Old-Keynesian Economics
Those who cannot remember the past are condemned to repeat it. George Santayana, The Life of Reason
This book is concerned with the question: Why do capitalist economies sometimes go very badly wrong? For several decades after the publication of Keynes' General Theory economists thought that they had an answer. But with the resurgence of classical ideas in the 1970's, the key premise of the General Theory, that market economies are not inherently self-stabilizing, has been called into question. Although there has been a recent resurgence of Keynesian ideas under the rubric of "new-Keynesian economics", the models studied by the new-Keynesians are hybrids that incorporate a classical core. New-Keynesian models allow for temporary deviations of unemployment from its "natural rate" as a consequence of sticky prices but they contain a stabilizing mechanism that causes a return to the natural rate over time.
In his1966 book, Axel Leijonhufvud made the distinction between Keynesian economics and the economics of Keynes. By Keynesian economics, he meant the interpretations of Keynes that became incorporated into the IS/LM model and ultimately, into the new-Keynesian paradigm. Leijonhufvud pointed out that the assumption that the General Theory is about sticky prices is central to Keynesian economics but it is not a central argument of the text of the General Theory. This book provides an alternative microfoundation to Keynesian economics that does not rely on sticky-prices. In successive chapters I construct a series of models that build on a single idea. Each of them is constructed around a conventional dynamic general equilibrium model in which real resources must be used to move unemployed workers into jobs using a "search technology". Although this technology is convex, I assume that the planning optimum cannot be decentralized as a competitive equilibrium because moral hazard prevents the creation of markets for the search inputs. As an alternative, I introduce an equilibrium concept called demand constrained equilibrium, in which the level of economic activity is determined by investor confidence or "animal spirits". I refer to the resulting model as "old-Keynesian" to differentiate it from new-Keynesian economics that incorporates the natural rate hypothesis of Edmund Phelps and Milton Friedman. In contrast to new-Keynesian models, those described in this book display multiple stationary perfect foresight equilibria, and there is a different stationary unemployment rate, for each possible level of beliefs.
