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Debunking Macroeconomics Steve Keen

Debunking Macroeconomics Steve Keen

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Economic AnAlysis & Policy, Vol. 41 no. 3, dEcEmbEr 2011
Debunking Macroeconomics
Steve KeenSchool of Economics & Finance,University of Western Sydney, Locked Bag 1797,Penrith 1797, NSW  Australia(Email: s.keen@uws.edu.au)
The ailre  elassial mdels t war  the emi risis has led t sme raresl searhig i a disiplie t kw r sh itrspeti. The dmiat reatiwithi the pressi has ee t admit the ailre, t t arge that there is  eed ra drasti revisi  emi thery. I rejet this mrtale lsi, ad argeistead that this risis illstrates the pit made erehad y Rert Slw, thatmdels i whih maremi pathlgies are impssile are t adeate mdels apitalism. Hiks’s ritie  his w IS-LM mdel als idiates that, thghpathlgies a e impsed  a IS-LM mdel, it is als iapprpriate r maremiaalysis ease  its alse impsiti  eilirim ditis derived rm Walras’Law. I the s p what I see as the key weakess i the elassial apprah tmaremis whih applies t th DSGE ad IS-LM mdels: the alse assmptithat the mey spply is exges. Ater tliig the alterative edges meyperspetive, I shw that Walras’ Law mst e geeralized r a redit emy t whatI all the “Walras-Shmpeter-Misky Law”. The empirial data strgly spprts thisperspetive, emphasizig the eed r a “rt ad rah” rerm  maremis.
I. InTRoDucTIon
The ailre  elassial mdels t war  the emi risis has led t sme rare slsearhig i a disiplie t kw r sh itrspeti. The dmiat reati withi thepressi has ee t admit the ailre, t t arge that there is  eed r a drasti revisi emi thery.I rejet this mrtale lsi, ad arge istead that this risis illstrates the pitmade erehad y Rert Slw, that mdels i whih maremi pathlgies areimpssile are t adeate mdels  apitalism. Hiks’s ritie  his w IS-LM mdel alsidiates that, thgh pathlgies a e impsed  a IS-LM mdel, it is als iapprpriater maremi aalysis ease  its alse impsiti  eilirim ditis derivedrm Walras’ Law. I the s p what I see as the key weakess i the elassial appraht maremis whih applies t th DSGE ad IS-LM mdels: the alse assmpti thatthe mey spply is exges. Ater tliig the alterative edges mey perspetive,
dEbunking mAcroEconomics
148I shw that Walras’ Law mst e geeralized r a redit emy t what I all the “Walras-Shmpeter-Misky Law”. The empirial data strgly spprts this perspetive, emphasizigthe eed r a “rt ad rah” rerm  maremis.
That mder elassial maremi mdels ailed t rewar  the emi risisthat ega i 2007 is dispted. What is i dispte is the impliatis this shld have rmaremi thery.Prmiet memers  the disiplie have arged that there shld e  seees.be berake (berake 2010), reet nel Prize lareate Thmas Sarget (Rlik 2010)ad the dig editr  the
 AER: Macro
olivier blahard (blahard et al. 2010) have allasserted that elassial mdels helped gide pliy drig the gd times, ad shld te aaded simply ease they did t see the ad times mig. berake’s argmet isrepresetative  this perspetive:
‘the reet aial risis was mre a ailre  emi egieerig ad emi maagemettha  what I have alled emi siee…D these ailres  stadard maremi mdels mea that they are irrelevat r at leastsigiatly awed? I thik the aswer is a alied . Emi mdels are sel ly i thetext r whih they are desiged.
 Most of the time, including during recessions, serious nancial instability is not an issue. The standard models were designed for these non-crisis periods, and theyhave proven quite useful in that context 
. ntaly, they were part  the itelletal ramewrk thathelped deliver lw iati ad maremi staility i mst idstrial tries drig thetw deades that ega i the mid-1980s.’ (berake 2010, pp. 3, 17; emphasis added)
I make no apology for describing this argument as specious, on at least two grounds.
