Question

Discuss Keynes and the invention of Macroeconomics in the first half of the 20th Century (maximum 1,000 words)

Answer 1

John Maynard Keynes is a founding father of macroeconomics.

In the first half of the 20th Century, after the publication of Keynes’s General Theory, the heydays of Keynesian macroeconomics based on the IS-LM model, disequilibrium and non-Walrasian equilibrium modelling, the invention of the natural rate of unemployment notion, the new classical attack against Keynesian macroeconomics, the first wave of new Keynesian models, real business cycle modelling and, finally, the second wage of new Keynesian models, i.e. DSGE models was propounded.

Without the Great Depression, Keynes’s The General Theory of Employment, Interest and
Money (1936) would not have seen the light of day.Progress (although some readers of the General Theory may consider it a step backwards) occurred when a session of the Econometric Society Conference was devoted to the book. James Meade (1937), Roy Harrod (1937) and John Hicks (1937) gave three separate papers aiming at bringing out the gist of Keynes’s book (see Young, 1987). All three took as their first task the reconstruction of the classical model in order to assess whether Keynes’s claim that his model was more general than the classical one was sustainable. They all concluded that it was not. Although their interpretations were rather similar, one of them, Hicks’s piece, was to have an extraordinary future, containing as it did the first version of what was to become the IS-LM model.  The IS-LM model became the workhorse of Keynesian macroeconomics, to the point that one wonders what would have become of the General Theory had Hicks’s interpretation never appeared.

Keynesian macroeconomics, which had its heyday in the 1950s and 1960s. At the end of the 1960s, it came under attack, first from Milton Friedman and later, in a more radical way, from Robert Lucas and his associates such as Robert Barro, Thomas Sargent and Neil Wallace. These economists, new classical macroeconomists as they were called at the time, were able to dethrone Keynesian macroeconomics in a move that had all the trappings of a scientific revolution. In turn, Lucas’s work triggered the rise of a series of new Keynesian models aimed at rebutting his claim, while adopting his neoclassical language. The next stage of the history of macroeconomics occurred when the baton was passed from new classical to real-business-cycle (RBC) theorists, in a move initiated by Finn Kydland and Edward Prescott. These economists transformed Lucas’s qualitative model into a quantitative research programme into which they enrolled a large chunk of the macroeconomic profession. The latest stage in the history of macroeconomics is the internal evolution of RBC models towards dynamic-stochastic general equilibrium (DSGE) modelling, whereby central elements of Keynesian macroeconomics, in particular monopolistic competition and sluggishness, are reintroduced into the real business cycle framework.