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Whatever happened to the General Theory

Author(s): Simon Wren-Lewis

From Mainly Macro:

My paper in the Review of Keynesian Economics is out. It is a special issue on the relevance of the General Theory 80 years after its publication. My paper is about the New Classical Counter Revolution (NCCR). At first this may seem an odd fit, but I think quite the opposite. If we go back 40 years, macroeconomics as it was then practiced could be justifiably described as being a development of that great work. In contrast students today would not see the General Theory as the foundation of macroeconomics. The change in view is the result of the NCCR.

I also think that many heterodox economists, who tend to read this journal, have failed to come to terms with the NCCR. They are critical of course, but often they fail to address the obvious question: why was the NCCR so successful? Revolutions may be plotted by a small number of individuals to whom you can ascribe (fairly or unfairly) ideological motives, but you also need to account for why the revolution succeeds. Do heterodox economists think that generations of PhD students who continue to ignore their arguments are being forced to do so against their will?

My paper is in part an attempt to begin to answer this question. It argues that the success of the NCCR had little to do with external events (stagflation), or with policy, or indeed with the specific innovations the revolution brought. Instead it was about being seduced by a methodology: the methodology of microfounded models. Where I probably depart from most heterodox economists is that I think macroeconomists were right to be attracted to the methodology, which is a progressive research programme, but the problem was the same as with all seductions: to see only the good and not the bad in their new love.

But my paper is not primarily directed at heterodox economists. I make two claims that should worry mainstream economists. The first is that what masters students are taught, which is that pre-NCCR methods are fatally flawed, is simply wrong. Microfoundations simply replaces one set of flaws with others. The mistake of the NCCR was not in developing DSGE models, but in believing that only these models can provide macroeconomic insight. The pre-NCCR methodology was also progressive, and as developments in UK macro in the 1990s showed, the two methodologies could help each other.

My second claim is that the exclusive focus on a microfoundations methodology seriously compromised the ability of the science to understand the Great Recession. Here I am very specific: mainstream macroeconomics ignored a clear property of the time series for aggregate consumption in the UK and US in a way that pre-NCCR methods would not have done. As a direct result, the importance of the financial sector was largely ignored before the global financial crisis. If pre-NCCR methods had not been trashed by mainstream macroeconomics, the discipline would have been in a far better shape to understand what happened during the Great Recession.

I cannot do justice to the arguments in this short post, so please read the paper.

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