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  Galí on the State of New Keynesianism

  By James Annable | Dec 6, 2019

  Last year when Jordi Galí published “The State of New Keynesian Economics: A Partial Assessment” in the Journal of Economic Perspectives (2018), I paid attention. Galí is among the elite of New Keynesian theorists, making him a bellwether on the condition of mainstream macro theory ten years after its spectacular failure to be useful during the Great Recession. Most embarrassingly, the stabilization policymakers were not shy about how inadequate they believed modern macroeconomics to be.

  Galí’s concludes that there has been great progress from 2008-09: “New Keynesian economics is alive and well. The New Keynesian model has proved to be quite flexible, with a growing number of extensions being developed by researchers in order to incorporate new assumptions or account for new phenomena.” I looked forward to reading his rationale for that optimism. I was disappointed. Especially relative to the fundamental problem of usefully explaining the extreme instability that characterized the perilous Great Recession, New Keynesian economics remains pretty much in the same sorry state it was a decade ago. Discussing three problems captures Galí’s misguided assessment.

  First problem. Galí gets the gets the central problem wrong: “Ten years later, tons of ammunition has been fired against modern macroeconomics in general, and against dynamic stochastic general equilibrium models that build on the New Keynesian framework in particular. The criticisms have focused on the failure of these models to predict the crisis, a weakness often attributed to their lack of a financial block in the model that could account for the key factors behind the crisis, whose origin was largely financial. Other aspects of the New Keynesian model and its extensions that have been the target of criticism include the assumptions of rational expectations, perfect information, and an infinitely lived representative household.”

  The GEM Project gets the central problem right. Market-centric rational-behavior modeling is inherently not up the task of explaining macro instability in highly specialized economies and must be fundamentally reworked. Failing to microfound MWR which we...

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