By the early 1980s many new classical theorists abandoned the mark I version of equilibrium business cycle theory and with the development of a mark II.
BRIAN SNOWDON [hme~,ity ~ Northumbria Neu:castle-upon-Tyne, United Ki)~gdom HOWARD R. VANE Liverpool John Moores Unitecsity l,i~>eq~ool, United Kingdom
The Development of Modern Macroeconomics: Reflections in the Light of Johnson's Analysis after Twenty-Five Years* This paper considers how far factors advanced by Harry" Johnson some twenty-five years ago to explain the success of the Keynesian revolution and subsequent monetarist counter-revolution, can help in understanding why new classical macroeeonomics has had such an impact on the more recent development of macroeconomics. At least three of Johnson's five "internal scientific characteristics" are seen to have played an important role in the development of both versions of new classical macroeconomics.
1. Introduction Twenty-flve years ago Harry Johnson (1971) in his lecture to the 1970 meeting of the American Economic Association attempted to provide reasons for the rapid propagation of the Keynesian revolution in order to better understand the monetarist counter-revolution which during the late 1960s and early 1970s had begun to fill the intellectual vacuum created by the retreat of the Keynesian orthodoxy in the face of accelerating inflation (see Friedman 1968, 1970; Kenway 1994). In Johnson's highly perceptive article attention is drawn to the shared characteristics of the Keynesian revolution and the monetarist counter-revolution that appear important in explaining the success of these developments. According to Johnson there are two types of factor which can help explain the rapid acceptance and propagation of new ideas among professional economists. The first factor relates to the "objectiw' social situation in which the new theory was produced" (italics added). The second important factor encompasses the "'scientific characteristics of tile *This paper is based on a series of lectures given within the Faculty of Economics at Ryukoku University and Doshisha University, in Kyoto, Japan, in mid-January 1995. The authors are grateful to Faculty members for their stimulating discussions and hospitality' during their visit. The authors would also like to thank an anonymo, ls referee for helpful comments and suggestions on an earlier draft of this paper.
Journal of Macroeconomics, Summer 1996, Vol. 18, No. 3, pp. 3 8 1 4 0 1 Copyright © 1996 by Louisiana State University Press
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new theory"' (italics added). Since tile early 1970s, when Johnson's article appeared, maeroeconomics has been in a state of"disarray" (Brunner 1989!. The Keynesian-monetarist debate whieh dominated macroeconomics up to the mid-1970s has been superseded by the appearance of a number of conflicting and competing approaches. During the 1970s the new elassical research programme replaced monetarism as the main rival to Keynesianism, By the early 1980s many new classical theorists abandoned the mark I version of equilibrium business cycle theory and with the development of a mark II version emphasized real supply-side factors, rather than monetary impulses, in their explanation of aggregate instability (see Hoover 1988, 199"2a; Stadler 1994). These two versions of new classical equilibrimn theor?~have in turn been challenged by a revitalized group of new Keynesian theorists (see Gordon 1990; Mankiw and Romer 1991; Romer 1993). The purpose of this paper is not to critically assess in detail the central tenets underlying, and policy implications of, the new classical and new Keynesian schools (for such a diseussion see Snowdon, Vane, and Wynarc~k 1994) rather it is to consider how far the factors identified by Johnson can help in understanding the rapid propagation of new classical ideas. Our focus on new classical maeroeconomics can be justified on two main grounds. First, new classical economists have set the agenda for macroeeonomies to the extent that "whether for or against, the views of the new classical school have been the ones to debate; the problems it set have been the ones to solve; the techniques it used have been the ones to adopt" (Hoover 1992a). As such, new Keynesian economics can be seen as a reaction to the new classical challenge. Second, there is no single unified new Keynesian model, rather there are a multiplicity of explanations of wage and price rigidities and their maeroeeonomie consequences. Although the numerous explanations are not necessarily mutually exclusive (indeed they often complement each other) different economists within the new Keynesian school emphasize various aspects and causes of market imperfeetions and their macroeeonomic effects (see Stiglitz 1992), In Section 2 of the paper we review Johnson's arguments with respect to the Keynesian revolution and the monetarist counter-revolution. In Section 3 we briefly review the main features of new classical maeroeeonomics before proceeding in Section 4 to apply Johnson's insights to these new classical developments in an attempt to identify the "scientific characteristics" of modern macroeeonolnies. In Section 5 we briefly consider the objective social situation in which new classical maeroeeonomics was produced and the influence of rhetoric. In eonelusion we reflect on how relevant Johnson's analysis is in helping understand the rapid propagation of new classical macroeeonomics, an approach which has had a dramatic influence on the more recent development of macroeconomics. 382
