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    Economic AnAlysis & Policy, Vol. 41 no. 3, dEcEmbEr 2011

    Debunking Macroeconomics

    Steve Keen

    School of Economics & Finance,

    University of Western Sydney,

    Locked Bag 1797,

    Penrith 1797, NSW

    Australia

    (Email: [email protected])

    Abstract: The ailre elassial mdels t war the emi risis has led t sme rare

    sl searhig i a disiplie t kw r sh itrspeti. The dmiat reati

    withi the pressi has ee t admit the ailre, t t arge that there is eed r

    a drasti revisi emi thery. I rejet this mrtale lsi, ad arge

    istead that this risis illstrates the pit made erehad y Rert Slw, that

    mdels i whih maremi pathlgies are impssile are t adeate mdels

    apitalism. Hikss ritie his w IS-LM mdel als idiates that, thgh

    pathlgies a e impsed a IS-LM mdel, it is als iapprpriate r maremi

    aalysis ease its alse impsiti eilirim ditis derived rm Walras

    Law. I the s p what I see as the key weakess i the elassial apprah tmaremis whih applies t th DSGE ad IS-LM mdels: the alse assmpti

    that the mey spply is exges. Ater tliig the alterative edges mey

    perspetive, I shw that Walras Law mst e geeralized r a redit emy t what

    I all the Walras-Shmpeter-Misky Law. The empirial data strgly spprts this

    perspetive, emphasizig the eed r a rt ad rah rerm maremis.

    I. InTRoDucTIon

    The ailre elassial mdels t war the emi risis has led t sme rare slsearhig i a disiplie t kw r sh itrspeti. The dmiat reati withi the

    pressi has ee t admit the ailre, t t arge that there is eed r a drasti revisi

    emi thery.

    I rejet this mrtale lsi, ad arge istead that this risis illstrates the pit

    made erehad y Rert Slw, that mdels i whih maremi pathlgies are

    impssile are t adeate mdels apitalism. Hikss ritie his w IS-LM mdel als

    idiates that, thgh pathlgies a e impsed a IS-LM mdel, it is als iapprpriate

    r maremi aalysis ease its alse impsiti eilirim ditis derived

    rm Walras Law. I the s p what I see as the key weakess i the elassial appraht maremis whih applies t th DSGE ad IS-LM mdels: the alse assmpti that

    the mey spply is exges. Ater tliig the alterative edges mey perspetive,

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    I shw that Walras Law mst e geeralized r a redit emy t what I all the Walras-

    Shmpeter-Misky Law. The empirial data strgly spprts this perspetive, emphasizig

    the eed r a rt ad rah rerm maremis.

    II. DEfEnDInG THE InDEfEnSIbLE

    That mder elassial maremi mdels ailed t rewar the emi risis

    that ega i 2007 is dispted. What is i dispte is the impliatis this shld have r

    maremi thery.

    Prmiet memers the disiplie have arged that there shld e seees.

    be berake (berake 2010), reet nel Prize lareate Thmas Sarget (Rlik 2010)

    ad the dig editr theAER: Macro olivier blahard (blahard et al. 2010) have all

    asserted that elassial mdels helped gide pliy drig the gd times, ad shld t

    e aaded simply ease they did t see the ad times mig. berakes argmet isrepresetative this perspetive:

    the reet aial risis was mre a ailre emi egieerig ad emi maagemet

    tha what I have alled emi siee

    D these ailres stadard maremi mdels mea that they are irrelevat r at least

    sigiatly awed? I thik the aswer is a alied . Emi mdels are sel ly i the

    text r whih they are desiged.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 they

    have proven quite useful in that context. ntaly, they were part the itelletal ramewrk that

    helped deliver lw iati ad maremi staility i mst idstrial tries drig thetw deades that ega i the mid-1980s. (berake 2010, pp. 3, 17; emphasis added)

    I make no apology for describing this argument as specious, on at least two grounds.firstly, this argmet wld ly e tleraly aeptale i elassial emis als had

    well-develped mdels that were sitale r perids risis, t it des t.1 Sedly,

    this las aeptae that there a e ad times sits ddly agaist the trimphalism that

    haraterized elassial disrse maremis prir t this risis. This is est

    exempliied y Lass Presidetial Address t theAmerican Economic Association i 2003,

    i whih he asserted that elassial emis had seeded i elimiatig the pssiility

    extremely ad times like thse we are w experieig:

    Maremis was r as a distit eld i the 1940s, as a part the itelletal respse

    t the Great Depressi. The term the reerred t the dy kwledge ad expertise that we

    hped wld prevet the rerree that emi disaster. My thesis i this letre is that

    maremis i this rigial sese has seeded:Its central problem of depression prevention

    has been solved, for all practical purposes, and has in fact been solved for many decades. (Las,

