1993 Articles

New and Old Keynesians

Stiglitz, Joseph E.; Greenwald, Bruce C.

Despite the fundamental differences in views between these different schools, they have agreed upon two methodological premises: that macroeconomics should be grounded in microeconomic principles, and that understanding macroeconomic behavior requires the construction of a (simple) general equilibrium model. The real difference arises here: real business cycles and (to a lesser extent) new classical economists base their theories on simple (we would say simplistic) models of markets that employ perfect information, perfect competition, the absence of transactions costs, and the presence of a complete set of markets. They also often employ a representative agent model. These assumptions often interact: the absence of risk markets is of no import in a world in which all individuals are identical--since there is no one to whom a representative agent can transfer risk. Problems of asymmetric information cannot arise if all individuals are identical. Moreover, the strong assumptions allow market results to be Pareto efficient, despite the fact that economies with imperfect information and incomplete markets are generally not constrained Pareto efficient (Greenwald and Stiglitz, 1986, 1988a). In contrast, modern Keynesians have identified these real world "imperfections" as the source of the problem: leaving them out of the model is like leaving Hamlet out of the play.