The Develop~lwnt qf Moderv~ Macroeconomics 2. The Keynesian Revolution and the Monetarist Counter-Revolution The first factor identified by Johnson in his explanation of the success of the Keynesian revolution and subsequent monetarist counter-revolution was the existence in each case of an "objective social situation" where the established orthodoxy was "clearly inconsistent with the most salient facts of reality." In the case of the Keynesian revolution this problem was persistent and severe unemployment. In Britain the experience of tile 1920s and 1930s appeared to shatter the classical assmnption that fidl employment eqnilibrium was the normal state of affairs. Between 1921 and 1938 the rate of unemployment never fell below 10% and exceeded 20% in 1931 and 1932. In tile United States unemployment reached 25% in 1933, and despite rapid rates of growth of real output in the mid and late 1930s unemployn~ent was still almost 10% in 1941 (see Romer 1992). For Keynes this crisis suggested that capitalism was not terminally ill but unstable. His objective was to modit\ the rules of the game within the capitalist system in order to preserve and strengthen it. He wanted lull employment to be the norm rather than the exception and his would be a conservative revolution. Against this background Keynes (1936) put forward a new and revolutionary, theory to explain, and provide a remedy for, the then-prevailing sew~re unemployment. In a parallel fashion the inability of Keynesian theory to provide an adequate explanation of and solution for inflation, which by the late 1960s had come to be seen as the major social and economic problem t:acing capitalist market economies, paved the way for a monetarist counter-revolution. The second factor identified by Johnson to explain the rapid progress and widespread acceptance of Keynesian and subsequently monetarist theory was that in each case the new ideas possessed certain "scientific characteristics" which helped to win intellectual acceptance. Although an established orthodoxy which is in apparent contradiction to the "most salient facts of reality" is the "most helpfid circumstance for the rapid propagation of a new and revolutionary theory" Johnson also identified five internal scientific characteristics which in his view were crucial because it was these aspects of the new theory which appealed to the younger generation of economists. In summary the five main characteristics Johnson identified involved: (i) "a central attack, on theoretically persuasive gr(mnds, on the central proposition of the orthodoxy of the time" (italics added). Keynes (1936) attacked the classical assumption that the economy automatically tends to full employment equilibrium. In turn monetarists attacked the extreme Ke)aaesian case that money does not matter represented in the Keynesian IS-LM model by the liqnidity trap and interest-inelastic investment cases. (ii) "'theproduction of an apparently new theorTj that nevertheless absorbed 3S3
Brian Snowdon and Howard B. Van(: all that was valid in the existing theory while so far as possible git in~ thes'e valid concepts confitsing new names" (italies added). In tile latter case Johnson cited examples taken from Keynes's (1936) General 77u'or~j which included the classical concept of tile marginal productM~, of capital being re-named the marginal efficiency of capital. To support this characteristic with regard to monetarist theory Johnson made reference to Don Patinkin's (1969) article in which it was suggested that Milton Friedman's (1956) restatement of the quantity theo U of money should be regarded as an "elegant exposition of the modern portfolio approach to the demand for money which . . . can only be seen as a continuation of the Keynesian theory of liquidity preference." (iii) a new theory having an "'appropriate degree of difficulty to understand" that would "'challenge the intellectual interest of younger colleagues and students" (italics added). In essence Johnson's argmnent is that there is little incentive tbr older academies to invest time mastering a new theory, especially as they have already invested considerable intellectual capital in the established orthodoxy. In contrast a new theory offers younger academies an opportunity to be part of a new and exciting approach and gain intellectual recognition with associated promotion possibilities. A case of having the opportunity to run with and be the leaders of the pack rather than follow in its wake. (iv) "a new nmre appealing nwthodology'" (italics added) than that prevailing. In the case of the Keynesian revolution Johnson suggested that this involved the move away from a partial to a general-equilibrimn approach. On the other hand the monetarist counter-revolution offered the new methodology of positive economies and a move away from large-scale models of the economy. (v) "the advancement of a new and important empirical relationship suitablefi)r deter~nined estimation" (italics added) by econometricians. As in the ease of the first characteristic this is easily identified in that the Keynesian revolution offered the consumption function, and the monetarist counter-revolution the stability of the demand for money fnnetion, as subjects for empirical scrutiny. To what extent have these five internal scientific characteristics played an important role in explaining the success of new classical maeroeeonomies? Before attempting to answer this question we briefly review the main features of new classical macroeconomies.
