In economics, the freshwater school (or sometimes sweetwater school) comprises US-based macroeconomists who, in the early 1970s, challenged the prevailing consensus in macroeconomics research. A key element of their approach was the argument that macroeconomics had to be dynamic and based on how individuals and institutions interact in markets and make decisions under uncertainty. [1]
This new approach was centered in the faculties of the University of Chicago, Carnegie Mellon University, Stanford University , Cornell University, Northwestern University, the University of Minnesota, and the University of Rochester. They were called the "freshwater school" because Chicago, Pittsburgh, Ithaca, Rochester, Minneapolis, etc. are close to the North American Great Lakes. [1]
The established methodological approach to macroeconomic research was primarily defended by economists at the universities and other institutions near the east and west coasts of the United States. These included University of California, Berkeley, University of California, Los Angeles, Brown University, Duke University, Harvard University, MIT, University of Pennsylvania, Princeton University, Columbia University, and Yale University. They were therefore often called "saltwater schools".
Differences
The differences in methodological approach to answer aggregate economic questions lead to different policy implications.
Discretionary policies
One of the main differences between so-called "freshwater economics" and "saltwater economics" were in their findings on the effects of and relative importance of structural and discretionary policies.
An implication of saltwater economic theory was that the government has an important role to play in order to actively and discretionarily stabilize the economy over the business cycle through striving to fine-tune "aggregate demand". [5]
Researchers associated with the "freshwater school" found that government economic policies are of utmost importance for both the economy's abilities to respond to shocks and for its long-term potential to provide welfare to its citizens. These economic policies are the rules and structure of the economy. They might be how markets are regulated, what government insurance programs are provided, the tax system, and the degree of redistribution, etc. Most researchers that have been associated with the "freshwater school" have, however, found it hard to identify mechanisms through which it is possible for governments to actively stabilize the economy through discretionary changes in aggregate public spending. [2]
Internal model consistency ("rational expectations")
Another important difference between so-called "freshwater economics" and "saltwater economics" is what is required from an economic model and, in particular, about the internal consistency of the economic model.
In general, "saltwater economists" insist less on internal model consistency than freshwater economists. Typically, they find "examples of irrational behavior interesting and important." [6] Like behavioral psychologists, they tend to be interested in situations where individuals and groups behave in a seemingly boundedly rational way.
In contrast, freshwater economists have in general been interested in accounting for the behaviour of large groups of people interacting in markets, and believe that understanding market failures requires framing problems that way. [7]
Fiscal policy
"Saltwater Keynesian economists" argue that business cycles represent market failures, and should be counteracted through discretionary changes in aggregate public spending and the short-term nominal interest rate.
"Freshwater economists" often reject the effectiveness of discretionary changes in aggregate public spending as a means to efficiently stabilize business cycles. Economists loosely associated with the "freshwater school" have found that market failures might be important both as a cause of and as amplification and propagation of business cycles. However, it does not follow from these findings that governments can effectively mitigate business cycles fluctuations through discretionary changes in aggregate public spending or the short-term nominal interest rate. Instead they find, in general, that government policies would be more effective if they concentrate on structural reforms that target identified market failures. These economists also emphasize that the government budget constraint is the unavoidable accounting identity and connection between deficits, debt, and inflation. [7]
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."
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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.
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Nicholas Gregory Mankiw is an American macroeconomist who is currently the Robert M. Beren Professor of Economics at Harvard University. Mankiw is best known in academia for his work on New Keynesian economics.
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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.
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The neoclassical synthesis (NCS), neoclassical–Keynesian synthesis, or just neo-Keynesianism was a neoclassical economics academic movement and paradigm in economics that worked towards reconciling the macroeconomic thought of John Maynard Keynes in his book The General Theory of Employment, Interest and Money (1936). It was formulated most notably by John Hicks (1937), Franco Modigliani (1944), and Paul Samuelson (1948) dominated economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s 1960s, and 1970s.
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In macroeconomic theory, general disequilibrium is a situation in which some or all of the aggregated markets, such as the money market, the goods market, and the labor market, fail to clear because of price rigidities. In the 1960s and 1970s, economists such as Edmond Malinvaud, Robert Barro and Herschel Grossman, Axel Leijonhufvud, Robert Clower, and Jean-Pascal Benassy investigated how economic policy would impact an economy where prices did not adjust quickly to changes in supply and demand. The most notable case occurs when some external factor causes high levels of unemployment in an economy, leading to households consuming less and firms providing less employment, leading to a rationing of both goods and work hours. Studies of general disequilibrium have been considered the "height of the neoclassical synthesis" and an immediate precursor to the new Keynesian economics that followed the decline of the synthesis.
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.
