Keynes: The Return of the Master by Robert Skidelsky

Author:Robert Skidelsky [Skidelsky, Robert]
Language: eng
Format: epub, pdf
ISBN: 9781610390033
Google: KxY5DgAAQBAJ
Amazon: 158648897X
Published: 2010-10-26T15:12:53.340000+00:00

The New Classical Economics

However, Friedman’s theory of ‘adaptive expectations’ did not go far enough for a new generation of mathematically trained economists like his former student Robert Lucas. Friedman has agents learning from, and adapting their behaviour to, changing market signals, but with an inevitable lag since market processes take place in time. But rational agents should be able to do better than that. They should already have learned from past experience (their own and everyone else’s) that certain types of event will bring about certain results. In that case, Friedman’s distinction between the short period in which agents can be fooled and the long period in which they know what to expect becomes superfluous. Adaptive behaviour is a description of irrational behaviour if agents know what to expect already.

So, in the 1980s, the theory of adaptive expectations was followed by the theory of rational expectations. Rational expectations theorists have carried Friedman’s scepticism about managing the business cycle to its logical conclusion. If monetary policy is systematically operated according to Keynesian principles, it will be anticipated, and have no real effects even in the short run! Stabilization policy would then be possible only if governments had better information than private agents. By abolishing the ‘short period’, the New Classical macroeconomics abolished the narrow interval of time that Friedman’s monetarism had left for Keynesian policy to work in. In Robert Solow’s words, the rational expectations revolution swept away ‘all of the loopholes that provided some fuzziness in the vertical long-run Phillips Curve’.4

Real business cycle theory was invented to close any remaining loop-hole for government intervention. The economy is constantly at full employment, since the observed fluctuations in output are fluctuations in Friedman’s ‘natural rate’ of unemployment and not deviations from it. Thus, government interference to reduce instability will always result in a reduction in welfare.

It is hard to know whether real business cycle theorists actually believed in their models, or whether they just found it more mathematically elegant to do their economics in this way. The political comfort their theory gave to those clamouring to reduce taxes and ‘get Washington off our backs’ was clear enough. Nothing a government could do to stimulate the economy would work; in fact it was bound to make things worse. So government might as well cut taxes, deregulate economic life, and let businessmen get on with the job of producing wealth, not least for themselves.

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