3. N e w Classical Macroeconomics Although the mark I version of new classical macroeconomics initially evolved out of monetarist macroeconomics during the 1970s it is clear that
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it should be regarded as a separate school of thought from orthodox monetarism (see for example Hoover 1984; Laidler 1992). In new classical analysis continuous market clearing ensures that aggregate demand shifts impact first of all on prices. Quantity adjustment follows if rational agents misperceive global price lnovements as relative price movements due to incomplete information. By contrast, in Keynesian and orthodox monetarist analysis quantities adjust first because prices are sticky in the short run. David Laidler (1986) regards this as a "fundamental theoretical difference" which leads him to treat new classical macroeconomics as a "distinct body of analysis, rather than a simple extension of monetarism.'" From the mid 1970s to the early 1980s (at least as t~aras the United States was concerned) the mark I version of new classical inacroeconomics replaced monetarism as the main counterrevolutionary theory to Kevnesian economics. Such was the impact of new classical theorizing, particularly in the U.S. that by 1978 Robert Lucas and Thomas Sargent were contemplating lil~ "After Keynesian Macroeconomits." In their view the Keynesian luodel could not be patched tAp. The problems were much more fundamental and related in particular to (i) inadequate micro foundations which assume non-market clearing; and (ii) the incorporation in both Keynesian and monetarist models of a hypothesis concerning the formation of expectations which was inconsistent with maximizing behavior; that is, the use of an adaptive rather than rational expectations hypothesis. In 1980 commenting on "The Death of Keynesian Economics: Issues and Ideas" Lucas went so far as to claim that "people even take offense if referred to as Keynesians. At research seminars people don't take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another" (cited in Mankiw 1992). In a similar vein, Alan Blinder (1988) has suggested that "by about 1981), it was hard to find an American academic inacroeconomist under the age of 40 who professed to be a Keynesian. That was an astonishing intellectual turnabout in less than a decade, an intellectual revolution fi)r sure." Bv this time the United States most distinguished "old" Keynesian economist had already posed the question, "How Dead is Keynes?" (see Tobin 1977). ttowever~ it should be noted that while Blinder (1988) recalls how "the yonng were recruited disproportionately into the new classical ranks" during the 1970s Robert Gordon (1989), citing evidence on citation cou n ts and co~fe fence pa rticipant.s., rejects this view arguing that the influence that new classical macro had on the younger generation of economists has been greatly exaggerated and that "new classical macro did not conquer the Ph.D.s during the decade when it was most influential!" It is also true that few non-academic economists converted to new classicism in the U.S. In addition to the theoretical fidlings of the orthodox Keynesian model it has also become part of the conwmtional wisdom that its demise was 385
Brian Stu~wdo~ arm Howard B. V(me
brought about by empirical failings (Mankiw 1990). The empirical thilings were highlighted by Lucas and Sargent (1978) when they described Keynesian models as having experienced "econometric failure on a grand scale." Barro (1989) also attributes the considerable loss of prestige of Keynesian models to the disappearance of the Phillips curve in the mid-1970s. However there is another possible interpretation. Critics of new classical macroeconomics reject their view of grand empirical failure. By the mid-1970s, at least as far as the U.S. was concerned, the vertical in the long-run view of the Phillips curve had won the day and the influence of supply side shocks, unforseen by Keynesians, monetarists and new classicists alike, was being incorporated into mainstream models (see Blinder 1988 and Laidler 1986, 1992). Such developments led to an "empirical revival" of the Keynesian model (Gordon 1989). As a result monetarist influences were absorbed within the existing framework leading to a Keynesian-monetarist synthesis, a development clearly anticipated by Johnson in his prediction that the monetarist counter-revolution would gradually "peter out" as a result of "compromises" with the Keynesian opposition. An acceptance of this interpretation of academic developments during the 1970s suggests that "the most salient facts of reali~," the stagflation of this period, did not constitute an "objective social situation" incapable of explanation within the emerging Keynesian-monetarist synthesis. Nevertheless such was the momentum of the new classical bandwagon that it continued to have a dramatic influence on the development of maeroeconomic analysis. Underlying the first phase of new classical theorizing is the joint acceptance of three main sub-hypotheses comprising: (i) the rational expectations hypothesis, (ii) the aggregate supply hypothesis and (iii) the Walrasian assumption of continuous market clearing. The structure of mark I new classical models in turn produces a number of well known and controversial policy implications, namely: (i) the policy ineffectiveness proposition (Sargent and Wallace 1975, 1976); (ii) the absence of output/employment costs following credible monetary contraction (Sargent 1993); (iii) the time inconsistency argument against discretionary policies in favor of rules (Kydland and Prescott 1977); (iv) the strong Ricardian equivalence result limiting the usefulness of tax changes as a stabilization instrument (Barro 1974); (v) the role of microeconomic policies to increase aggregate supply (see Minford 1991a); and (vi) the Lucas critique of econometric policy evaluation (Lucas 1976). According to Gordon (1989) the influence of this first phase of new classical theorizing peaked in the period 1976-1978. Gordon also dates the downt~al] of this phase "precisely at 8.59 a.m. EDT on Friday 13th October 1978 at Bald Peak, New Hampshire" for it was here that Robert Barro and Mark Rush began their presentation "of an empirical test of the policyineffectiveness proposition on quarterly U.S. post-war data that was not only 386
