Difference between Old Keynesian and New Keynesian economics

Alex Cukierman of Tel Aviv University has written an excellent paper comparing Old Keynes thinking with the New Keynesian thinking. The paper is mainly on differences and similarities between Great Depression and Great Financial Crisis.

He begins the paper reviewing developments in macroeconomics from Keynes to Friedman to New Keynesian. He then compares the GD with GFC which is pretty much known by now.

There is a nice discussion on the policy lessons from the two episodes. He divides it into two:

  • Lessons learnt from GD which have been applied in GFC usefully – Monetary expansion, Fiscal Policy expansion, bank runs have disappeared, no to trade protectionism
  • Lessons from GFC which are Open Issues now- i-bank runs, leverage, too big to fail, risk mismanagement, liquidity trap revisited

He then compares Old Keynes with New Keynes economics:

The sixties are generally believed to be the heydays of Keynesian economics with respect to both theory and policy prescriptions. During the last decade a technically sophisticated body  of theory known as “New Keynesian” managed to introduce Keynesian sticky price ideas into dynamic stochastic general equilibrium (DSGE) opening the door for integration of real business cycle (RBC) with monetary theory and policy. Woodford (2003) impressive monograph lays foundations to this approach. Gali (2008) is a compact graduate textbook introduction to the area.

This new body of literature is taught to recent generations of Phd students and is quite active research wise. To many young researchers in the sub-area it is the standard way of doing macro models with sticky nominal variables. My experience has been that many (of the highly clever young researchers) in this active area possess only vague notions about the “old” Keynesian models of the sixties. By the same token, most older researchers who contributed to the development of such models are largely ignorant of the contributions made within the New Keynesian framework. The main objective of this section is to close some of this intergenerational gap by presenting a non technical but conceptually precise comparison of the main similarities and differences between the new and the old Keynesian frameworks .

Read the paper for further details.

He ends the paper saying

The GD led to the Keynesian revolution in economics. It is natural, by analogy, to expect that the GFC will also engender changes in the agenda of economic research. I conclude  this article with some speculations about possible changes in the focus of economic research in the aftermath of the current crisis. First, much more attention will be paid to explicit modeling of the behavior of financial intermediaries. The currently popular New Keynesian framework will either be extended to include a meaningful financial sector or be seconded/replaced by other paradigms. Second, the extreme New Keynesian view that monetary policy operates only through the interest rate channel (developed in chapter 3 of Woodford (2003)) is likely to be pushed aside by the view that this policy can operate via both stocks (quantitative easing) as well as through the interest rate.Third, future monetary policy procedures are likely to give more emphasis to financial stability in comparison to price stability. In parallel, the role central banks in supervision and regulation is likely to increase.  

Very very useful paper. Full of insights.

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2 Responses to “Difference between Old Keynesian and New Keynesian economics”

  1. Matthew Yglesias » Health Care vs Health Insurance | FinanceBlogr Says:

    […] Difference between Old Keynesian and New Keynesian economics … […]

  2. strainer3 Says:

    In my view the actions of the US government (and other governments that have followed in their footsteps) in their attempts to “improve” the economy is very wreckless and poorly crafted. It has wasted trillions of dollars bailing out creditors and shareholders of failed institutions with broken business models rather than addressing the structural flaws in the system of too much debt. And this is going to lead to massive problems down the road with regard to our currency and interest rates, in my opinion. And I think that the gold price breaking out to a new high is a strong indication of the reduction in faith and confidence that people have in governments and their fiat currencies. I recently read a good article on this at Gold Price Cheaper Now than at $300 – Hathaway that discusses the Federal Reserve’s easy monetary policies in order to try to prevent any sort of deflation from occurring and to try to reflate assets prices. There are also several more articles here that I think are very helpful for any investor to read because they help to explain the investment implications for the dollar, the gold price, and gold mining companies who I believe will continue to benefit from central banks’ inflationary programs.

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