A Critique of Neoclassicism and New Keynesianism

Abstract

The author argues that demand management was abandoned in the 1970s because, as presently understood, it proved incapable of controlling the world-wide acceleration of inflation that began in the 1960s, that led to the abandonment of the Bretton Woods system of fixed exchange rates in 1973, and that became explosive in the next two or three years. Monetary and fiscal policies were diverted to depressing the spending stream instead of supporting it, in an inappropriate attempt (only partially and belatedly successful) to end inflation; an alternative strategy that would control inflation without making unemployment worse would permit demand management to be revived. Neoclassical criticisms played a part in discrediting demand management among academic economists, but only after policymakers had already abandoned it for practical reasons. The theoretical analysis behind these criticisms is open to challenge in three crucial areas: the nature of the equilibrium that is relevant for the discussion, the nature of the unemployment that is observable in the real world, and the implications of the present inflationary environment. New Keynesian attempts to meet the neoclassical criticisms are vitiated by their acceptance of most of the crucial neoclassical assumptions. Finally, the author refutes the neoclassical assertion that Keynesian analysis does not provide a convincing macroeconomic foundation for its macroeconomic conclusions.Neoclassicism