The Developuwnt of Modern Macroeconomics severely criticized by three discussants, but also contained dubious results that seemed questionable even to the authors" (see Hoover 1992a, vol 1, 211-61). Thus the early 1980s witnessed the demise of the mark I (monetary surprise) version of the new classical approach ill large part due to the implausibility of supposed information gaps relating to aggregate price level and money supply data, and the failure of empirical tests to provide strong support ior the policy ineffectiveness proposition (see Barro 1989). Meanwhile Stanley Fischer (1977) and Edmund Phelps and John Taylor (1977) had already shown that nominal disturbances were capable of produeiug real effects in models incorporating rational expectations providing the assumption of continuously clearing markets was abandoned. Following these embryonic new Ke~lesian contributions it was realized that the rational expectations hypothesis was a neeessa~ but not sufficient condition for polic.v ineflbetiveness. As a result the policy-ineffectivenessproposition was left "to die neglected and unmourned" and "into this vacuum stepped Edward Preseott from Minnesota, who has picked up the frayed new classical hamlet with his real business cycle theory" (Gordon 1989). The first phase of equilibrium theorizing sowed the seeds tbr the development of a mark II version which, while maintaiuing the assumption of continuous market clearing, has reverted to a filll information assumption and ~4ews business cycles as being caused by persistent real (supply-side) shocks to the economy. Whereas Lucas sought to improve the mierofbundations of aggregate supply within a market clearing Walrasian general equilibrium framework in order to explain the non-neutral impact of monetary- shocks, real business cycle theorists provide an explanation of aggregate fluctuations which have their origins predominantly in shocks to the supply side of the macro equation. The impulse force driving most of these models is random shocks to the production function. Following the development of unit root econometrics by Charles Nelson and Charles Plosser (1982) it is now generalbT accepted that shocks (demand and supply) have non-trivial permanent el}~cts which existing theories need to incorporate (see Durlauf 1989; Stadler 1994). While real business cycle theory has abandoned the monetary surprise approach to explaining business cycles it has retained and developed the propagation mechanisms of the earlier mark I new classical models. Jolm Taylor (1989) has even referred to these recent developments as comprising a "'real business cycle revolution," It is somewhat of a paradox that while the idea "that money does not matter" used to be associated with the ultra KQ,nesian school it is now embraced by several prominant former new classical monetary theorists (see Barro 1989; Kydland and Prescott 1!)90). Real business cycle theorists find the use of the term "business cycle" unfortunate because it suggests there is a phenomenon to explain which is independent of the fbrces determining economic growth (see Prescott 1986). By providing an integrated 3,";7
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approach to growth and fluctuations, they have shown that large fluctuations in output and employment over relatively short time periods are "what standard neoclassical theory predicts." Indeed it "would be a puzzle if the economy did not display large fluctuations in output and employment" (Prescott 1986). Since instability is the outcome of rational economic agents responding optimally to changes in the economic environment, observed fluctuations are an equilibrium phenomena and should not be viewed as welfare-reducing deviations from some ideal trend path of output. In a competitive theory of fluctuations the equilibria are Pareto optimal (see Plosser 1989; Stadler 1994). The idea that the government should in any way attempt to reduce these fluctuations is therefore anathema to real business cycle theorists. Such policies are ahnost certain to reduce welfare. As Prescott (1986) has argued: "The policy implication of" this research is that costly efforts at stabilization are likely to be counter-productive. Economic fluctuations are optimal responses to uncertainty in the rate of technological progress." To real business cycle theorists the emphasis given by Ke~lesian and monetarist economists to the issue of stabilization has been a costly mistake. In a d~mmic world instability is as desirable as it is inevitable. As a result of these developments the impact of the new classical approach can be seen in at least five main directions. First, it has led to the widespread adoption of the rational expectations hypothesis, resulting in a so-called "rational expectations revolution" in macroeeonomics. Second, the insights provided by the time-inconsistency literature and the Lucas critique have led economists to reconsider approaches to policy making and evaluation. Third, it has led to the widespread practice of applying equilibrium modeling to macroeconomie analysis (see Mullineux and Dickinson 1992). Fourth, as noted earlier, it has set the agenda fbr macroeconomics to the extent that, following the new classical contributions, it has become much more widely accepted that any satisfactory macroeconomic analysis needs to be based on firm microeconomic foundations. Fifth, real business cycle t h e o ~ has challenged the pre-1980 consensus that growth and fluctuations are distinct phenomena to be studied separately an(] requiring different analytical tools. Modern business cycle theory utilizes a unifying framework of the neoclassical growth model to explain both growth and fluctuations (see Cooley 1995). We now turn to consider how lhr Johnson's five internal characteristics help to explain the rapid propagation of these new classical ideas. 4. The Scientific Characteristics of Modern Macroeconomics
The Ability qf a New Theory to Attack the Central Proposition ~f the Established Orthodoxy The first characteristic can be straight forwardly identified in both versions of new classical theory. In the case of the mark I version of new
