New Old Keynesianism (crosspost from Crooked Timber)

The term “New Old Keynesian” was coined by Tyler Cowen a couple of years ago, to describe the revival of the view that the Keynesian analysis of recessions caused by lack of aggregate demand is relevant, not only in the short run (in this context, the time taken for wage contracts to reset, say 2-3 years) but in the long run (5 years or more) as well. When Cowen was writing, in September 2011, the New Depression could still, just about, be seen as a short run phenomenon[1]. In particular, the anti-Keynesian advocates of austerity in the US, UK and Europe were predicting rapid recovery.

As 2014 begins, it’s clear enough that any theory in which mass unemployment or (in the US case) withdrawal from the labour force can only occur in the short run is inconsistent with the evidence. Given that unions are weaker than they have been for a century or so, and that severe cuts to social welfare benefits have been imposed in most countries, the traditional rightwing explanation that labour market inflexibility [arising from minimum wage laws or unions], is the cause of unemployment, appeals only to ideologues (who are, unfortunately, plentiful).

So, on the face of it, Cowen’s “New Old Keynesianism” looks pretty appealing. But what are the alternatives? Leaving aside anti-Keynesian views for the moment, the terminology suggests four logical possibilities: Old Old Keynesianism, Old New Keynesianism, New Old Keynesianism and New New Keynesianism.

But do these logical possibilities correspond to actual viewpoints, and, if so, whose?

In Cowen’s “New Old” terminology, we can take New to mean “post Global Financial Crisis” and “Old” to refer to a belief that the economy can be in a long-run high unemployment equilibrum.

Old Old

So, “Old Old Keynesians” refers most naturally to the Keynesians who dominated the economics profession in the 1950s and 1960s (Hicks, Samuelson and Solow being obvious examples). They regarded Keynes as having refuted the errors of Classical economics, and saw the management of aggregate demand through fiscal policy as the key to macroeconomic stability. The Old Old Keynesians were discredited (or so it seemed at the time) in policy terms by their failure to respond adequately to the stagflation of the 1960s (correctly predicted by Milton Friedman), and in theoretical terms by the absence of consistent foundations in microeconomics, as demanded by the New Classical school led by Robert Lucas.

Old New

After the 1970s, the “Old Old Keynesians” became, or were replaced by “Old New Keynesians”. The Old New Keynesians tried to develop microeconomic foundations for models that would yield Keynesian conclusions. In general, this could only be done for the short term. The corollary was that fiscal policy (which typically takes the better part of a year to adjust) was too clumsy a tool and that the primary responsibility for macroeconomic stabilization should lie with interest rate adjustments by central banks like the Fed. Over time, as it became clear that the “Real Business Cycle” approach of the New Classical School was unrealistic in its pure form, New Classical and (Old) New Keynesian macroeconomists converged on the Dynamic Stochastic General Equilibrium (DSGE) approach

After the Global Financial Crisis, it became clear that the concessions made by the New Keynesians were ill-advised in both theoretical and political terms. In theoretical terms, the DSGE models developed during the spurious “Great Moderation” were entirely inconsistent with the experience of the New Depression. The problem was not just a failure of prediction: the models simply did not allow for depressions that permanently shift the economy from its previous long term growth path. In political terms, it turned out that the seeming convergence with the New Classical school was an illusion. Faced with the need to respond to the New Depression, most of the New Classical school retreated to pre-Keynesian positions based on versions of Say’s Law (supply creates its own demand) that Say himself would have rejected, and advocated austerity policies in the face of overwhelming evidence that they were not working

New Old

The failure of DSGE macroeconomics in the crisis gave rise to New Old Keynesianism, represented most notably by Paul Krugman, and rather less notably by me. I won’t presume to state Krugman’s position for him, but will give my own.

