Keynesian Economics vs New Classical
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New Classicals and Keynesians, or the Good Guys and the Bad Guys
By Robert J. Barro, Harvard University
Keynesian Models When I was a graduate student at Harvard in the late 1960s, the Keynesian model was the only game in town as far as macroeconomics was concerned. Therefore, while I had doubts about the underpinnings of this analysis, it seemed worthwhile to work within the established framework to develop a model that was logically more consistent and hopefully empirically more useful. Collaborating with Herschel Grossman, we made some progress in clarifying and extending the Keynesian model. But that research also made obvious the dependence of the central results on fragile underlying assumptions. The model stressed the failure of private enterprise economies to ensure full employment and production, and the consequent role for active macro policies as instruments to improve outcomes. Shocks to aggregate demand - but not aggregate supply - were the key to business fluctuations, and mere changes in optimism or pessimism turned out to be self fulfilling. These properties, which seem odd to economists who think in terms of price theory and well-functioning private markets, suggest coordination problems on a grand scale. But this perspective hardly accords with the basic source of market failure that characterizes the standard Keynesian model. It is the mere stickiness of prices or wages, primarily in the downward direction, that accounts for the principal results. Of course, many macroeconomists think of price stickiness as an "as if" device - a problem that is not to be viewed literally, but instead as a proxy for serious matters, such as incomplete information, adjustment costs, and other problems of coordination among economic agents. But this viewpoint has not been borne out by subsequent research. For example, the incorporation of these serious matters does not support the Keynesian stress on aggregate demand, and also does not provide a normative
New Classicals and Keynesians, or the Good Guys and the Bad Guys
By Robert J. Barro, Harvard University
Keynesian Models When I was a graduate student at Harvard in the late 1960s, the Keynesian model was the only game in town as far as macroeconomics was concerned. Therefore, while I had doubts about the underpinnings of this analysis, it seemed worthwhile to work within the established framework to develop a model that was logically more consistent and hopefully empirically more useful. Collaborating with Herschel Grossman, we made some progress in clarifying and extending the Keynesian model. But that research also made obvious the dependence of the central results on fragile underlying assumptions. The model stressed the failure of private enterprise economies to ensure full employment and production, and the consequent role for active macro policies as instruments to improve outcomes. Shocks to aggregate demand - but not aggregate supply - were the key to business fluctuations, and mere changes in optimism or pessimism turned out to be self fulfilling. These properties, which seem odd to economists who think in terms of price theory and well-functioning private markets, suggest coordination problems on a grand scale. But this perspective hardly accords with the basic source of market failure that characterizes the standard Keynesian model. It is the mere stickiness of prices or wages, primarily in the downward direction, that accounts for the principal results. Of course, many macroeconomists think of price stickiness as an "as if" device - a problem that is not to be viewed literally, but instead as a proxy for serious matters, such as incomplete information, adjustment costs, and other problems of coordination among economic agents. But this viewpoint has not been borne out by subsequent research. For example, the incorporation of these serious matters does not support the Keynesian stress on aggregate demand, and also does not provide a normative