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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, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...
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, an ...
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'' (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 (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 and the work of monetarists 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 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 and new classical 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", 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 ...
. The first generation of neo-Keynesians was focused on unifying the ideas into workable paradigms, combining them with ideas from classical economics 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 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,
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,
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 ...
and Don Patinkin. 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 ra ...
. An immediate example of this is the consumer theory 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 nati ...
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. * 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 ...
and fiscal 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 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

The interpretation of J. Keynes suggested by neoclassical synthesis economists is based on the mixture of basic features of general equilibrium theory with Keynesian 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. 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"), 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. 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": 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 foundat ...
and new Keynesianism. 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 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 foundat ...
* New neoclassical synthesis ;General * History of macroeconomic thought * Mainstream economics


Notes

{{Authority control Neoclassical economics Keynesian economics