The neoclassical synthesis (NCS), neoclassical–Keynesian synthesis, or just neo-Keynesianism was a
neoclassical economics
Neoclassical economics is an approach to economics in which the production, consumption and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a good ...
academic movement and paradigm in
economics
Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services.
Economics focuses on the behaviour and intera ...
that worked towards reconciling the
macroeconomic
Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole.
For example, using interest rates, taxes, and ...
thought of
John Maynard Keynes
John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...
in his book ''
The General Theory of Employment, Interest and Money
''The General Theory of Employment, Interest and Money'' is a book by English economist John Maynard Keynes published in February 1936. It caused a profound shift in economic thought, giving macroeconomics a central place in economic theory and ...
'' (1936). It was formulated most notably by
John Hicks
Sir John Richards Hicks (8 April 1904 – 20 May 1989) was a British economist. He is considered one of the most important and influential economists of the twentieth century. The most familiar of his many contributions in the field of economic ...
(1937),
Franco Modigliani
Franco Modigliani (18 June 1918 – 25 September 2003) was an Italian-American economist and the recipient of the 1985 Nobel Memorial Prize in Economics. He was a professor at University of Illinois at Urbana–Champaign, Carnegie Mellon Un ...
(1944), and
Paul Samuelson
Paul Anthony Samuelson (May 15, 1915 – December 13, 2009) was an American economist who was the first American to win the Nobel Memorial Prize in Economic Sciences. When awarding the prize in 1970, the Swedish Royal Academies stated that he "h ...
(1948), who dominated economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 60s, and 70s.
A series of developments occurred that shook the neoclassical synthesis in the 1970s as the advent of
stagflation
In economics, stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since action ...
and the work of
monetarists
Monetarism is a school of thought in monetary economics that emphasizes the role of governments in controlling the amount of money in circulation. Monetarist theory asserts that variations in the money supply have major influences on nationa ...
like
Milton Friedman
Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the ...
cast doubt on neo-Keynesian conceptions of monetary theory. The conditions of the period proved the impossibility of maintaining
sustainable growth
Sustainable development is an organizing principle for meeting human development goals while also sustaining the ability of natural systems to provide the natural resources and ecosystem services on which the economy and society depend. The desi ...
and low level of inflation via the measures suggested by the school.
The result would be a series of new ideas to bring tools to macroeconomic analysis that would be capable of explaining the economic events of the 1970s. Subsequent
new Keynesian
New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroec ...
and
new classical
New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous foundat ...
economists strived to provide macroeconomics with
microeconomic foundations, incorporating traditionally Keynesian and neoclassical characteristics respectively. These schools eventually came to form a "
new neoclassical synthesis
The new neoclassical synthesis (NNS), which is now generally referred to as New Keynesian economics, and occasionally as the New Consensus, is the fusion of the major, modern macroeconomic schools of thought – new classical macroeconomics/ real ...
", analogous to the neoclassical one,
that currently underpins the mainstream of macroeconomic theory.
[Woodford, Michael. ''Convergence in Macroeconomics: Elements of the New Synthesis''. January 2008. http://www.columbia.edu/~mw2230/Convergence_AEJ.pdf.][Mankiw, N. Greg. ''The Macroeconomist as Scientist and Engineer''. May 2006. p. 14–15. http://scholar.harvard.edu/files/mankiw/files/macroeconomist_as_scientist.pdf?m=1360042085.][Goodfriend, Marvin and King, Robert G. ''The New Neoclassical Synthesis and The Role of Monetary Policy''. Federal Reserve Bank of Richmond. Working papers. June 1997. No. 98–5. http://www.richmondfed.org/publications/research/working_papers/1998/pdf/wp98-5.pdf .]
Main contributors
John Maynard Keynes
John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...
provided the framework for synthesizing a host of economic ideas present between 1900 and 1940 and that synthesis bears his name, known as
Keynesian economics
Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output an ...
