The Third Nordic Post-Keynesian Conference
22-23 May 2014
Finn Olesen
Aalborg University – Department of Business and Management
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A scientific revolution – how and
why?
Thomas Kuhn: a scientific revolution should be
explained by the existence of anomalies
→ theoretical anomalies
→ empirical anomalies
→ conceptual anomalies
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The 1930s
 The era of the Great Depression:
mainstream under attack – time to change the
macroeconomic understanding!
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The 1930s
Kuhn's theory can easily explain how and why we talk
about The Keynesian Revolution:
→ lack of optimality: Yt is less than full employment
→ what is involuntary unemployment all about
(theoretically, empirically and conceptually)?
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The 1930s
With Keynes’s General Theory the scene was set for a
revolution in economics
Research (normal science activities) followed with
inspiration from Keynes’s macroeconomic model: ’the
principle of effective demand’
Still today we are using the 45o-diagram, the IS/LM model
and the AD/AS model when we teach basic macroeconomics
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1930s
Economics did undergo many changes as a result of The
General Theory
(theoretical as well as methodological – as any Post
Keynesian would tell you)
Just to mention six important aspects
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1930s
 Firstly, macroeconomists acknowledged the necessity
of having focus on how the level of aggregated output
was determined and how it could be manipulated e.g.
by economic policy
(focus on the processes of income determination by use
of a macroeconomic model)
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1930s
Secondly, macroeconomists got a new view on the
importance of aggregated demand
Aggregated demand now came to play a much more
active role in the economic analysis
(at the same time within basic Keynesianism aggregate
supply took over the more passive role that demand
effects had hitherto played in the economic analysis)
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1930s
 Thirdly, macroeconomists got a new view on how to
conduct monetary policy
Away with the classical view that monetary policy had to
do with price stability and nothing else. From now on,
fluctuations in aggregate production was very important
and also a concern of bankers: monetary policy should
be coordinated with other aspect of the general
economic policy (especially fiscal policy)
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1930s
 Fourthly, macroeconomists got a new view on how to
conduct fiscal policy
Away with the classical view on fiscal policy stating, that
the budget should always be balanced. Potential
crowding out effects were no longer that important if the
economy functioned at a level less than full
employment. Budget deficits (and a public debt) could
be acceptable
(functional fiscal policy)
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1930s
 Fifthly, macroeconomists got a new view on
international affairs – countries should operate
internationally in coordination not in conflict with
each other
(the Bretton Woods System)
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1930s
 Sixthly, macroeconomists began doing econometrics
and thereby gave the politicians a vital instrument,
that they could use when deciding what to do
economic policy wise when they tried to minimise the
fluctuations in aggregated demand and output
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The 2010s
 2008: from an international financial crisis to the
present Great Recession of many countries:
mainstream under attack once again – time to change
the macroeconomic understanding???
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The 2010s
 mainstream under attack:
1.
Bye-bye to the representative agent and rational
expectations?
2. And what about financial matters?
3. And still DSGE modelling?
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The 2010s
 Well:
Yes, probably
2. Yes, it seems so
3. No, TINA governs
1.
