Are Novel Keynesian Dsge Models A Faustian Bargain?

Some write every bit if this were true. The floor is that later the New Classical counter revolution, Keynesian ideas could exclusively live reintroduced into the academic mainstream past times accepting a whole charge of New Classical macro inside DSGE models. This has turned out to live a Faustian bargain, because it has crippled the might of New Keynesians to empathize subsequent existent footing events.

Is this how it happened? It is truthful that New Keynesian models are essentially RBC models plus viscid prices. But is this because New Keynesian economists were forced to convey the RBC structure, or did they voluntarily create together with then because they thought it was a skillful foundation on which to build?

One means of looking at this (and I’ll fighting at the destination that it misses a fundamental element) is to holler back close the private components of models. If you lot create this, the Faustian create out floor looks implausible. Let’s start alongside the mainstream earlier the New Classical revolution. This was the famous post-war neoclassical synthesis popularised past times Paul Samuelson, which integrated traditional Keynesian together with Classical models inwards a mutual overall framework. While prices were viscid nosotros were inwards a Keynesian world, but ane time prices had adjusted the footing was Classical.

In terms of components, the RBC model is precisely the classical macromodel alongside 2 fundamental additions. The offset is rational expectations. The minute is intertemporal optimisation past times agents. (In non-jargon, it takes seriously the might of agents to select when they eat past times saving or borrowing, rather than but assuming they precisely eat a fixed proportion of their electrical flow income. This is oftentimes called the consumption smoothing model, because typically consumers polish consumption relative to income e.g. past times saving for retirement.) In both cases I create non holler back Keynesian economists were forced to adopt these ideas against their meliorate judgement. Instead I holler back quite the contrary is true: both ideas were readily adopted because they appeared to live a distinct improvement on previous methods.

The fundamental betoken hither is that they were an improvement on previous practice. It does non hateful that economists thought they were the lastly answer, or indeed that they were one-half adequate answers. Instead they were a meliorate foundation to construct on compared to what had gone before. I’ve argued this for rational expectations before, but I also holler back it is truthful for intertemporal consumption. I detect it real hard to holler back close to a greater extent than complex ideas, similar liquidity constraints or precautionary saving, without starting alongside consumption smoothing.

I receive got talked about the existent footing events that convinced me of this, but hither permit me brand the same betoken inwards a to a greater extent than informal way. When didactics on the Oxford masters programme, I laissez passer on students a question. If they won a large sum, would they pass it over the adjacent year, over the adjacent few years, pass a pregnant proportion instantly but salve the rest, or salve nearly all. The lastly response is the reply given past times the unproblematic intertemporal model, but I fighting that the offset 2 responses brand perfect feel if you lot are a credit constrained student. However I enjoin my audience that those who gave the offset reply are non intending to create a PhD later finishing the masters, piece those who gave the minute are, because they are expecting the credit constraint to lastly longer. The serious betoken is that credit constrained consumers create non automatically eat all of a temporary increase inwards income. If the catamenia over which income is higher is less than the catamenia over which they expression to live constrained, they volition polish their additional consumption.

So, inwards terms of the components of New Keynesian models, I tin run across petty that most modellers would honey to junk if it wasn’t for those nasty New Classicals. [1] But what this ignores is methodology, together with the fact that the RBC model is a microfounded Classical model. (By microfounded, I hateful that every macroeconomic human relationship has to live formally derived from optimisation past times private agents.) Yet hither again, I dubiety that most New Keynesian modellers adopted the microfoundations perspective against their meliorate judgement. Instead I suspect most saw the might of the microfoundations approach (in analysing consumption, inwards particular), recognised the dangers inwards advertizing hoc theorising close dynamics (as inwards the traditional Phillips curve), together with thought at that topographic point was no contest.

The to a greater extent than interesting query is whether this has turned out to live a Faustian pact betwixt macroeconomics together with microfoundations ex post. To live to a greater extent than precise, past times putting all our macroeconomic model edifice eggs inwards ane microfounded basket, receive got nosotros significantly slowed down the stride at which macroeconomists tin tell something helpful close the speedily changing existent world? That is a query I receive got written a lot close (e.g. here, together with here) together with no dubiety volition write more, but the fundamental betoken I desire to brand instantly is this. If at that topographic point was a Faustian bargain, I holler back nosotros should admit that most Keynesian economists agreed to it for skillful reasons, together with that they were non forced into it past times others.

[1] I must add together a caveat here, although it is rather controversial. I holler back ane feel inwards which RBC models receive got cast an annoying shadow is the thought that nosotros must receive got models inwards which labour furnish is endogenous. Often it would brand things simpler if nosotros could assume a fixed labour supply, together with my ain persuasion is that for many issues nosotros would lose petty empirical relevance if nosotros did so. Here I create think New Keynesians are also deferential to the ever silly thought of trying to explicate movements inwards unemployment every bit but a labour furnish choice.