The theory of new classical macroeconomics: a positive critique.

• Main Author: Peter Galba´cs.
• Format: Book
• Language: English
• Published: Springer 2020
• Subjects: Macroeconomics
• Online Access: http://dspace.uniten.edu.my/jspui/handle/123456789/15343

My career as a researcher started under the spell of Keynes. I took a sincere interest in the ultimate questions of economic theory relatively early, surprising even myself. Attending lectures on sociology and social philosophy at the faculty of humanities and social sciences, I almost ran away from the philosophy lectures. The lack of firm answers and the different systems of thoughts contradicting and overwriting each other were too disturbing and what is more even frustrating for me. So, my interest turned to economic sociology first and then to economics itself, hoping to find a disciplined science built on mathematics. I did believe that schools of economic thoughts could harmonize in the most fundamental questions and have only minor differences in their opinions. I could hardly realize that economic theories suffer the same confusion. Moreover, having been armed with lectures given by Endre Nagy, Mikl os Mar oth, and Gy€orgy Mikl os, all these impressions made it obvious and nearly inevitable that my interest as an economist would turn to economic theory and to the philosophy of economics. Today, I know that economic theory for me, due to these early experiences, has become a thesaurus of philosophical texts describing the economic aspects of processes going on in societies. Of course, it is true as well that I realized only as an economist that the questions raised by a branch of science itself cannot be answered on the grounds of its methodology and theory. If we want to consider the objects and methods of economics, the theory of marginal utility does not help us too much. I made myself familiar with Keynes’ theory as an undergraduate student. Fortunately, my first attempts were helped and controlled by professors who required me to study the most important texts in the history of economic thoughts very young. The impact that Keynes exerted on me was huge, since, on one hand, I could become not only acquainted with the principles that had governed operative economic policy for decades but also got an insight into the most significant and most extensive theoretical debate of economics of the twentieth century. My early interest was mainly focused on the points on which Keynes was opposed to the program of neoclassical economics that had been generally accepted up to that time. Back then, of course, I regarded all the scientific debates as black and white and, with all my strength, I tried to declare Keynes the winner, wherever and whenever it was possible. I often entered into indirect criticism (while doing so, its master, Prof. La´szl o Vı´gh, also helped and encouraged me), so the conflict I was inquisitive about was soon relocated between Keynes and Milton Friedman. The orthodox monetarism led by Milton Friedman was the first after-Keynes great theoretical system with which I got acquainted thoroughly. I think, I made quite a good job, since a serious antipathy to Friedman’s theory took shape in my mind and it still exists even today. However, there is no doubt that I indulged in studying monetarism thanks to Friedman. Previously, I tended to evaluate new classical macroeconomics similarly, in which I was encouraged by both the oversimplified sights formed on the new classical group and the vulgarization of the new classical theory itself. I do not know exactly what that turning point was after which I showed greater concerns to Lucas and his group than to my former master, Keynes. It was roughly at the end of my university years, so, as a fellow, I devoted my dissertation to new classical macroeconomics. I remember well, my initial purpose was to write a monographic comparison of Keynes and monetarism, but it was expected to be a monumental mission, so a Ph.D. dissertation could not have been able to embrace all the results I wanted to include. Finally, the dissertation was written on the monetary and fiscal policy recommendations of new classical macroeconomics—and it soon has become the basis of this book as well. The genre of this book is comparative critical history of economic thoughts. It must be noted that I was aware of neither the ultimate aim nor the path leading to it, so I could not foresee where I would get to in the end. Curiosity was my only guiding principle, and the book as a whole should be considered an explanatory note to my readings. My interest was not governed by a single theorem to be proved or criticized. I just wanted to know where the economists labeled as new classicals came from and what they actually taught. Therefore, I based my investigation on the original texts, so the first level of comparison was made between these texts and their commentaries (i.e., reviews on economic theories). Of course, the comparison emerged in the context of the history of economic thoughts as well, since I had to realize at an early stage that, for example, either the Phillips curve elaborated by the new