The Reasonable Dialog, Again

Let's pause and see where we have come, in terms of Reasonable Dialog.

First, it is clear that the dialog is not over! The New Classical Policy Ineffectiveness Proposition, powerful as it is, is not clearly true, and Keynesians have found ways to incorporate the part of it that is pretty clearly true into their own position. There are still (at least!) two sides in the dialog.

It seems that the Policy Ineffectiveness Proposition has been fairly badly undercut by the learning that production is highly permanent. We have three propositions, no more than two of which can be true at the same time.

  1. People have unbiased expectations.
  2. Production is highly permanent.
  3. The NAIRGDP is path-independent.

The Policy Ineffectiveness Proposition needs the first and third. They cannot all be true because: to the extent that production is highly permanent, big changes from time to time will move it away from any given NAIRGDP, and it will then tend to stay where it has moved. Then, either people fail to understand this (their expectations are biased) or the NAIRGDP will move toward the new level of production. If it does move in that way, it is path-dependent.

Since the first two propositions are at least somewhat backed by the evidence, our suspicion falls on number 3. Why did New Classical Economists expect that the NAIRGDP would be path-independent? The reason goes back to basics. The older ideas the New Classicals had set out to reformulate centered on the idea that production is determined by supply and demand. In particular, the New Classicals wanted to revive the view that employment is determined by the supply and demand for labor, that is, that the supply and demand for labor are equal. When supply and demand are equal, we say that the market "clears," so we could call this "the Market-Clearing Proposition."

In the framework of classical economics, the supply and demand for labor do not depend on the past history of production, so the Market-Clearing Proposition leads to the conclusion that the NAIRGDP is path-independent.

So now we could replace the first list of three propositions with a second:

  1. People have unbiased expectations.
  2. Production is highly permanent.
  3. The Market-Clearing Proposition: The supply and demand for labor are always equal.
Once again, we conclude that the last of the three must be incorrect. But we have come full circle! Remember, we began the study of Keynesian economics because it seemed that labor markets did not clear -- that there was unemployment, an excess supply of labor -- and so we needed a macroeconomic theory that would explain, interpret, "map" a kind of equilibrium that could coexist with an excess supply of labor. We have that, in the Complete Keynesian theory together with a path-dependent Aggregate Supply curve. But, of course, that's not quite the end of the story.


Next:Continuing Dialog
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