Billy Swanson

I didn’t go hunting for an article, because honestly, I was a little afraid of getting something bad/irrelevant off the web. So instead, I read “the new classical contribution to macroeconomics” by David Laidler, pp 334-358. I tried reading the Lucas-Sergant article entitled “After Keynsian Economics,” but couldn’t make too much sense of it. In this article, Laidler is arguing for the New-Keynsian/monetarist approach to macroeconomics. While recognizing that new classical had its contributions, it also had more than its share of false predictions and missteps. Therefore, Laidler argues that even though the Keynsian model failed to explain stagflation, there are other alternatives to the new-classical model; even if the contributions of new classical are inherently important to that alternative.

First, Laidler shows the reconcilability of monetarism and Keynsianism; a hybrid that is stronger than either model separately. The Keysnian “test” failed in the 1970’s when the gains in output and expenditure only corresponded to a short-term change in output, and Inflation rose at higher and higher rates, rather than shifting to a higher stable level. The monetarist contributions to the Phillips curve (such as the expectations augmentation) “pose no radical theoretical challenge to” Keynsian theories, but in fact resemble extensions of the ISLM model. From an analytic point of view, the new rendition of the Phillips curve–compliments of Friedman and Phellps—did not provide the deep explanation that Luca and the new-classical economists attempted.

There are a few major characteristics that distinguish new classical, from new-keynsian. In Keysnina macroeconomics, prices are inflexible (sticky). Therefore the supply of labor, inventories and capital must accommodate the sticky prices, causing aggregate demand shifts and more pressure on price changes. This system in one “in which prices are sticky, in which quantities change to absorb demand side shocks in the short run, and in which inflation expectations though mainly backward looking are endogenous.”(Pg. 338) In knew classical however, prices are assumed to be flexible and always the mechanism by which markets equilibrate. The individual is likely to misinterpret a money price change for a relative price change, therefore altering the quantity of goods s/he produces. Therefore, output and employment fluctuations occur because the individual is reacting to price changes. Prices have the effect on output; the opposite of the Keynsian approach. Furthermore, if prices are flexible and the market agents are not tied down by contracts and stick prices, in order for the rational maximizers to avoid unnecessary loses to income, s/he must form expectations consistent with the model. The “demand and supply schedules which determine the equilibrium structure of market prices” do not depend on “full and accurate information,” but rather the “agents perceptions of that structure.” (Pg. 339)

There are a few fundamental drawbacks to the approach of Neo-classical economics. First of all, Laidler points out that the “truthfulness” of a model should not be contingent upon weather or not it can explain the data on which it was designed; “this is just testing the logical ability of the economist.” Rather a model should be able to anticipate those events that the economist did not know about first, or define the model to address beforehand. The desperate attachment to maximization, deducibility, and the a priori non-empirical model, has hobbled the predictive abilities of neo-classical thought.

Empirically and historically, there are some demonstrations of these weaknesses. 1) Because the neo-classicals propose that the Phillips curve reflect the elasticity of the supply of labor with respect to real wages, we are able to test the hypothesis. Aggregate employment fluctuates too strongly relative to inflation, given that the changes in employment are only supposed to be a result of “is perceived nominal wage changes as reflecting real wage changes.” 2) Prices fluctuate and then output changes. The data show, however, that quantity changes seem to precede associate changes in price. 3) Because prices automatically adjust, the “economy should always be on its long-run demand for money function,” although empirically this is untenable. (Pg. 342)