Making Sense of the Neoclassical Synthesis

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In his History of Macroeconomics (2016), Michel De Vroey identifies the Early Keynesians’ neoclassical synthesis (NS) as a critical marker in the development of modern macro theory. Its importance is particularly evident in the enduring debate over the proper relation between Keynesian and neoclassical modeling. De Vroey’s wrote his History prior to the establishment of the Generalized-Exchange Macroeconomics (GEM) website that is home to this Blog. My interest in his NS analysis is most piqued by the degree to which his conclusions are altered by including the workplace-marketplace synthesis in the mix of theories considered. Spoiler alert: The answer is a lot.

Four salient quotes tell the story. First: “At stake is the establishment of a Keynes-Walras synthesis, more precisely demonstrating how short-period Keynesian disequilibrium states might gravitate towards a long period” neoclassical general market equilibrium. Gravitation to long-period market-centric equilibrium is a maxim of mainstream thinking. From the perspective of generalized exchange, however, it is easily understood to be badly off target, complicit in the macro academy’s fundamentally misleading policymaking advice. GEM modeling shows that the hypothesized gravitation is properly replaced by a continuous general decision-rule equilibrium constructed on micro-coherent meaningful wage rigidity (MWR), micro-coherent persistent wage rent (PWR), and chronic market disequilibrium. The three conditions hold in the short and long runs. Indeed, that temporal distinction loses most of its analytic value once the arbitrary confinement of rational exchange to the marketplace is dropped. Stabilization-relevant macro theory, focused on the discretionary management of aggregate demand, is made consistent with the neoclassical tenets of optimization and equilibrium, producing evidence-consistent continuous-equilibrium paths of employment and unemployment, The stakes are greater than De Vroey imagines. His market-centric stage is simply too small for the big ideas needed to microfound stabilization-relevant macroeconomics.

Second: “… the neoclassical synthesis has come to mean the exact opposite of its literal meaning. That is, the neoclassical synthesis viewpoint has turned out to be a consensus on the non-necessity of building a synthesis between Keynesian and Walrasian analysis, while nonetheless asserting that both are necessary…. It all started with Hicks. Not only did he praise Keynes for having shifted the emphasis in monetary theory from the long to the short period. He also made the point that the short and the long period could be studied independently from each other This view carried on throughout the reign of Keynesian macroeconomics. The neoclassical synthesis then came to designate the defense of an eclectic macroeconomic field, with room for different, admittedly incompatible, modeling strategies.”

Microfounding powerful nominal wage rigidities transforms the Neoclassical Synthesis into an important staging ground for the effective merger of the short and long periods into a continuous general equilibrium along the lines that Sir John Hicks, armed with his flex- and fix-price aggregate supply, anticipated in his Crisis in Keynesian Economics (1974). Hicks used his familiarity with the mid-century labor economics of Clark Kerr, John Dunlop, and the other Neoclassical Revisionists to motivate his fix-price sector with his intuitive grasp of the keystone nonconvex Workplace Exchange Relation: “Employers were reluctant to raise wages, simply because of labor scarcity; for to offer higher wages to particular grades of labor that had become scarce would upset established differentials. They were reluctant to cut wages, simply because of unemployment; for if they did so they would alienate those whom they continued to employ. The ‘stickiness’ is not a matter of money illusion; it is a matter of continuity.” (p.66) De Vroey’s caricature of Hicks’ contribution is far off the mark. If New Keynesians had pursued the reasoning of Crisis, the profession could have avoided decades of stabilization irrelevance and bad policy advice.

Third: “First generation new Keynesian economists regarded the defense of the neoclassical synthesis idea as an important component of their response to Lucas. More or less grudgingly admitting the validity of the Walrasian theory for the long period, they adamantly refused its hegemony.” The generalization of price-mediated exchange from confinement to the marketplace to information-challenged workplaces permits a kinder and more accurate treatment of first generation new Keynesians. While they erred badly in accepting in accepting the validity of long-period general market equilibrium, their intuitive rejection of the hegemony of the reborn Walrasian general market equilibrium has stood the test of time. Their defense of the early Keynesians’ Neoclassical Synthesis is indicative of their strong preference for evidence-consistent analysis that is a necessary condition of stabilization-relevant macroeconomics, explaining why first-generation theorists  continued their high-priority quest for microfounded wage rigidities. The fourth quote explains why the second generation did not.

Fourth: “”Second -generation new Keynesians took a different standpoint. Abandoning the defense of eclectic macroeconomics was one of the concessions that they made when they created a Keynesian/RBC synthesis (this time, a synthesis in the strong sense of the term).” That bargain, captured in the New Neoclassical Synthesis, motivated the dangerous myth that the FGME model is fundamentally finished theory, with no more work on its foundations needed. Research on stabilization-relevant modeling consistent with neoclassical tenets of optimization has for decades been effectively stifled by gatekeeper insistence that such work is not needed. In pursuit of professional convenience and, perhaps more insistent, protection of their existing human capital, the second NK generation deliberately put macro theory on a path that can be consistent with neither the crucial instability evidence nor effective policy advice. For example, did any second-generation NK theorist really believe that the Fed should set aside its trend full-employment objective in deference to the primacy of low trend inflation?

The point of enriching De Vroey’s take on the history of the Neoclassical Synthesis with generalized-exchange macroeconomics is to provide another powerful illustration of the necessity of GEM thinking. De Vroey unwittingly demonstrates that you cannot make sense out of the Neoclassical Synthesis, and a whole lot of other important topics, without it.

Blog Type: Wonkish Chicago, Illinois

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