    Jr. 2003, p. 1 ; emphasis added)

    The prpsiti that there a e separate mdels r gd ad ad times als implies that

    there is asal lik etwee gd ad ad times, whih wld e tre i they were simply

    1 It wld als have t e prvaly tre that there is asal lik etwee gd times ad ad times a pitI retr t elw.

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    the prdt exges shks t the maremy. This is i at hw mst elassial

    mdelers have reated: y retrspetively treatig the risis as eig de, t merely t

    preedetedly large exges shks, t shks whih varied i magitde ver time

    while still remaiig egative rather tha psitive:

    the Great Reessi ega i late 2007 ad early 2008 with a series adverse preeree ad

    tehlgy shks i rghly the same mix ad rghly the same magitde as thse that hit

    the uited States at the set the previs tw reessis

    The strig adverse preeree ad tehlgy shks tied, hwever, thrght 2008 ad

    it 2009. Mrever, these shks grew larger i magitde, addig sstatially t jst t the

    legth t als t the severity the great reessi (Irelad 2011, p. 48, see als MKii

    ad Stekel 2009)

    The at that these shks ame rm the iaial setrwhih the rdiary pli wld

    ted t regard as eig part the emy, ad therere t e mre a edges

    emi pheme tha a exges evethas ee treated as largely irrelevat y

    leadig elassials:

    The risis has shw that large adverse shks a ad d happe. I this risis, they ame rm

    the aial setr, t they ld me rm elsewhere i the trethe eets a pademi

    trism ad trade r the eets a majr terrrist attak a large emi eter. (blahard,

    DellAriia ad Mar 2010, p. 207)

    Give the severity ad persistee this risis, this is als speis reasig: i the risis was

    merely de t a large exges egative shk, srely y w it wld e ver? Srely t,sie the shks emaated rm the iae setr, ad the stadard elassial dtrie

    that permits a separati emis rm iae has w ee empirially rejeted (fama

    ad freh 2004), the treatmet distraes i the iae setr as exges t the

    emy shld als e rejeted?

    These reatis elassial therists ad mdelers are therere mre tha a plea

    that the re elassial visi the maremy as a stale system sjet t exges

    shks shld e preserved, despite a preedeted empirial ailre. This prpsiti has

    ee pt pely y blahard et al., amgst thers:

    It is imprtat t start y statig the vis, amely, that the ay shld t e thrw t withthe athwater. (blahard, DellAriia ad Mar 2010, p. 204)

    Hwever, lesser nelassials tha Jh Hiks (Hiks 1981) ad Rert Slw (Slw

    2003, 2001, 2008) have pt the trary ase that these aies th tdays DSGE mdels

    ad the IS-LM mdel that preeded themshld ever have ee eived i the irst plae.

    Hikss diswig IS-LM appears t have disappeared witht trae i elassial

    literatre. Slws vie was at least akwledged y blahard whe he plished his

    exriatigly adly timed srvey mder maremis (blahard 2009, blahard

    2008),2 i whih he stated that:

    2 The risis is geerally dated rm Agst 6 2007, whe the bnP sht dw 3 its ds that were expsedt uS sprime ledig e year before blahards wrkig paper was irst psted.

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    ater the explsi the eld i the 1970s, there has ee erms prgress ad sstatial

    vergee.,, largely ease ats have a way t gig away, a largely shared visi th

    tatis ad methdlgy has emerged... nt everythig is e bt e this is deadly.

    The state of macro is good. (blahard 2009, p. 210; emphasis added).

    I a tte, he added others, I kw, disagree with this ptimisti assessmet (r example,

    Slw 2008), t he did t egage at all with Slws ritie. As the gle is w i its

    ith year reletig emi trmil, it is time Slw was listeed t.

    III. SoLoWS cRITIquE of DSGE

    Slw eame a riti elassial maremis ease he was simply iredls

    that the grwth mdel he develped ld e eve sidered as a asis r mdelig the

    siess yle:

    The prttypial real-siess-yle mdel is thig t the elassial grwth mdel

    The pzzle I wat t disssat least it seems t me t e a pzzle, thgh part the pzzle is

    why it des t seem t e a pzzle t may my yger lleagesis this. Mre tha rty

    years ag, I ... wrked t ... elassial grwth thery... [I]t was lear rm the egiig what

    I thght it did t apply t, amely shrt-r tatis i aggregate tpt ad emplymet

    ... the siess yle...

    [n]w ... i y pik p a artile tday with the wrds siess yle i the title, there is a airly

    high praility that its asi theretial rietati will e what is alled real siess yle

    thery ad the derlyig mdel will e ... a slightly dressed p versi the elasssial grwth

    mdel. The esti I wat t irle ard is: hw did that happe? (Slw 2001, pp. 23, 19)

    Slw idetiied the searh r mirdatis r m