium condition implied, but this equilibrium can be achieved through appropriate monetary and fiscal policies.[14]
The implication of tâtonnement: prices adjust to excess demand or supply along the lines of the dynamic processes of adjustment suggested by Paul Samuelson in «Foundations of Economic Analysis» (Samuelson, 1947).[6]
Implication of very active interventionist state: besides the Keynesian macro-economic policy and traditional regulatory and antitrust activities in troublesome areas of industrial organization, it also implies active state participation in areas of market failures, social costs and benefits.[15]
An economic management is considered as a search for the appropriate mix of monetary and fiscal policies, with relative weight of them being based on the relative elasticities of the IS and LM curves.[16]
An important role is devoted to the empirical studies of the impact of different economic policies.[6]
Extensive use of mathematics as a tool for economic analysis.[17][18]
The interpretation of J. Keynes suggested by neoclassical synthesis economists is based on the mixture of basic features of general equilibrium theory with Keynesian concepts.[11] Thus, most models of neoclassical synthesis have been labelled as "pragmatic macroeconomics".[11] Neo-Keynesians generally looked at labor contracts as sources of wage stickiness to generate equilibrium models of unemployment. Their efforts resulted in the development of the IS–LM model and other formal modelling of Keynes' ideas.
The development of the neoclassical synthesis started in 1937 with J. Hicks's publication of the paper Mr. Keynes and Classics, where he proposed the IS-LM scheme that has put the Keynesian theory into the more traditional terms of a simplified general equilibrium model with three markets: goods, money, and financial assets.[19] This work marked the beginning of neo-Keynesian macroeconomics.[11] Later, in the 1940s–1950s, the ideas of J. Hicks were supported by F. Modigliani and Paul Samuelson.[11]F. Modigliani in 1944 elaborated on J. Hicks publication, expanding the IS-LM scheme by incorporating the labor market into the model.[19] P. Samuelson coined the term "neoclassical synthesis" in 1955[7] and put much effort into building and promoting the theory, in particular through his influential book Economics, first published in 1948.[20] One of the main contributions of P. Samuelson made in the first edition of Economics was the 45-degree diagram (frequently known as "Keynesian cross"), that reconciled the competing economics of J.M. Keynes and neoclassical school by placing the neoclassical theory of price and income formation in the context of market competition with Keynesian macroeconomics as a theory of government intervention.[20]
The IS–LM model is used to analyze the effect of demand shocks on the economy.
Many breakthroughs in the development of neoclassical synthesis had happened by the 1950s, with the creation of the IS-LM model by J. Hicks (1937) and A. Hansen (1949), the clarification of the role of the rigidity of nominal wages in the Keynesian model in the work of F. Modigliani (1944), the identification of the importance of the wealth effects and the role of public debt in the work of L.Metzler (1951), and D. Patinkin's clarification of the structure of the macroeconomic model (1956).[6]
Legacy
Through the 1950s, moderate degrees of government-led demand in industrial development and use of fiscal and monetary counter-cyclical policies continued and reached a peak in the "go go" 1960s, where it seemed to many neo-Keynesians that prosperity was now permanent. By the beginning of 1970s, the research program formulated after WWII was generally completed, and the neoclassical synthesis had proved to be very successful.[6] However, with the oil shock of 1973 and the economic problems of the 1970s, many economies experienced "stagflation": high and rising unemployment, coupled with high and rising inflation, contradicting the Phillips curve's normal behaviour.
As the scientific success of the neoclassical synthesis was largely due to its empirical success, this stagflation led to a collapse of the consensus around the neoclassical synthesis and it was attacked for its inability to explain events.[6][7] Although neoclassical synthesis models were further expanded to include shocks, empirics exposed the main flaw that lay in the core of the theory: the asymmetry of considering individual agents as highly rational but markets as inefficient (particularly labour markets).[6] R. Lucas and T. Sargent highly criticized the theory, claiming that predictions [based on this theory] were widely incorrect, and "that the doctrine on which they were based was fundamentally flawed is now a simple matter of fact".[21]
Stagflation meant that both expansionary (anti-recession) and contractionary (anti-inflation) policies had to be applied simultaneously, a clear impossibility. This produced a "policy bind" and the collapse of the neoclassical-Keynesian consensus on the economy, leading to the development of new classical macroeconomics and new Keynesianism.[22] Through the work of those such as S.Fischer (1977) and J.Taylor (1980), who demonstrated that the Philips curve can be replaced by a model of explicit nominal price and wage-setting with saving most of the traditional results,[6] these two schools would come together to create the new neoclassical synthesis that forms the basis of mainstream economics today.[8][9][10]
Following the emergence of the new Keynesian school in the 1970s, neo-Keynesians have sometimes been referred to as "Old-Keynesians".[23]
↑ Chapter 1. Snowdon, Brian and Vane, Howard R., (2005). Modern Macroeconomics: Its Origin, Development and Current State. Edward Elgar Publishing, ISBN1-84542-208-2
↑ Hayes, M.G. (2008). The Economics of Keynes: A new guide to the General Theory. Edward Elgar Publishing. pp.2–3, 31. ISBN978-1-84844-056-2.
