The New Keynesian Framework and employment persistence
Over at Econlog, Arnold Kling stated that “persistence” in employment implied that the New Keynesian story was off (ht Marginal Revolution)
This sounded a bit funny to me – New Keynesianism is a framework for models, one where I had seen the persistence in unemployment, and employment (which is a well known stylized fact) before. So I went to google:
And it immediately came up with a working paper from two of the big boys – Blanchard and Gali. Conclusion being:
The extent of real wage rigidities determines the amplitude of unemployment fuctuations under the optimal policy. Furthermore, unemployment displays intrinsic persistence, i.e. persistence beyond that inherited from productivity. The degree of persistence is decreasing in the job finding rate. Hence, the more sclerotic is the labor market the more persistence is unemployment.
In the paper there is discussion of models with hiring costs, labour market frictions, rigidities in the real wage, and in nominal prices. They don’t discuss some other things I’ve seen from New Keynesians, such as employment/investment/production decisions made off the back of a lagged state variable, but those sorts of concepts are rolling around as well.
In essence, the New Keynesian framework is grappling with a large number of issues, and trying to analyse them in a consistent way. I just find it a little strange that we would say “and so the New Keynesian story is wrong” just because some of the current models can’t pick some things – it is like saying “microeconomics is wrong, because it doesn’t perfectly describe all human behaviour”. Yes, it is a discipline that needs investment and time – but as a framework for putting models inside, it is pretty useful right.
I’m not saying things are perfect now, but I am saying that all the hating on the New Keynesian framework seems a touch out of place – given that all it is doing is providing a transparent and internally consistent method where people can build their own model of the economy by introducing what they believe are realistic “core” assumptions.
Why is it NEW Keynesian but Neo-Classical?
@Kimble
Neo-classical has two meanings I’d say:
1) A disparaging term by people who don’t understand economics to attack economists with 😉
2) The neo-classical synthesis which brought together insights from the classical and Keynesian schools post WW2 to come up with a tractable way of discussing macroeconomics.
Of course, when the neo-classical synthesis broke down we had a whole bunch of stuff – post-Keynesians were there, there was a New Keynesian school that is different from the current one, and of course New Classicals.
While the “New Keynesians” (I’ve heard them called neo-Keynesians before) discussed the idea of microfoundations for pricing issues and competition issues, New Classicals developed the Real Business Cycle framework – essentially they used the idea of intertemporal maximisation and rational expectations to form a tractable way of describing the macroeconomy.
Eventually, people started putting the New Keynesian and New Classical ideas together, and we got the modern New Keynesian style model – which is a intertemporal model with rational expectations, and a bunch of nominal rigidities (or other things – more and more game theory is getting involved). I’ve also heard this called the New Keynesian synthesis before – and a bunch of other names.
New Keynesian is the predominant school at the moment, and as a result people that don’t understand economics will call it “neo-classical” as it is mainstream economics – I believe that is the reason.