. The first generation of neo-Keynesians was focused on unifying the ideas into workable paradigms, combining them with ideas from
classical economics
Classical economics, classical political economy, or Smithian economics is a school of thought in political economy that flourished, primarily in Britain, in the late 18th and early-to-mid 19th century. Its main thinkers are held to be Adam Smith ...
and the writings of
Alfred Marshall
Alfred Marshall (26 July 1842 – 13 July 1924) was an English economist, and was one of the most influential economists of his time. His book '' Principles of Economics'' (1890) was the dominant economic textbook in England for many years. I ...
.
Paul Samuelson
Paul Anthony Samuelson (May 15, 1915 – December 13, 2009) was an American economist who was the first American to win the Nobel Memorial Prize in Economic Sciences. When awarding the prize in 1970, the Swedish Royal Academies stated that he "h ...
started the program of neoclassical synthesis, outlining two main objects of study:
# Static theories: equilibrium is described as a result of actions of rational price-taking agents;
# Dynamic theories: price adjustments toward equilibrium after shocks realization, with prices moving in the direction of excess demand functions proportionally to the functions' magnitudes.
Much of neo-Keynesian economic theory was developed by leaders of economic profession, such as
John Hicks
Sir John Richards Hicks (8 April 1904 – 20 May 1989) was a British economist. He is considered one of the most important and influential economists of the twentieth century. The most familiar of his many contributions in the field of economic ...
,
Maurice Allais
Maurice Félix Charles Allais (31 May 19119 October 2010) was a French physicist and economist, the 1988 winner of the Nobel Memorial Prize in Economic Sciences "for his pioneering contributions to the theory of markets and efficient utilization o ...
,
Franco Modigliani
Franco Modigliani (18 June 1918 – 25 September 2003) was an Italian-American economist and the recipient of the 1985 Nobel Memorial Prize in Economics. He was a professor at University of Illinois at Urbana–Champaign, Carnegie Mellon Un ...
, Paul Samuelson,
Alvin Hansen
Alvin Harvey Hansen (August 23, 1887 – June 6, 1975) was an American economist who taught at the University of Minnesota and was later a chair professor of economics at Harvard University. Often referred to as "the American Keynes", he was a w ...
,
Lawrence Klein
Lawrence Robert Klein (September 14, 1920 – October 20, 2013) was an American economist. For his work in creating computer models to forecast economic trends in the field of econometrics in the Department of Economics at the University of Penn ...
,
James Tobin
James Tobin (March 5, 1918 – March 11, 2002) was an American economist who served on the Council of Economic Advisers and consulted with the Board of Governors of the Federal Reserve System, and taught at Harvard and Yale Universities. He devel ...
and
Don Patinkin
Don Patinkin (Hebrew: דן פטינקין) (January 8, 1922 – August 7, 1995) was an American-born Israeli monetary economist, and the President of the Hebrew University of Jerusalem.Nissan Liviatan, 2008. "Patinkin, Don (1922–1995)," ''The N ...
.
The process began soon after the publication of Keynes' ''
General Theory'' with the
IS-LM model (investment saving–liquidity preference money supply) first presented by John Hicks in a 1937 article. It continued with adaptations of the
supply and demand
In microeconomics, supply and demand is an economic model of price determination in a Market (economics), market. It postulates that, Ceteris paribus, holding all else equal, in a perfect competition, competitive market, the unit price for a ...
model of markets to Keynesian theory. It represents incentives and costs as playing a pervasive role in shaping
decision making
In psychology, decision-making (also spelled decision making and decisionmaking) is regarded as the cognitive process resulting in the selection of a belief or a course of action among several possible alternative options. It could be either rati ...
. An immediate example of this is the
consumer theory
The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pref ...
of individual demand, which isolates how prices (as costs) and income affect quantity demanded.
The term "neoclassical synthesis" appears to be coined by Paul Samuelson in his influential textbook
''Economics''.