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The Development of Modern Maeroeconomics classical macroeconomies the policy ineffectiveness proposition, first presented in two influential papers by Sargent and Wallace (1975, 1976), suggests that only unanticipated monetary surprises have real output effects and then only in the short run. This proposition has had major implications tbr the Keynesian-monetarist controversy over the role and conduct of macroeconomic stabilization policy. Most significantly the mark I version of new classical analysis implies that the authorities will be unable to influence output and employment even in the short mm by pursuing a systematic monetary policy. The argument advanced against Keynesian policy activism is therefbre subtly different and potentially more devastating than that put forward as a result of the monetarist counter-rew)lution. Within the more recent real business cycle approach economic fluctuations in ontpnt and employment are seen as Pareto optimal responses to shocks to the production function, largely resulting from fluctuations in the rate of technological progress. Prior to 1980 the established consensus regarded business cycles as socially undesirable (Sheffrin 1989). In shaq~ contrast the main policy implication of real business cycle theory is that, because the existence of fluctuations in aggregate output do not imply the failure of markets to clear, the government should refrain from any attempt to reduce such fluctuations, not only because such policies are unlikely to achieve their desired objective, but also because reducing instability would reduce welt:are! While monetary policy has no real effects in a fidl information equilibrium framework, real business cycle theorists suggest that the government conld do a great deal of harm if it created various distortions through its taxation and spending policies.
The Construction of a New Theor~j Which Still Absorbs Valid Components of the Existing Orthodox Theory The application of Johnson's second internal characteristic can also be applied to new classical theory. While the early new classical monetarysurprise models absorbed the monetarist analysis of inflation and the natural rate hypothesis, the real business cycle approach has pioneered the use of the orthodox neoclassical growth model as a framework for the quantitative analysis of aggregate fluctuations. These more recent developments can be ~fiewed as the latest phase of the agenda of some economists to reclaim the short run for neoclassical analysis (see Lucas 1994, 224). While equilibrium dynamics is inconsistent with tradition'a] Keynesian analysis it is a natural development within the neoclassical paradigm. Finally with regard to Johnson's second internal characteristic it is very difficult to find examples where valid concepts have been re-named with new and confusing names, 389
Brian Snow&m and Howard B. Vaue The Production of an Intellectually Challengin~ New Theory with Appeal to the )~mnger Generation of Economists Johnson's third characteristic is one that again can be readily applied to new classical theory. There is no question that tile new classical revolution pushed macroeconomic theory into new more abstract directions involving the introduction of new techniques not tbund in the "kit bags of the older economists" (Blinder 1988). Being better trained mathematically the younger generation has been able to absorb the new techniques giving them a "heavy, competitive edge" over the "older" economists. Examples of such techniques include the mathematics of tbrward looking solutions to rational expectations models and calibration in real business cycle theory. In the former case the rational expectations revolution was a "godsend for aspiring young technicians" (Blinder 1988). Furthermore, since the solution of larger models requires considerable computing power, the rapid expansion of interest in rational expectations modeling during the 1970s was greatly enhanced by the explosion "in the capability of the electronic computer" (Minford and Peel 1983). Given the greater incentive and potential for the younger generation of economists to lnaster new techniques the same kind of generational conflict observed in the wake of the Ke)qlesian revolution was also a feature of the debates which took place following the early new classical contributions. As Lucas has observed in commenting on Keynesian reactions to his ideas in the 1970s "it left me with a feeling of being way ahead of the game" (see Klamer 1984, 34). The impression of being ahead of the game undoubtedly wins converts. As Mayer (1993) has noted in his recent critique of tbrmalist economics this characteristic appeals to the new generation of economists. To Mayer the most admirable quality of new classical theorists is their "infectious enthusiasm, a dedication to the advancement of economics, and an obvious sense of mission that conveys the impression of a research programlne on the move . . . . No wonder their work excites the young" (Mayer 1993). In a similar vein McCloskey (1994) has argued that "The new classical macroeconomics has enchanted many young economists with their lust for certitude." As a result the new classical research progrannne has enabled fresh and creative thinkers to produce "dazzling displays of technical ~reworks" certain to impress referees and editors of prestigious journals (Blinder 1988). This is very important since there is considerable pressure, particularly in North America, ~br economists to publish in respected academic journals, not least in order to gain tenure of office. Hutchinson (1992) goes so far as attributing many developments characterizing modern theory to "careerism," and Blanchard and Fischer (1989) also suggest that the incentive structure in academia is such that strong pressures exist to differentiate products. In commenting on the evolution of macroeconomics since the Keynesian, revolution David Colander (1988) has also drawn attention to the 390
The Development of Modern Macroeconomics "article criteria" and the need to publish whereby "to succeed graduate students needs topics upon which to write 'good' dissertations and professors :need topics about which to write." Furthermore, as Colander notes "a paradigm which is article laden is contagious." The new classical research programme has proved to be article laden and has opened up a rich vein of topics to mine. It is worth noting that according to Phelps (1990) the longevity of the General Theory can in part be attributed to the fact that it remains a text which is "not yet fully mined."
