Keynesian Economics Is Hot Again

Related Link Economists are arguing over how their profession messed up during the Great Recession. This is what happened.

To the growing list of famous mainstream macroeconomists who have publicly criticized their discipline, add another: In a recent essay, Lawrence Christiano of Northwestern University argues that the Great Recession was an “earthquake” that dramatically changed how researchers think about the U.S. economy.

Christiano is known as a scholar who straddles macroeconomics’ great divide. His models adopt the basic form and some of the bedrock assumptions of the New Classicals, the economists who insisted in the 1980s that monetary and fiscal policy can’t fight recessions. But he also incorporates some elements of Keynesianism, the idea that aggregate demand shortages exist and can be corrected by the government stimulus. Perhaps as a result of their centrist take on that long-running debate, theories inspired by Christiano’s have won pride of place in central banks around the world.

But after the Great Recession, Christiano says, the pendulum should swing decisively in the Keynesian direction:

The Great Recession was the response of the economy to a negative shock to the demand for goods all across the board. This is very much in the spirit of the traditional macroeconomic paradigm captured by the [simple Keynesian] model… The Great Recession seems impossible to understand without invoking…shocks in aggregate demand. As a consequence, the modern equivalent of the IS-LM model—the New Keynesian model—has returned to center stage.

Another way of putting this is that Paul Krugman was right. Krugman has long advocated that macroeconomists learn to once again think in terms of simple simple Keynesian theory. And when more fully developed, complex models are needed, Krugman uses the kind of models that Christiano endorses. ...