Keynesian economics are the various macroeconomic theories and models of how aggregate demand strongly influences economic output and inflation. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy. Instead, it is influenced by a host of factors – sometimes behaving erratically – affecting production, employment, and inflation.
Macroeconomics is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and government spending to regulate an economy’s growth and stability. This includes regional, national, and global economies. According to a 2018 assessment by economists Emi Nakamura and Jón Steinsson, economic "evidence regarding the consequences of different macroeconomic policies is still highly imperfect and open to serious criticism."
Neoclassical economics is an approach to economics in which the production, consumption and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a good or service is determined through a hypothetical maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production. This approach has often been justified by appealing to rational choice theory, a theory that has come under considerable question in recent years.
In economics, stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.
Post-Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, with subsequent development influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor, Sidney Weintraub, Paul Davidson, Piero Sraffa and Jan Kregel. Historian Robert Skidelsky argues that the post-Keynesian school has remained closest to the spirit of Keynes' original work. It is a heterodox approach to economics.
IS–LM model, or Hicks–Hansen model, is a two-dimensional macroeconomic tool that shows the relationship between interest rates and assets market. The intersection of the "investment–saving" (IS) and "liquidity preference–money supply" (LM) curves models "general equilibrium" where supposed simultaneous equilibria occur in both the goods and the asset markets. Yet two equivalent interpretations are possible: first, the IS–LM model explains changes in national income when the price level is fixed in the short-run; second, the IS–LM model shows why an aggregate demand curve can shift. Hence, this tool is sometimes used not only to analyse economic fluctuations but also to suggest potential levels for appropriate stabilisation policies.
New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.
This aims to be a complete article list of economics topics:
Paul Anthony Samuelson was an American economist, who was the first American to win the Nobel Memorial Prize in Economic Sciences. When awarding the prize in 1970, the Swedish Royal Academies stated that he "has done more than any other contemporary economist to raise the level of scientific analysis in economic theory". Economic historian Randall E. Parker has called him the "Father of Modern Economics", and The New York Times considers him to be the "foremost academic economist of the 20th century".
The General Theory of Employment, Interest and Money is a book by English economist John Maynard Keynes published in February 1936. It caused a profound shift in economic thought, giving macroeconomics a central place in economic theory and contributing much of its terminology – the "Keynesian Revolution". It had equally powerful consequences in economic policy, being interpreted as providing theoretical support for government spending in general, and for budgetary deficits, monetary intervention and counter-cyclical policies in particular. It is pervaded with an air of mistrust for the rationality of free-market decision making.
Alvin Harvey Hansen was an American economist who taught at the University of Minnesota and was later a chair professor of economics at Harvard University. Often referred to as "the American Keynes", he was a widely read popular author on economic issues, and an influential advisor to the government on economic policy. Hansen helped create the Council of Economic Advisors and the Social Security system. He is best remembered today for introducing Keynesian economics in the United States in the 1930s and 40s.
Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Also known as orthodox economics, it can be contrasted to heterodox economics, which encompasses various schools or approaches that are only accepted by a minority of economists.
Robert Graham King is an American macroeconomist. He is currently professor at the Department of Economics at Boston University, editor of the Journal of Monetary Economics, research consultant to the Federal Reserve Bank of Richmond, and a member of the National Bureau of Economic Research.
In the history of economic thought, a school of economic thought is a group of economic thinkers who share or shared a common perspective on the way economies work. While economists do not always fit into particular schools, particularly in modern times, classifying economists into schools of thought is common. Economic thought may be roughly divided into three phases: premodern, early modern and modern. Systematic economic theory has been developed mainly since the beginning of what is termed the modern era.
New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous foundations based on microeconomics, especially rational expectations.
Paul Davidson is an American macroeconomist who has been one of the leading spokesmen of the American branch of the post-Keynesian school in economics. He is a prolific writer and has actively intervened in important debates on economic policy from a position critical of mainstream economics.
Axel Leijonhufvud was a Swedish economist and professor emeritus at the University of California, Los Angeles (UCLA), and professor at the University of Trento, Italy. Leijonhufvud focused his studies on macroeconomic monetary theory. In his defining book On Keynesian Economics and the Economics of Keynes (1968) he focuses on a critique of the interpretation of Keynesian economic theory by Keynesian economists. He goes on to call the standard neoclassical synthesis interpretation of the Keynes' General Theory as having misunderstood and misinterpreted Keynes. In one of his papers, "Life Among the Econ" (1973), he takes a comical yet critical look at the inherent clannish nature of economists; the paper was considered a devastating takedown of economics and economists.
The Keynesian Revolution was a fundamental reworking of economic theory concerning the factors determining employment levels in the overall economy. The revolution was set against the then orthodox economic framework, namely neoclassical economics.
Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
The new neoclassical synthesis (NNS), which is now generally referred to as New Keynesian economics, and occasionally as the New Consensus, is the fusion of the major, modern macroeconomic schools of thought – new classical macroeconomics/real business cycle theory and early New Keynesian economics – into a consensus view on the best way to explain short-run fluctuations in the economy. This new synthesis is analogous to the neoclassical synthesis that combined neoclassical economics with Keynesian macroeconomics. The new synthesis provides the theoretical foundation for much of contemporary mainstream macroeconomics. It is an important part of the theoretical foundation for the work done by the Federal Reserve and many other central banks.
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