A Macroeconomics Reader

By Brian Snowdon; Howard R. Vane | Go to book overview

22

New and old Keynesians

Bruce Greenwald and Joseph Stiglitz

Journal of Economic Perspectives (1993) 7, Winter, pp. 23-44

All Keynesians, whether new or old, would agree on three propositions. First, during some periods—often extended—an excess supply of labor exists at the prevailing level of real wages (and expectations concerning future wages and prices).

Second, the aggregate level of economic activity fluctuates markedly, whether measured by capacity utilization, GDP, or unemployment. These fluctuations are greater in magnitude and different in pattern from any that might be accounted for by short-run changes in technology, tastes, or demography.

Third, money matters, at least most of the time, although monetary policy may be ineffective in some periods (like the Great Depression).

From these three propositions follow certain important policy conclusions; while old and new Keynesians may disagree upon the exact form of their policy recommendations, they would agree generally that government intervention is at least sometimes (many would argue frequently) desirable to stabilize the level of economic activity.

Agreement upon these three propositions, and the associated policy perspective, sets old and new Keynesians apart from advocates of other major schools of macroeconomic thought, including new classical and real business cycle theorists. Both of these, for instance, believe that the labor market and other markets essentially always clear, with wages and prices adjusting quickly to any disturbances; that shifts in the demand or supply curves for labor can explain fluctuations in observed levels of employment; and that the economy’s (presumably efficient) responses to shocks can explain these fluctuations in output. In the case of real business cycles, the focus is on shocks to technology; for many new classical theories, the focus is shocks to the money supply.

Despite the fundamental differences in views between these different schools, they have agreed upon two methodological premises: that macroeconomics should be grounded in microeconomic principles, and that understanding macroeconomic behavior requires the construction of a (simple) general equilibrium model. The real difference arises here: real business cycles and (to a lesser extent) new classical economists base

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