Escolar Documentos
Profissional Documentos
Cultura Documentos
Synthesis
Real Balance Effects and the
Neoclassical Response to Keynes
The Neoclassical Response to the
Keynesian Critique
1. Some neoclassical economists became
Keynesians
2. Some tried to ignore Keynes
3. Some misinterpreted Keynes as arguing that
sticky wages and prices could cause
unemployment in the long run (this result was
already in neoclassical economics—if that is all
that Keynes was arguing, then Keynes was not
making a new contribution).
Neoclassical Response to Keynes
4. This next response was the most
interesting: it said, “Keynes is making
some real contributions and we should
recognize that. His theory of the multiplier,
his argument that we should conduct
aggregate analysis and that money should
play a central, determining role, even his
liquidity preference theory, are all real
contributions and should be incorporated
into the analysis.”
Response to Keynes
• “But,” this response continued, “if Keynes
is saying he is refuting neoclassical theory
he is going too far.” “Because,” they said,
“it can be shown that all of these
contributions can be incorporated into the
broader neoclassical framework and it can
still be demonstrated that the central
proposition of neoclassical macro theory
still holds.”
Central Proposition of Neoclassical
Macro
• They argued: “It can still be shown that if
wages, prices, and interest rates are
perfectly flexible that the economy will
tend to full employment in the long run.”
• The argument will look a little different, it
won’t be simply the old neoclassical labor
and loanable funds markets story.
Grand Neoclassical-Keynesian
Synthesis
• This argument, which came to be known
as the neoclassical synthesis, used the
real balance effects arguments to
demonstrate their proposition.
• The real balance effects has two parts: the
direct real balance effect, or Pigou effect,
and the indirect real balance effect, or
Keynes effect, or interest rate effect.
Real Balance Effects
• The real balance effect argument begins by
noting that in Keynes if there is unemployment,
or aggregate supply is greater than aggregate
demand, firms will cut back production, income
will fall, and employment will fall.
• But, they ask, what if instead of cutting output,
firms cut prices in response to insufficient
demand? And if this occurred throughout the
economy, the price level would fall (there would
be deflation). Deflation means that the real value
of money would rise.
Direct Real Balance
(or Pigou) Effect
AS>AD P ↓ real value of $ ↑ (C + I)↑ mult
effects Y↑ Yf