The dominant paradigm in mainstream macroeconomics is a synthesis of new Keynesian and new endogenous growth economics, which has modified the new classical and monetarist-based neoliberal macroeconomics known as the "Washington Consensus." The same model appears dominant in the United Kingdom and perhaps in Euroland's European Central Bank and the EU countries as well. Evolutionary/institutionalist and Post Keynesian economics (IPK) offers a very different approach to policy making which could be characterized as "evolutionary Keynesianism." (1) This paper compares and contrasts the two approaches to macroeconomics. (2)
Dominant (or hegemonic) in the mainstream means
The view of most policy advisors (Federal Reserve, Council of Economic Advisors, IMF, World Bank, Bank of England, European Central Bank).
Appearing in the most widely adopted textbooks and taught in the universities.
Taught and supported in the elite graduate schools.
Accepted by the majority of the profession.
The history of macroeconomics over the last fifty years can be interpreted as a dialectical struggle between two opposing visions of the economy (as in Schumpeter's "pre-analytic visions" with which economists begin their work):
Stable, tending toward short-run equilibrium at the natural rate of unemployment and potential output; tending toward a "steady state" long-run rate of growth determined by the rate of technological change and growth in inputs. Business cycles are caused by external disturbances or supply shocks. The role of the state should be limited to providing the necessary institutional infrastructure, especially property rights, money and competitive markets. This approach originated in classical economics and reappeared in new classical economics (NCE); it also underlies Solovian growth theory (see chaps. 5 and 11 in Snowden and Vane 2005 for good overviews of NCE and Solow-type growth model).
Inherently unstable, with unemployment usually greater than optimal, and capacity utilization lower than optimal. The actual growth rate is determined by short-run cycles in production as well as the factors cited in classical, NCE, and Solovian growth theory; the growth rate is usually lower than optimal. Demand is unstable and usually insufficient. Macro policy can improve performance greatly. Marx, Keynes, and institutionalist-Post Keynesian economists share this view of the economy.
New Keynesian economics (NKE) emerged in the 1980s; it occupies a third, intermediate position.
New Keynesian Economics
NKE accepts most of the NCE microeconomic core: flexible wages, prices, and interest rates lead the economy to the "natural rate" of unemployment (usually termed the NAIRU, or "non-accelerating rate of inflation unemployment rate"), which can be described as a Walrasian and Hicksian general equilibrium. But the adjustment process may take a long time due to "coordination failures" caused by inflexible wages and prices. The level of GDP fluctuates around the "potential" GDP, which is produced when unemployment is at the natural rate. Business cycles are temporary deviations from the long-run trend growth rate, caused by supply or demand shocks. The trend growth rate and the natural rate of unemployment are both "strong attractors" dominated by the rate of technological change and the institutional and historical factors which influence labor markets.
Large demand gaps can and should be offset by demand management policies, using monetary policy. Fiscal policy is too clumsy a tool because the political and implementation time lags are too long and the multiplier effects of fiscal policy are small. Therefore, fiscal policy is useful only for extreme crises and monetary policy should be used for normal stabilization situations; although "fine tuning" is impossible, "rough tuning" is possible. This represents a modification of the extreme laissez-faire/ nonintervention approach supported by NCE.
NKE recognizes the social costs of recessions and the importance of demand factors; it defends countercyclical monetary policy and advocates demand management using "constrained rules" such as (John) Taylor's rule. In most versions, the procedure is to estimate (or forecast) potential GDP and any demand gap and then adjust (nominal and real) interest rates to move actual GDP to its potential; monetary policy should target interest rates rather than the money stock since the velocity of money is unstable and the money supply is endogenous. Fiscal budgets should be balanced over the business cycle. (See Mankiw 1990 and Mankiw and Romer 1991 for descriptions of the NK...