firstly, this argmet wld ly e tleraly aeptale i elassial emis als hadwell-develped mdels that were sitale r perids  risis, t it des t.
Sedly,this lasé aeptae that there a e ad times sits ddly agaist the trimphalism thatharaterized elassial disrse  maremis prir t this risis. This is estexempliied y Las’s Presidetial Address t the
 American Economic Association
i 2003,i whih he asserted that elassial emis had seeded i elimiatig the pssiility extremely ad times like thse we are w experieig:
‘Maremis was r as a distit eld i the 1940’s, as a part  the itelletal respset the Great Depressi. The term the reerred t the dy  kwledge ad expertise that wehped wld prevet the rerree  that emi disaster. My thesis i this letre is thatmaremis i this rigial sese has seeded:
 Its central problem of depression preventionhas been solved, for all practical purposes, and has in fact been solved for many decades.
’ (Las,Jr. 2003, p. 1 ; emphasis added)
The prpsiti that there a e separate mdels r gd ad ad times als implies thatthere is  asal lik etwee gd ad ad times, whih wld e tre i they were simply
It wld als have t e prvaly tre that there is  asal lik etwee gd times ad ad times – a pitI retr t elw.
stEVE kEEn
149the prdt  exges shks t the maremy. This is i at hw mst elassialmdelers have reated: y retrspetively treatig the risis as eig de, t merely tpreedetedly large exges shks, t shks whih varied i magitde ver time—while still remaiig egative rather tha psitive:
‘the Great Reessi ega i late 2007 ad early 2008 with a series  adverse preeree adtehlgy shks i rghly the same mix ad  rghly the same magitde as thse that hitthe uited States at the set  the previs tw reessis…The strig  adverse preeree ad tehlgy shks tied, hwever, thrght 2008 adit 2009. Mrever, these shks grew larger i magitde, addig sstatially t jst t thelegth t als t the severity  the great reessi…’ (Irelad 2011, p. 48, see als MKiiad Stekel 2009)
The at that these shks ame rm the iaial setr—whih the rdiary pli wldted t regard as eig part  the emy, ad therere t e mre  a edgesemi pheme tha a exges evet—has ee treated as largely irrelevat yleadig elassials:
‘The risis has shw that large adverse shks a ad d happe. I this risis, they ame rmthe aial setr, t they ld me rm elsewhere i the tre—the eets  a pademi trism ad trade r the eets  a majr terrrist attak  a large emi eter.’ (blahard,Dell’Ariia ad Mar 2010, p. 207)
Give the severity ad persistee  this risis, this is als speis reasig: i the risis wasmerely de t a large exges egative shk, srely y w it wld e ver? Srely t,sie the “shks” emaated rm the iae setr, ad the stadard elassial dtriethat permits a separati  emis rm iae has w ee empirially rejeted (famaad freh 2004), the treatmet  distraes i the iae setr as “exges” t theemy shld als e rejeted?These reatis  elassial therists ad mdelers are therere  mre tha a pleathat the re elassial visi  the maremy as a stale system sjet t exgesshks shld e preserved, despite a preedeted empirial ailre. This prpsiti hasee pt pely y blahard et al., amgst thers:
‘It is imprtat t start y statig the vis, amely, that the ay shld t e thrw t withthe athwater.’ (blahard, Dell’Ariia ad Mar 2010, p. 204)
Hwever,  lesser nelassials tha Jh Hiks (Hiks 1981) ad Rert Slw (Slw2003, 2001, 2008) have pt the trary ase that these aies— th tday’s DSGE mdelsad the IS-LM mdel that preeded them—shld ever have ee eived i the irst plae.Hiks’s diswig  IS-LM appears t have disappeared witht trae i elassialliteratre. Slw’s vie was at least akwledged y blahard whe he plished hisexriatigly adly timed srvey  mder maremis (blahard 2009, blahard2008),
i whih he stated that:
The risis is geerally dated rm Agst 6 2007, whe the bnP sht dw 3  its ds that were expsedt uS sprime ledig – e year
blahard’s wrkig paper was irst psted.

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