* In theoretical terms, New Old Keynesianism recognises that the Old Old Keynesians oversold the capacity of aggregate demand management to ‘fine-tune’ the economy, and select from a menu of macroeconomic outcomes represented by the Phillips curve[2], and that the Old New Keynesians provided valuable understanding of the way in which relatively minor deviations from standard microeconomic models could have significant macroeconomic consequences. Nevertheless, in conditions like those of the New Depression it is the ideas and policy prescriptions of Old Keynesianism that are needed. To the extent that microeconomic foundations are needed at all, they are likely to end up being radically different from those of current micro textbooks, incorporating bounded rationality and large-scale co-ordination failures

* In political terms, projects of convergence have been shown to be futile. As on all scientific issues, those on the political right are ideologues whose views are immune to empirical evidence. There is no value in intellectual debate with Classical macroeconomists, any more than with climate denialists (the overlap between the groups being large and growing)

* Relative to DSGE, the key point is that there is no unique long-run equilibrium growth path, determined by technology and preferences, to which the economy is bound to return. In particular, the loss of productive capacity, skills and so on in the current depression is, for all practical purposes, permanent. But if there is no exogenously determined (though maybe still stochastic) growth path for the economy, economic agents (workers and firms) can’t make the kind of long-term plans required of them in standard life-cycle models. They have to rely on heuristics and rules of thumb. (Update in response to comments This is, in my view, the most important point made by post-Keynesians and ignored by Old Old Keynesians).

New New

The prominence of New Old Keynesians like Krugman in the public debate contrasts with the situation in academic macroeconomics, which has gone on almost unchanged since the crisis (and in a state of massive intellectual retrogression relative to Old Old Keynesianism). It’s still the norm to assume that recessions can at most be transitory, and quite common to see New Classical/Real Business Cycle models that assume full employment at all times. Within this framework, the New Keynesian program (at least as I see it), is to incorporate a volatile financial sector into DSGE-style models, and aim to reproduce the observed outcome that financial crises are commonly followed by long and deep recessions. From the outside, I don’t see much progress being made here. But the sense of crisis that briefly gripped the profession in 2008 and 2009 is long gone.

There hasn’t been much overt conflict between New New and New Old Keynesians. That’s because nearly all Keynesians are in agreement on the need for more fiscal stimulus in the major economies, and because New Old Keynesians have, in general, confined themselves to policy debate while New New Keynesians have mostly steered clear of those debates. But the need to refound Keynesian macroeconomics on firmer foundations is every bit as clear as in the 1970s.

I haven’t said much about the other side of the debate: the New Classical/Chicago/austerity camp. That’s because, on this as on most issues (climate science, energy, environmental hazards etc), the political right has immunised itself against evidence that conflicts with its desired views. The difference between economics and the natural sciences is that natural scientists have almost uniformly rejected the Republican/right position (around 6 per cent of scientists identify as Republicans). By contrast, in economics, there are plenty of Nobel prizewinners (yes, yes I know) on both sides.

fn1. Although the NBER dated the recession as having started in Dec 2007 and ended in 2009, the Lesser Depression began later, with the financial meltdowns of 2008, and has never ended.

13 thoughts on “New Old Keynesianism (crosspost from Crooked Timber)

  1. What, indeed, are the alternatives? But isn’t this approach – asking what kind of Keynesianism might do the trick, also unduly restrictive? For instance, what is so unreasonable about asking if the problem could indeed be caused by labour market inflexibility other than the sort that would be addressed by constraining matters “arising from minimum wage laws or unions” by means of “severe cuts to social welfare benefits”, for instance by an externality that might remain even after those other things were addressed?

  2. For sure, the Walrasians and Lucasians are either corrupt or religious or autistic. Or a 3-in-1 trinity.

    But you are too easy on your OldKey comrades. A few years ago, you guys were sure the deficit spending would end the New Depression. But if the natural interest rate is negative, deficit spending might be exactly what the right-wingers say it is, somewhere between sheer waste and a drug high.

    Indeed, so far as I know, no contemporary economist has yet been smart and brave enough to ask the right question. The best available evidence (interest rates) suggests that both waves of globalization, the one before the World Horror and the one after it, generated a huge and robust savings glut. Why so?

    I suspect the right answer is implicit in Keynes’s 1944 proposal for an International Clearing Union. If so, the master was way ahead of his disciples, including the most recent version of Summers at the IMF.

  3. Real problems with the economy are always political economy problems not economics problems. Very soon these real problems will be compounded by limits to growth problems. Thus bourgeois economics, which fails to address the issues of power and class and also fails to address the issues of real limits (material and energetic) has NOTHING useful to tell us about the new era we are about to enter.