The Creation of a New More Appealing Methodology Turning to the fourth characteristic the new classical research programme has whole heartedly embraced a methodological framework involving a formal general-equilibrimn approach. Minford (1991b) has described the new classical methodology as "tile only theoretical game in town.'" Although new classicists "probably comprise a fairly small minori~ among macroeconomists" (Hoover 1992a) they have succeeded in nurturing what Blanchard (1992) has referred to as a "back to basics" mentality. This has fostered an emphasis on a return to first principles in the quest to establish sound microfoundations for general-equilibrium macroeconomic models. Following the Lucas critique this movement towards microfoundations was given a further boost since, when expectations are rational, the parameters of aggregate eeonometrically estimated relationships are not invariant to changes in the policy enviromnent. New classicists argue that invariance can only be secured by getting back to first principles and solving the underling optimization problem, taking economic agents' tastes and technology as given (see Hoover 1992b). If Ke}mes set the research agenda in 1936 then Lucas most certainly set the agenda after 1970. In contrast to most traditional approaches new classical theorists place emphasis on fbrmal mathematical technique in their analysis assigning a much lower priority to conventional empirical testing. This is especially the case with the advent of the calibration method in real business cycle the(nT. The calibration method involves choosing quantitative values fbr the parameters of the model (e.g., from microeconomic studies) and then, using a computer, simulating the behavior of the numerically specified model, in terms of key macroeconomic variables~ when subjected to a series of random (e.g., technology) shocks. The sinmlated results are then compared with the behavior of the main macroeconomic time series. To some economists it is this new research methodology which forms the substantive contribution of real business cycle theory. Since real business cycle methodology is in principle ideologically neutral it has the capability of fbstering models with enormous diversity. This characteristic has wide appeal to the new generation of macroeconomists (see Danthine and Donaldson 1993; Parkin 1992). AI39l
Brian Snowdon and Howard 1{. Vane though Lucas regards the emphasis given in real business cycle theol.' to real, as opposed to monetary,, Ltctors to be a "mistake" he freely admits that Kydland and Prescott "have taken macroeconomic modeling into new territory"(Lucas 1987, 46). That prowess in new methods of mathematical modeling has become "the halhnark of competence in macroeeonomics" appears to be confirmed by the "triumph of technique" even among those who deny the fimdamental premises of new classical macroeconomics (see Hoover 1992a). Bnt an uMbrtunate by-product of the "quasi religions" adherence to micro foundations and the emphasis on technique has been the construction of' numerous elegant theories with "few interesting results," a "bewildering array" of "monsters" which has taken maeroeconomics away from "data oriented research" (Blanchard 1.992). The emphasis these "monsters" give to excessive mathematical formalism has also come in for considerable criticism (see McCloskey 1994; Quaddus and Rashid 1994). Excessive formalism and analytical rigor at the expense of policy relevance associated with this methodological force has been viewed in a negative light by many notable critics. Blaug (1994) from a positivist perspective has restated his belief that "economics must aspire to address real-world economic problems" and that this objective "is best satisfied by the production of theories with empirically refutable implications." For technical puzzle solving to be the only game in town, "is not to be held out to as an ideal to students."
