In the account of the history of macroeconomic thought I gave here, the New Classical counter revolution was
both methodological and ideological in nature. It was successful, I suggested,
because too many economists were unhappy with the gulf between the methodology
used in much of microeconomics, and the methodology of macroeconomics at the
time.
There is a much simpler reading. Just as the original Keynesian
revolution was caused by massive empirical failure (the Great Depression), the
New Classical revolution was caused by the Keynesian failure of the 1970s:
stagflation. An example of this reading is in this piece by the philosopher Alex Rosenberg (HT
Diane Coyle). He writes: “Back then it was the New Classical macrotheory that
gave the right answers and explained what the matter with the Keynesian models
was.”
I just do
not think that is right. Stagflation is very easily explained: you just
need an ‘accelerationist’ Phillips curve (i.e. where the coefficient on expected
inflation is one), plus a period in which monetary policymakers systematically
underestimate the natural rate of unemployment. You do not need rational
expectations, or any of the other innovations introduced by New Classical
economists.
No doubt the inflation of the 1970s made the macroeconomic
status quo unattractive. But I do not think the basic appeal of New Classical
ideas lay in their better predictive ability. The attraction of rational
expectations was not that it explained actual expectations data better than
some form of adaptive scheme. Instead it just seemed more consistent with the
general idea of rationality that economists used all the time. Ricardian
Equivalence was not successful because the data revealed that tax cuts had no
impact on consumption - in fact study after study have shown that tax cuts do
have a significant impact on consumption.
Stagflation did not kill IS-LM. In fact, because empirical
validity was so central to the methodology of macroeconomics at the time, it
adapted to stagflation very quickly. This gave a boost to the policy of
monetarism, but this used the same IS-LM framework. If you want to find the
decisive event that led to New Classical economists winning their
counterrevolution, it was the theoretical realisation that if expectations were
rational, but inflation was described by an accelerationist Phillips curve with
expectations about current inflation
on the right hand side, then deviations from the natural rate had to be random.
The fatal flaw in the Keynesian/Monetarist theory of the 1970s was theoretical
rather than empirical.