According to Samuelson, the neoclassical synthesis should have become a new general economic theory, that could unite positive aspects of previous economic research and become a consensus, over which all members of the economic community believed that the active fiscal and monetary interventions can be used for stabilizing economy and ensuring full employment.
Following
him, the market economy, based on the reasons described by J. Keynes, cannot provide full employment on its own. But if monetary and fiscal policy is used to tackle underemployment, it will put the economy on a trajectory that applies the principles of classical equilibrium analysis to explain relative prices and resource allocation. The broader neo-Keynesian intellectual program would eventually produce
monetarism
Monetarism is a school of thought in monetary economics that emphasizes the role of governments in controlling the amount of money in circulation. Monetarist theory asserts that variations in the money supply have major influences on nation ...
and other versions of Keynesian macroeconomics in the 1960s.
Main provisions
* Firms and individuals are considered as largely rational, and their behavior can be studied by standard microeconomic methods.
*
Animal spirits still matter; they are perceived as the main source of movements in aggregate demand through investment.
* Prices and wages do not adjust quickly to clear markets; thus, markets cannot be considered as
competitive
Competition is a rivalry where two or more parties strive for a common goal which cannot be shared: where one's gain is the other's loss (an example of which is a zero-sum game). Competition can arise between entities such as organisms, indivi ...
.
* There is no automatic labor market equilibrium condition implied, but this equilibrium can be achieved through appropriate
monetary
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are as ...
and
fiscal
Fiscal usually refers to government finance. In this context, it may refer to:
Economics
* Fiscal policy, use of government expenditure to influence economic development
* Fiscal policy debate
* Fiscal adjustment, a reduction in the government ...
policies.
* The implication of
tâtonnement: prices adjust to excess demand or supply along the lines of the dynamic processes of adjustment suggested by
Paul Samuelson
Paul Anthony Samuelson (May 15, 1915 – December 13, 2009) was an American economist who was the first American to win the Nobel Memorial Prize in Economic Sciences. When awarding the prize in 1970, the Swedish Royal Academies stated that he "h ...
in «Foundations of Economic Analysis» (Samuelson, 1947).
* Implication of very active interventionist state: besides the Keynesian macro-economic policy and traditional regulatory and antitrust activities in troublesome areas of industrial organization, it also implies active state participation in areas of
market failure
In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where indiv ...
s, social costs and benefits.
* An economic management is considered as a search for the appropriate mix of monetary and fiscal policies, with relative weight of them being based on the relative elasticities of the IS and LM curves.
* An important role is devoted to the empirical studies of the impact of different economic policies.
*Extensive use of mathematics as a tool for economic analysis.
Development
![Philipsus60](https://upload.wikimedia.org/wikipedia/commons/d/d4/Philipsus60.png)
The interpretation of J. Keynes suggested by neoclassical synthesis economists is based on the mixture of basic features of
general equilibrium theory
In economics, general equilibrium theory attempts to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that the interaction of demand and supply will result in an ov ...
with
Keynesian
Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output an ...
concepts.
Thus, most models of neoclassical synthesis have been labelled as "pragmatic macroeconomics".
Neo-Keynesians generally looked at labor contracts as sources of wage stickiness to generate equilibrium models of unemployment. Their efforts resulted in the development of the IS–LM model and other formal modelling of Keynes' ideas.
The development of the neoclassical synthesis started in 1937 with
J. Hicks's publication of the paper ''Mr. Keynes and Classics'', where he proposed the
IS-LM scheme that has put the Keynesian theory into the more traditional terms of a simplified general equilibrium model with three markets: goods, money, and financial assets.
This work marked the beginning of neo-Keynesian macroeconomics.
Later, in the 1940s–1950s, the ideas of J. Hicks were supported by
F. Modigliani and
Paul Samuelson
Paul Anthony Samuelson (May 15, 1915 – December 13, 2009) was an American economist who was the first American to win the Nobel Memorial Prize in Economic Sciences. When awarding the prize in 1970, the Swedish Royal Academies stated that he "h ...
.