    Keynesian economics was useful and even correct for a time, while the “boundary conditions” were the mixed capitalist economy with effective government and distant limits on material and energy resources. The “boundary conditions” have now changed. We have corporate oligarchy in effective charge, not democratic government, and we are at the material and energetic limits of economic growth on earth.

  4. Just a question, Professor Quiggin.

    I am concerned about the way in which you describe New Old Keynesianism. You state:


    This, in the AD-AS model (which is very Old Keynesian) is a shift in the vertical Long Run Aggregate Supply Curve to the left. Potential Output is less than it was.

    In the Old Keynesian world, aggregate demand solutions (fiscal and monetary policy) cannot correct this. In the long run, the economy will return to potential.

    Leaving aside all policy prescriptions that are are used in his name, isn’t this the essence of Say’s Law? That the current low growth may be structural and not cyclical? That the productive capacity of the economy needs to be improved (by mobilising more factors of production or improving technology) for potential output to be increased.

    Now, what am I missing in terms of the model to get to a New Old Keynesian world? Your point about a lack of an exogenous growth path is puzzling. Are you implying that there is no notion of a LRAS? Or that there is no unique LRAS, because of behavioural macro concerns. And that there is essentially a role for government in equilibrium selection.

    I am not disputing anything in the post. Just trying to better grasp it. A more expansive post on New Old Keynesianism would be enlightening.

  5. @Chris






    In my view, it’s more the other way around, that cyclical downturns have structural effects on the economy. Think of it this way, if Australia is Greece (hypothetically) with unemployment rate at 16.1% (or youth unemployment rate at 57.9%), it is likely to affect a person’s decision to undertaken tertiary education or higher education (masters/PHD etc.); whether it’ll be due to lack of employment opportunities after graduation or current family financial stress if the parents are unemployed. These outcomes may be increasingly severe the longer the recession/depression lasts, thus affecting the skills/productive capacity of the future workforce.

  6. There seems to be a footnote missing. You have a ‘[2]’ as an indicator after the words ‘Phillips curve’ but there’s no matching note at the foot.

  7. There is the problem of

    I understand the theory of aggregation provides an alternative approach to the microeconomic foundation found in DSGE [1]

    To quote from one of the master contributers to the theory of aggregation:

    <“The aim of aggregation theory is to link the micro and macroeconomic notions of aggregate demand. One would like such a link to exist for any heterogeneous population, for a large set of all conceivable income assignments, and for a small number of statistics of the income distribution. This cannot be achieved. What can be achieved is critically discussed in Section 2. In Section 3, another important topic of aggregation theory is considered: how does mean demand react to price changes? As an example, the ‘law of demand’ is discussed” ,
    Reference: Hildenbrand, Werner. "aggregation (theory)." The New Palgrave Dictionary of Economics. Second Edition. Eds. Steven N. Durlauf and Lawrence E. Blume. Palgrave Macmillan, 2008. The New Palgrave Dictionary of Economics Online. Palgrave Macmillan. 23 January 2014 doi:10.1057/9780230226203.0020 >

    JQ, I’d be very interested in your opinion on Hildenbrand’s methodological approach. It seems to me, possibly wrongly, Hildenbrand’s insistence of theoretical rigour that is compatible with empirical measurables is the approach closest to what you have been talking about on a few occasions.

    [1] My exposure to the theory of aggregtion at a workshop at the University of Bonn at least 15 years ago is too limited to put the crux of the matter in my own words.

  8. Missing, of course, are financial Keynesians or any reference to debt or money. Curious, since that fringe of economists who did consider debt and money was well represented among those who best predicted the crash. I also wonder why demand is not seen as in second order to employment, since Keynes seemed to be clear in his General Theory — “Employment, Interest and Money.”

  9. This is the purist’s side of Quiggin.

    I only dimly understand the subject and terminology, but am grateful I have the choice of whether to try and understand it or not…bits and pieces trickle through and the understanding does grow, if only exponentially slowly.

    Have a good weekend, the lot of you.

  10. What’s “bankrupt”? Is it any more “bankrupt” than that mangy excuse for plunder and violence, Classical economics?

  11. So, when Quiggin says no exogneously determined growth path, he means that any short run equilibirum has implications for a long run equilibrium.


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