The Promotion of a New and Significant Empirical Relationship for Estimation The fifth characteristic is more difficult to apply to new classical developments. As Mayer (1993) points out in his articulate defense of empirically orientated economics, while new classical maeroeconomics has emphasized rigor and focused on technique, it has downplayed empirical tests. This is especially true of the more recent real equilibrium business cycle theories which have attracted much criticism for their lack of fbrlnal empirical testing (Fair 1992; Laidler 1992). However, in the case of the mark I version of new classical macroeconomics it is possible to cite empirical studies which relate to the Lucas "surprise" aggregate supply function and tire related "anticipated-unanticipated money debate." Following Lucas's (1972) interpretation of the Phillips curve within a Walrasian general equilibrium framework the following testable proposition emerged; "the higher the variance of demand, the more unfavourable are the terms of the Phillips trade-off (Lucas 1973). Lucas examined the experience of eighteen countries in the period 1952-67 and concluded that their experience supported the above proposition that "the trade-off tends to fade away the more frequently it is used, or abused" (for a critique see Ball, Mankiw and Romer 1988). As far as the 392
The Development of Modern Macroeconomies anticipated-unanticipated money debate is concerned some of the early empirical tests undertaken seemed to offer support to the policy ineffectiveness proposition (in particular, tile seminal papers bv Barro 1977 and 1978). Subsequent investigations did not lend support to the view that systematic monetary policy has no real effects (see fbr example Mishkin 1982 and Gordon 1982). Furthermore, rather than attempting to provide models capable of conventional econometric testing real business cycle theorists have instead developed the "calibration method" ira which the simulated results of their specific models (when hit by random shocks) in terms of key macroeconomic variables are compared with the actual behavior of the economy. Unfortunately calibration does not provide a method that allows one to judge between the performance of real and other (e.g. Ke}~lesian) business cycle models. As Hoover (1995) notes "the calibration methodology, to (late, lacks any discipline as stern as that imposed by econometric methods . . . . Aboxe all, it is not clear on what standards coxnpeting, but contradictoD', models are to be compared and adjudicated." Finally it is interesting to note that new Keynesian research has concentrated on providing more rigorous microfoundations for wage and price stickiness to the relative neglect of empirical research. As Mankiw (1995) has commented "there is a small empirical literature, but I can probably count the number of empirical papers on the fingers of two hands." From the above discussion it should be evident that while Johnson put forward five main "internal" characteristics to help explain the success of the Keynesian revolution and monetarist counter-revolution, at least three of these same characteristics (most notably the first, third and fourth) also hell? in understanding why new classical macroeconomics has had such a powerful impact on the development of macroeconomics since the mid 1970s. From roughly the mid 1970s to the early 1980s the new classical approach dominated developments within macroeconomics. It is instructive to recall that prior to the publication of the General Theory Ke~les made it clear, in a letter to Roy Harrod, that his attack on the classical economists in his forthcoming book was quite deliberate because he wanted "to fbrce the classicals to make a rejoinder." His objective was "so to speak, to raise a dust" (see Skidelskv 1992, 534). We can only conclude that in this objective Keynes was spectacularly successful. In the 1970s it was unquestionably Robert Lucas more than anyone else who raised the dust, forcing Ke~lesians to make a rejoinder. As one prominent new Keynesian has remarked when asked about the dominant influences on macroeconomics in general and his own work in particular during the past twenty-five' },ears, tile biggest impact has undoubtedly come from Lucas. He put the cracks into the Keynesian consensus that existed in the 1960s. He really pulled macro-
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Brian Snowdon and Howard B. ~,~me
economies apart . . . . We need to address the concerns of Lucas while still maintaining the element of tnlth in the neoclassical synthesis. . . . The new Keynesian school has tried to fix these theoretical problems raised by Lueas anti also to accept his argmnent that we need models supported by better microeconomic {bundations (Mankiw 1995).