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The 2010s
Yes, probably because:
The assumption of rational expectations is:
”a strong one, and one may wonder if it should be
relaxed, especially when considering relatively short-run
responses to disturbances, or the consequences of newly
adopted policies that have not been followed in the past
– both of which are precisely the types of situations
which macroeconomic analysis frequently seeks to
address”
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2010s
And furthermore:
”the assumption that an economy’s dynamics must
necessarily correspond to an RE equilibrium may seem
unjustifiably strong … It makes sense to assume that
expectations should not be completely arbitrary, and
have no relation to the kind of world in which the agents
live; indeed, it is appealing to assume that people’s
beliefs should be rational, in the ordinary-language
sense, though there is a large step from this to the RE
hypothesis”
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The 2010s
And that is why:
”We should like, therefore, to replace the RE hypothesis
by some weaker restriction, that nonetheless implies a
substantial degree of conformity between people’s
beliefs and reality – that implies, at the least, that people
do not make obvious mistakes”
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The 2010s
And this is a view on rational expectations that is given
by a mainstreamer:
Michael Woodford (2013:304): Macroeconomic Analysis
Without the Rational Expectations Hypothesis, Annual
Review of Economics, 2013, Vol. 5, pp. 303-46
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The 2020s
Yes, it seems that financial aspects matters more than
expected hitherto by mainstreamers
As stated by e.g. Romer (2011:358):
”The crisis of 2008-2009 has made it clear that nonWalrasian features of credit markets have important
macroeconomic consequences. Disruptions in credit markets
can cause large swings in economic activity, and creditmarket imperfections can have large effects on how other
shocks affect the macroeconomy”
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The 2010s
An alternative to DSGE modelling? No, apparently TINA still
rules the game:
”While the problems of the field have hardly all been
resolved, there are no longer such fundamental
disagreements among leading macroeconomists about
what kind of questions one might reasonably seek to
answer or what kinds theoretical analyses or empirical
studies should even be admitted as contributions to
knowledge … [and this is done by using DSGE models] …
there are really no longer alternative approaches to the
resolution of macroeconomic issues”.; Woodford (2008:2 &
13)
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The 2010s
However, some mainstreamers express themselves a little less
fundamentalist (perhaps due to empirical facts of resent
years):
“First, despite the models’ complications, there is a great deal
they leave out. For example, until the resent crisis, the
models’ treatment of credit-market imperfections was
generally minimal. Second, the microeconomic case for
some important features of the models is questionable.
Most notably, the models include assumptions that
generate inertia in decision making … [which] … is mainly
motivated not by microeconomic evidence, but by a desire
to match macroeconomic facts”; Romer (2011:361)
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The 2010s
And actually, the DSGE modelling has been empirical
falsified as:
 Although the DSGE models can cope with random
exogenous events; events or shocks need not be
random nor exogenous – often disturbances are
endogenous in nature rather than exogenous
Stiglitz (2012:32): “In most models, the disturbances to
the tranquillity of the economy were exogenous, but
historically – as now – the important shocks are
endogenous”
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The 2010s
 Macroeconomic patterns in real life are not only
patterns of unique steady-states paths – real life
phenomena is seldom ergodic
 DSGE try to include aspects of uncertainty; however,
only of an epistemological nature – there is no room
for an uncertainty that is ontological
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The 2010s
 Of course, economic behaviour is dependent on
expectations; however in real life, households and firms do
not act economically based on perfect rational
expectations. They make mistakes (stochastically but much
more important also of a systematically kind).
 Likewise, of course, households and firms make decisions
of an intertemporal kind; however, these intertemporal
decisions are not characterised by perfect optimality, rather
decisions are often (always) of a 2. best kind
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The 2010s
 And methodologically, the ‘hypothetical-deductive
method’ used by the DSGE modelling is not the most
relevant method when you acknowledge that:
”unlike atoms or cells, individuals are free and, so,
unpredictable, because they learn and change their
behavior; because institutions also change their
behavior; and because a general uncertainty permeates
individual behavior and economic analysis”; BresserPereira (2012:9)
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The 2010s
So apparently, it seems, the modern macroeconomic
understanding is currently undergoing some revisions
However, seen from a Post Keynesian perspective, it is
more than questionable if these revisions would be
sufficient to make mainstreamers to be able to perform a
macroeconomic analysis that really, in a relevant way,
copes with the essential concepts of: time, money,
expectations & uncertainty.
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The 2010s
Unfortunately, it seems that mainstreamers are still
bound to do analyses that are ergodic in nature
The non-ergodic view on economics is regrettable only
accepted by the Post Keynesian understanding, as nonmainstreamers have had no influence at all on the
modern macroeconomic New Neoclassical Synthesis
We might be right but hardly no one seems to listen
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The 2010s
No hope for the future then?
Well, that depends on the students of economics today
Perhaps we are able to tell them a story about the
interplay between economic theory and the facts of real
life that is interesting and convincing to them
At least, we have to try. As we actually do at The
University of Aalborg
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The Making of a Revolution
Thank you very much
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