F. Modigliani in 1944 elaborated on J. Hicks publication, expanding the IS-LM scheme by incorporating the labor market into the model.
P. Samuelson coined the term "neoclassical synthesis" in 1955
and put much effort into building and promoting the theory, in particular through his influential book ''Economics'', first published in 1948.
One of the main contributions of P. Samuelson made in the first edition of ''Economics'' was the 45-degree diagram (frequently known as "
Keynesian cross
The Keynesian cross diagram is a formulation of the central ideas in Keynes' ''General Theory of Employment, Interest and Money''. It first appeared as a central component of macroeconomic theory as it was taught by Paul Samuelson in his textbook ...
"), that reconciled the competing economics of J.M. Keynes and neoclassical school by placing the neoclassical theory of price and income formation in the context of market competition with Keynesian macroeconomics as a theory of government intervention.
![Islm](https://upload.wikimedia.org/wikipedia/commons/b/b9/Islm.svg)
Many breakthroughs in the development of neoclassical synthesis had happened by the 1950s, with the creation of the
IS-LM model by J. Hicks (1937) and
A. Hansen (1949), the clarification of the role of the rigidity of nominal wages in the Keynesian model in the work of F. Modigliani (1944), the identification of the importance of the wealth effects and the role of public debt in the work of
L.Metzler (1951), and
D. Patinkin's clarification of the structure of the macroeconomic model (1956).
Legacy
Through the 1950s, moderate degrees of government-led demand in industrial development and use of fiscal and monetary counter-cyclical policies continued and reached a peak in the "go go" 1960s, where it seemed to many neo-Keynesians that prosperity was now permanent. By the beginning of 1970s, the research program formulated after WWII was generally completed, and the neoclassical synthesis had proved to be very successful.
However, with the
oil shock of 1973 and the economic problems of the 1970s, many economies experienced "
stagflation
In economics, stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since action ...
": high and rising unemployment, coupled with high and rising inflation, contradicting the Phillips curve's normal behaviour.
As the scientific success of the neoclassical synthesis was largely due to its empirical success, this stagflation led to a collapse of the consensus around the neoclassical synthesis and it was attacked for its inability to explain events.
Although neoclassical synthesis models were further expanded to include shocks, empirics exposed the main flaw that lay in the core of the theory: the asymmetry of considering individual agents as highly rational but markets as inefficient (particularly labour markets).
R. Lucas and T. Sargent highly criticized the theory, claiming that predictions
ased on this theorywere widely incorrect, and "that the doctrine on which they were based was fundamentally flawed is now a simple matter of fact".
Stagflation meant that both expansionary (anti-recession) and contractionary (anti-inflation) policies had to be applied simultaneously, a clear impossibility. This produced a "policy bind" and the collapse of the neoclassical-Keynesian consensus on the economy, leading to the development of
new classical macroeconomics
New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous founda ...
and
new Keynesianism
New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroe ...
. Through the work of those such as
S.Fischer (1977) and
J.Taylor (1980), who demonstrated that the
Philips curve can be replaced by a model of explicit nominal price and wage-setting with saving most of the traditional results,
these two schools would come together to create the
new neoclassical synthesis
The new neoclassical synthesis (NNS), which is now generally referred to as New Keynesian economics, and occasionally as the New Consensus, is the fusion of the major, modern macroeconomic schools of thought – new classical macroeconomics/ real ...
that forms the basis of mainstream economics today.
Following the emergence of the new Keynesian school in the 1970s, neo-Keynesians have sometimes been referred to as "Old-Keynesians".
See also
*
New classical macroeconomics
New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous founda ...
*
New neoclassical synthesis
The new neoclassical synthesis (NNS), which is now generally referred to as New Keynesian economics, and occasionally as the New Consensus, is the fusion of the major, modern macroeconomic schools of thought – new classical macroeconomics/ real ...
;General
*
History of macroeconomic thought
Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classi ...
*
Mainstream economics
Notes
{{Authority control
Neoclassical economics
Keynesian economics