Macroeconomics revolution in sight?

Let’s talk about macroeconomics --a subject that discusses the national output, inflation, unemployment, and the likes. If you fancy more thorough definition of macroeconomics, you can always consult the text-book, of course.

But firstly we need to imagine how a (national) economy works. And in this respect, I think the credit goes to John Maynard Keynes and his General Theory of Employment, Interest, and Money, who brought the macroeconomics into the world, as a result of his thinking on Great Depression in 1930s. This was the first revolution.

With help of IS-LM model of Hicks (1937), how an economy work, in Keynesian way, can be best described as interaction between goods market (equilibrium of aggregate demand that consist of consumption, investment, government spending, and, export import; and output) and assets market (equilibrium of money market and asset market), connected by the interest rate.

This is a powerful model, at least until the 1970s. It also gives a room for government to fine-tune the economy along its cyclical pattern of boom and bust through fiscal policy (in goods market) and monetary policy (in money market).

But in 1970s the assault of Keynesian model came from two directions, empirically and theoretically (Akerlof, 2007). Empirically, the Philips curve, one of main feature of Keynesian model, for converse relationship between inflation and unemployment didn’t hold, mainly in US. They had stagflation.

And theoretically, and more interestingly, some of basic Keynesian model tenets were no longer valid as a result of the discovery of five neutralities: the independence of consumption and current income, the independence of investment and finance decision, inflation stability at natural rate of unemployment, and ineffective monetary policy with rational expectation; and Ricardian equivalence.

Alright, OK, I see you raise you eyebrows. That’s OK, don’t bother too much, I just want to say that the science gave birth to its second revolution, particularly after the Lucas rational expectation theory, and called the outcome New Classical macroeconomics.

And this took places by mainly adopting the micro-foundations approach of firms profit maximising and consumer utility maximising; and lending heavy weigh on market perfection. And they believe, more or less, any government intervention and fine-tuning effort would be useless.

Afterward the works have been going on, as well as the battle between two schools of thought. By incorporating market imperfection (frictions) into the model to defend the old Keynesian pre-suppositions, the New Keynesian reacted to New Classical Model. And the newest proposal came from Akerlof (2007), in pdf, who introduces sociological term of norm into equation to nullify five neutralities championed by New Classical macroeconomists abovementioned.

But, in my opinion, the New Classical revolution and the works afterward haven’t really brought a new general model of the economy, they way Keynesian did. All are only partial assaults on the Keynesian framework, without producing a comparable great model on how the economy works.

I once emailed one of the authorities in the field, Gregory Mankiw, asking for another possibility of scientific revolution in Macroeconomics:

I was expecting that Asia crisis in 1998 brought a revolution in the field, the way Great Depression in 1930s delivered Keynesian revolution. Alas, it wasn't the case. Why?
-r

And his answer

Good question, I don’t know.

greg

Maybe you know the answer?

P/s: This is the extension of this old posting, adding a little methodological issue into the discussion here.

macroeconomics