5. The Objective Social Situation and the Influence of Rhetoric In Section 2 we noted that Johnson drew atteution to two types of factor which contribute to our understanding of the rapid acceptance and propagation of new ideas among economists. We have seen that at least three of the "scientific characteristics" of new classical theory have played a crucial role in its development. The other factor emphasized by Johnson was the "objective social situation," unemployment in the 1930s and inflation in the late 1960s and early 1970s. Indeed Johnson went so far as to argue that, in his judgment, "the key determinant of success or failure lies, not in the aeademic sphere, but in the realm of policy." On this basis undoubtedly Johnson would have been surprised by the equilibrium business cycle revolution especially the ultra neoclassical versions developed since 1982. So far the technical wizardry which has been such a winning {brmula in academia has "hardly made a ripple in the world of policy'" (Blinder 1988). While the early development of new classical macroeconomics was certainly related to the infation crisis (hence Tobin's 1981 description of new classical macroeconomics as "monetarism mark II") it is difficult to identil~ an important social problem "that orthodoxy cannot solve" to account for the development of real business cycle theory. Real business cycle theory has demonstrated that in frictionless perfeetly competitive environments real shocks can generate cycles through the reactions of optimizing agents. As a result, while real business cycle theorists are determined to explain economic fluctuations they do not see such fluctuations as an issue requiring corrective public policy actions since fluctuations represent the Pareto optimal response of the free enterprise system to various shocks. In contrast to Keynesian and monetarist analysis the inability to identify an important social problem addressed by new classical macroeconomics further highlights the relevance and importance of Johnson's internal scientific characteristics in explaining the success of the approach. One line of argument regarded by some economists as playing a major role in the evolution and spread of ideas is the use of rhetoric in economics discourse (see Klamer 1984; McCloskey 1985; Colander and Coats 1989). More recently Donald McCloskey (1994) has announced the death of positivism and David Colander (1994) and Roger Backhouse (1994) have reminded us that the optimism concerning the ability of econometrics to settle 394
The Development of Modern Macroeconomics disputes has waned considerably since the early 1970s. Because econometric methods rarely produce decisive tests of economic theories by themselves some economists have emphasized the,' importance of rhetoric in economic analysis. That Johnson neglected the importance of the power of persuasion in his analysis is puzzling given the well documented rhetorical powers of both Keynes and Friedman. Arjo Klamer (1984) has argued that the art of" persuasion played a crucial role in the development of new classical macroeconomics. What is also likely is that the rhetoric of laizzez-faire associated with the policy recommendations of new classical models proved to be attractive at a time when in the U.S. the ideological balance was drifting to the right (see Blinder 1988; Taylor 1989). The failure of both monetarism and new classical macroeconomics to have as much influence in U.K. academic circles as they did in the U,S. particularly during the 1970s, has been attributed by Patrick Minford (1994) to the tendency of U.K. economists "to be quite left wing" and their "dislike of the policy implications of monetarism." Mintord also suggests that they "liked even less the policy implications of new classical macroeconomies." Nevertheless, the rise o f the word "rational" in the presentation of the expectations hypothesis proved to be an important rhetorical weapon in the battle to win the minds of macroeconomists dnring the 1970s. As Robert Barro (1984) has pointed out: One of the cleverest features of the rational expectations revolution was the application of the term rational. Thereby, the opponents of this approach were forced into the defensive position of either being irrational or of modeling others as irrational, neither of which are comfortable positions for an economist. David Laidler (1992), in commenting on the rise of real business cycle theory during the 1980s, notes that rhetoric has been central to the debate between equilibrium theorists and economists who prefer m o n e t a u explanations of the business cycle. With some cynicism he writes: recent developments in business cycle theory provide a striking example of the power of the right words to draw attention to an idea. Who could resist the appeal of a "real" theory of the business cycle? How could it fail to be better than, shall we say', a "mythical" theoD'? To Laidler the empirical shortcomings of new classical economics failed to prevent a new classical revolution because many economists were persuaded by "theoretical elegance" and the "persuasive nse of langnage" (Laidler 1992). 6. Conclusion The past quarter century has witnessed remarkable developments in macroeconomic analysis. In 1971, writing on the eve of the classical resur-
395
Brian Sm~wclon and HowaM tl. Vatw gence in macroeconomics, Johnson provided an insightful explanation of the reasons fbr the rapid propagation of Keynesian ideas in the postwar period in order to better understand the inonetarist counter-revolution. In this paper we have highlighted the importance of at least three of Johnson's five "internal scientific characteristics" in explaining the development of" new classical macroeconoinics. As noted earlier in Section ,3 critics of new classical macroeconomics deny that a modified mainstream model, involxdng a Keynesian-monetarist synthesis, is incapable of explaining macroeconomic events in the post-1970 period. This in turn implies that the role of Johnson's "internal scientific characteristics" takes on even greater significance as an explanation of why new classical macroeconomics has had such a dominant impact on modern macroeconomics. An article-laden new theory which attacked the existing orthodoxy and provided a new methodology attractive to the new generation of economists proved to be a powerful intellectual force. Indeed the importance of Johnson's fourth internal scientific characteristic, concerning the attraction of a new more appealing methodolo~', may well turn out to be the most important and lasting new classical contribution. Such an interpretation of the development of modern macroeconomics, relying as it does on the important role played by internal scientific characteristics, in no way denigrates the contribution of new classical theorists since progress is impossible without controversy. As Lucas (1994) has recently argued, academic economists are primarily scholars and their responsibility is to create new knowledge by pushing research into new and hence necessarily controversial territory. Consensus can be reached on specific issues but consensus for a research area as a whole is equiwflent to stagnation, irrelevance and death. Any Rip Van Winkle economist who had fallen asleep in 1971 would surely be impressed on waking up in the mid 1990s and surveying tile changes that have taken place in the macroeconomics literature, many of which have been inspired and provoked by the contribution of new classicists. Received: February 1995 Final version: September 1995
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