classicals or their comprehensive suggestions of economic policy can be judged only by comparing them recurrently with the theory of Friedman or Keynes. Moreover, I did not want to write a reading log. I wanted to avoid a simple reformulation of the theory of new classical macroeconomics, so I tried to carry out a critical analysis. During my work I was mainly supported by the methodological principles set out in Chap. 1. My determination to avoid writing a mere summary explains why I discussed topics (albeit, sketchily) such as automatic fiscal stabilizers or the conceptual differences between fiscal consolidation and structural reforms, to which new classicals had not paid any attention no matter how close these issues were to the problems being investigated. This volume consists of seven chapters succeeding in birth order. Chapter 1 is the only exception as it was written only after the logical structure of the book had been ready. I had to face the recurrent critical remark made in debates that reproached me with the lack of a well-articulated methodological introduction. Although my declared purpose from the very beginning was to exert a constructive critique against new classical macroeconomics, the clarified methodological principles on which this book had been built were missing; I could give account of these fundamentals only in the course of private conversations at best, being satisfied with the belief that my interlocutors were familiar with them. The methodological and philosophical system detailed in Chap. 1 that later became the most important and interesting part of the book for me took form during these conversations. The ultimate goal of this chapter was to identify the characteristic aspect of mainstream economics and to clarify its methodological grounds, setting the discussion and the evolution of the methodology of (mainstream) economics in the context of general history and history of science. To my great surprise, the fundamental differences between orthodox monetarism and new classical macroeconomics emerge even at the level of the methodological principles. Chapter 2 turns directly to the new classical doctrines. Although mostly implicit doctrines were examined in Chap. 3 (for instance, when discussing the conception of new classical labor market), rational expectations hypothesis being the most often cited and the most influential new classical theorem was studied here. Underlying assumptions and theoretical consequences were also reviewed here. These investigations were made especially gripping by the direct intention of new classicals to give a realist description of processes and mechanisms observed in reality. This circumstance induced and justified me to compare new classical macroeconomics with reality. It is argued below that estimations of market participants, since agents do not have access to information the theory requires and do not possess the necessary methodological skills either, can meet the requirements that were specified by Muth (1961) only if agents are supported by an institution in a central position. It could be, as a typical example, an inflation targeting central bank—so, after all, rational expectations hypothesis can effectively underpin this monetary policy regime. This chapter is very precious for me, since it is based on my first important publication. Chapter 3 continues reviewing the fundamentals. Here, we can get an inside view of the underlying logic that determines the new classical way of thinking. We are going to be forced again and again to realize that the existence of (general) equilibrium is based on a set of fragile assumptions among which also the equilibrium itself stands as the most objectionable. The most of Chap. 3 was uncertain in the beginning. The text is based on notes that were made in the course of some fundamental reviews of John Weeks’ “A Critique of Neoclassical Macroeconomics.” Since Weeks laid his emphasis on other aspects and details than I had to concentrate, these notes advanced to be a chapter on their own as time was passing by. Weeks mainly focused on the analysis of aggregate reproduction while I was rather interested in the theory of macroeconomic cycles and countercyclical economic policies. I supposed (and suppose even today) that the most fundamental discrepancy separating rivaling macro-theories is determined by how these theories explained and answered the problem of business cycles. My interest in the theory of business cycles may be explained by the fact that the theories scrutinized below could and can start governing operative economic policies. I could hardly deny the fundamental effects Weeks had on the tone and the methodology of this work. I think, Weeks’ Critique can be referred to as the most essential and significant critical treatise on mainstream economics. Its impacts and importance are hard to estimate—moreover, in stylistic terms, it is an outstanding manifestation of the collection of the briefest and most disciplined works in economics. But, at the same time, it is a difficult and ponderous piece of reading. It is only for the third or fourth time when the inter- and