I was privileged last week to present one of six plenary lectures at the annual meetings of the Society for Economic Measurement in the brand new Samberg Center at MIT. The conference was organized by the eminent macroeconomist Bill Barnett, founder of the Society for Economic Measurement and founding Editor of Macroeconomic Dynamics. Other keynote speakers included Erik Brynjolfsson on the measurement of welfare, Peter Diamond and Larry Kotlikoff, with alternative takes on social security, Peter Ireland on the importance of divisia aggregates and Gita Gopinath on Global Trade. My talk was predicated on the fact that there can be no measurement without theory and I revisited a theme that I first presented last June at a Post-Keynesian conference held at the University of Greenwich.
Here is an excerpt from a paper that I wrote for the Post-Keynesian conference, forthcoming in the European Journal of Economics and Economic Policies, with the title, Post-Keynesian Dynamic Stochastic General Equilibrium Theory. A prepublication version is available on my website here and the slides for the MIT talk are here.
Who is a Post-Keynesian? Who knows? Who cares? I believe that intellectuals are, or should be, inclusive in their acceptance of alternative approaches to interesting questions and I am not going to propose a Keynesian version of the Nicene Creed. If you self-identify as Post-Keynesian; that's good enough for me. I do think, however, that we can draw an interesting analogy with evolutionary biology. In his wonderful book, the Beak of the Finch, Jonathan Weiner describes evolution in action on the Galapagos Islands.
In response to a prolonged period of drought, Weiner describes how the characteristics of the birds that inhabit different parts of the island begin to diverge. If drought conditions persist, the finches on one part of the island stop breeding with those on another and, slowly, separate species begin to emerge. When eventually, the rains return with the arrival of El Niño, inter-breeding recommences and the divergent characteristics of the emergent populations are merged, once more, into a single species.
When did Post-Keynesians stop interbreeding with their orthodox cousins? It was in 1955. That was the year when Paul Samuelson introduced the neo-classical synthesis into the third edition of his influential introductory textbook. According to the neo-classical synthesis, the economy is Keynesian in the short-run, when prices and wages are ͚sticky͛, and classical in the long-run when they have time to converge to their Walrasian levels. Participants at this conference do not need me to point out that this idea has very little to do with Keynes.
The intellectual descendent of the neo-classical synthesis is New-Keynesian economics, an approach that is neither new nor Keynesian and that has more in common with Hume's essay, Of Money, than with The General Theory. New-Keynesian economics was constructed on the core of a representative agent real business cycle model by a group of neoclassical economists, notably Michael Woodford in his Magnus opus Interest and Prices. It is built onto the real business cycle framework by adding costs of changing prices and the resulting theoretical construction makes Frankenstein͛'s monster look like a beauty queen.
But although the New Keynesian reconciliation of Keynes with Walras is ugly, we should not infer that all possible reconciliations of Keynes with Walras will be similarly unattractive. New Keynesian economics is built on two assumptions. The first is that aggregate quantities can be modeled ‘as if’ they were chosen by a single optimizing household with superhuman perceptions of future prices. The second is that an ‘evil agent’ throws sand into the adjustment process and prevents prices from quickly moving to equate the demands and supplies of all commodities.
I argue in my body of work that we can make considerable progress in advancing our understanding of the macroeconomy by relaxing each of these assumptions. Lets discuss these two assumptions in turn. First, by dropping the representative-agent assumption, I have constructed models with multiple equilibria that can be Pareto ranked. Second, I have introduced a new branch of search theory that I referred to in Prosperity for All as Keynesian search theory. This alternative approach to search theory provides a reconciliation of Keynes’s concept of involuntary unemployment with Walrasian equilibrium theory that is different and more elegant than the sticky-price explanation of New Keynesian economics.
In my talk, I also discussed my work with Konstantin Platonov, "Animal Spirits in a Monetary Economy", in which we develop a micro-founded version of the IS-LM model that maintains the Keynesian idea that involuntary unemployment can be maintained as a long-run steady state equilibrium. In June I presented these ideas to a group of Post-Keynesians. Last week, I presented the same ideas at MIT, the intellectual home of the New-Keynesians. I continue to be encouraged by the ever growing embrace of my ideas and my agenda and the recent Greenwich and MIT conferences were no exception. To quote once more from my JEEP paper,
Post-Keynesian finches and their New Keynesian cousins have avoided each other for far too long. Just as the arrival of El Niño in the Galapagos Islands allowed diverging species to once more merge, it is my hope that the shock of the Great Recession will catalyse interbreeding between New Keynesian and heterodox economists. If I am right, more of my neoclassical contemporaries will need to listen to the drum beat that post-Keynesians have been sounding for 60 years. And post-Keynesians will need to explain to neoclassical and New Keynesian economists, in their own language, what they are doing wrong. General equilibrium theory, broadly interpreted, like mathematics, is a language. If you are young enough to have not yet been corrupted by establishment elites of either subspecies, I urge you to think hard about joining me in establishing post-Keynesian DSGE theory as the future of macroeconomics.
1. See Kerry Pearce and Kevin Hoover (1995) for a discussion of the evolution of the ideas contained in Samuelson’s textbook, Economics: An Introductory Analysis. The neoclassical synthesis first appeared in the third edition in 1955. I discuss the history of the development of New Keynesian economics, and its roots in Samuelson’s interpretation of Keynes, in my book, How the Economy Works.
2. Anyone who has ever tried to teach the New Keynesian Phillips curve will grasp my meaning. The student is first introduced to the ‘Calvo fairy,’ a mythical creature who randomly decides which firms, in any period, are allowed to contemplate changing prices. Next, one must assume that, in an inflationary environment, firms do not pick a price, they pick a mechanistic rule for adjusting their price on a weekly basis. The pricing rule must be aggregated over identical monopolistically competitive firms and the resulting equation must be linearized around a hypothetical stationary growth path. See my book, Prosperity for All for a discussion of the connection between the ugly and unrealistic assumptions that underpin the New Keynesian model and the concentric circles used by Ptolemacian astronomers to justify their assumption that the Earth is at the center of the Solar System. I first discussed the relationship between Ptolemacian astronomy and New Keynesian economics in my paper, "Animal Spirits, Persistent Unemployment and the Belief Function".