A Chat Bot Takes on New Keynesianism

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On a whim, I asked the Bing Chat Bot “What is New Keynesian economics?” As I understand it, such bots rapidly survey a broad swath of relevant literature, using their own algorithms to assemble an answer. The question is an interesting challenge for the new technology. The Bot’s answer is likely compromised by mainstream NK theory being deeply flawed, most notably failing to account for crucial characteristics of actual macro instability. Involuntary job loss is the most egregious of the exclusions. Blog readers know that adverse disturbances in nominal demand in highly specialized economies induce IJL in the millions in each and every recession. Inadequate treatment of the phenomenon renders NK modeling largely useless to stabilization authorities. I was curious to see how AI summarizes the mess that is mainstream macro theory.

The Bot’s answer: “New Keynesian economics is a school of macroeconomics that provides microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics. Two main assumptions define the New Keynesian approach to macroeconomics. First, that people and companies behave rationally and with rational expectations. Second, New Keynesian economics assumes a variety of market inefficiencies – including sticky wages and imperfect competition.”

That answer is incoherent, which may be understandable given that NK macroeconomics is incoherent. Hold that thought. The judgement is too harsh, but not by much. NK advertises itself as providing the microfoundations that Early Keynesians lacked. Indeed, EK theorists readily admitted that, in order to be stabilization-relevant, they arbitrarily posited sticky nominal wages, slow to respond to changes in labor-market conditions. More formally, EK stickiness irrationally suppresses wage recontracting in market-centric analysis. They compromised on rational behavior in order to allow their modeling to produce some involuntary layoffs.

The fundamental failure of NK theory is that, like the EK macroeconomists they were eager to replace, the new school never figured out how to rationally suppress wage recontracting. Blog readers further know that, however patiently they tinker with their market-centric models, they never will. Robert Lucas, a titan in the revolution that unseated the great Early Keynesians, recognized that and was not shy in advising his NK colleagues that, given their general market equilibrium (GME) framework, IJL cannot exist. His sound practical advice was to ignore involuntary unemployment. The implication: rational-behavior New Keynesian cannot be policy-relevant.

The incoherence of Bot’s answer is now more understandable. If NK analysis is constructed on rational behavior (the first condition in the Bot’s NK description), it cannot satisfy the second condition (the irrational use of sticky wages rooted in market frictions). Blog readers know that no market friction can suppress wage recontracting. It follows that NK theory cannot explain actual IJL. The GEM Project has demonstrated that such stabilization relevance requires the generalization of rational exchange from the marketplace to information-challenged workplaces.

Most NK theorists cannot tolerate stabilization irrelevance. Therefore, they abandon rational behavior as a condition of macro modeling and simply assume (irrational and badly misleading) market wage rigidities. There is little fundamental difference between this practical NK branch and Early Keynesians.  

Ask the Bot: “What are the differences between the NK and original Keynesians? The main difference between the original Keynesians and the new Keynesians is that the new Keynesians provide microeconomic foundations for Keynesian economics. They developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics. According to Investopedia, some of the main differences between new classical and new Keynesian macroeconomics are as follows:

The Bing Chat Bot gets a lot wrong, but probably no more than the New Keynesians themselves.

Blog type: New Keynesians

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