intra-textual relations and the limitations of the reasoning can be revealed. The robust text of Weeks makes us feel as if everything that is possible has been told about neoclassical-mainstream economics. Actually it is almost completely true since it is very difficult to find those points where the issues discussed could be complemented. Weeks’ work is indispensable: I believe that it is almost impossible to write about new classical macroeconomics without having Weeks’ monograph among the references: breaking away from his works could have only impaired my efforts and I would have seemed to reinvent the wheel. I did my best to avoid simply echoing Weeks’ discussion and I think I managed to do so. It would have been difficult indeed to refute his thoughts, so I had to agree with him and, wherever it was necessary for the sake of my reasoning, I strived for abundant completions. Chapters 4 and 5 make up the central part of the book. After the necessary theoretical preliminaries had been set out, new classical thoughts on monetary and fiscal policy could be analyzed and evaluated here for the first time. I was deeply biased by the conventional view on monetarism, according to which fiscal policy is only of secondary importance for mainstream economics, while monetary policy is assumed to have potential only in setting the price level. I think, if this notion was relevant at all, it was true only of Friedman’s system at best. For him, macroeconomic systems settle in stable (long-lasting) equilibrium state, as his accounts on the natural rate of unemployment highlight, from which they can be dislocated through monetary policy interventions only temporarily and only with considerable detriments and avoidable-unnecessary costs. I had to fumble in the dark for a while when scrutinizing the countercyclical potential of monetary policy on these grounds. In the beginning, I showed some inclination to think that Friedman had stressed the countercyclical impotency of monetary policy (and, as a consequence, of fiscal policy) through these doctrines of his—but, later, it became evident that business cycles originate in economic policy, as argued implicitly by him. Actually, Friedman talked about the possibilities of monetary policy in growth enhancement— however, it is completely and fundamentally impotent in these terms so the only consequences of its efforts are the business cycles it generates. So, the best option of monetary policy is to specify its goal of increasing the quantity of money at an appropriate rate—and, moreover, fiscal policy should abstain from all of these. The new classical system is much more elaborated. It is a significant step forward that the emergence of business cycles is allowed now, so the countercyclical potential of economic policy can be a sensible question. While new classical macroeconomics could not abandon the traditional and common interpretations when evaluating monetary policy, giving room for monetary policy only in price level setting at a maximum, new classical doctrines regarding countercyclical fiscal policy (its scope and potential) seemed to be mainly unclarified to me. On the grounds of the permanent income theory specified under rational expectations hypothesis or the Barro–Ricardo equivalence, it is really possible to declare that fiscal policy is predestined to be impotent in new classical macroeconomics as well. However, it has to be realized how thorough the theory is when considering the assumptions and conditions necessary for this ineffectiveness. The ineffectiveness of fiscal policy is dependent upon tight conditions in the new classical theory, and, in this context, underlying this conditionality proved to be the greatest merit of the school. Chapter 6 summarizes some conclusions that were highlighted by new classical macroeconomics but were outside the core of the theory. Such a topic is the problem of economic policy credibility to which we get starting from the equivalence theorem. Credibility is discussed with Reaganomics as a background, the interpretation of which can be found in the literature though, but it was worth stressing the relations to the equivalence theorem as well. It is also Chap. 6 where a topic analyzed previously recurs: it is inflation targeting, scrutinized in Chap. 2 before, with regard to the strong definition of rational expectations hypothesis. Here, some technical issues emerge such as strict inflation and output-gap targeting or flexible inflation targeting. I made efforts to stress the advantages of economic policy offered by flexible inflation targeting and to lay those features of the system in the limelight that can be evaluated and understood more easily with the support of new classical macroeconomics or rational expectations hypothesis. Chapter 7 gives a short summary and raises some further questions to which I could not even try to find ultimate and satisfying answers, not only for the reason that the chosen topic of this work or certain size constraints would not have made it possible at all. These are problems the solutions to which are the question of faith rather than the question of proofs or reasoning.