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Wednesday, November 20, 2019

What Can Neoclassical Theory Tell Us About Recessions (Serious Question)?

I have nearly finished the last pass of my manuscript, and then will be turning it over to an editor. This means I can come up for air, and start looking at other things. Right now, one of the big topics that are handing over me is simple: what does neoclassical theory tell us about recessions? No matter how charitable I want to be to neoclassical theory, there does not seem to be an obvious answer, at least when we are starting from a post-Keynesian theory of recessions. What value does neoclassical theory add?

I will immediately note that I am referring to theory; my manuscript has a chapter on empirical work, and the econometric work I reference is largely "mainstream." Econometrics is just time series analysis, and is not really tied to any body of theory.

I am throwing this article out there on the slim chance that people respond to my query, either here. or on Twitter. Since this is more of a plea from ignorance than statements of fact, I am keeping this article very short.

However, I will outline the issues as I see it. One typical insight offered from neoclassical modelling is that a recession would be the result of some sort of shock. Although my argument is that recessions are hard to forecast, that seems to offer almost no information. We can usually see certain mechanisms behind a recession, as is discussed in my manuscript (which is volume one). So it's a hard sell to say that recessions are purely random processes.

We can get slightly more specific, such as having some sort of shock to the credit markets, which might be used to help explain the events of the Financial Crisis. But once again, the Financial Crisis, was hardly "random," market participants (including bankers within "market participants") followed behavioural patterns that Minsky described long ago. Saying that there is a "random shock" to credit markets offers a whole lot less information than Minsky's writings.

So I am left with the conundrum: what is worthwhile from neoclassical theory that is worthwhile putting into a second volume of a book on recessions?

(c) Brian Romanchuk 2019


  1. Pure neoclassical theory assumes away recessions.

    It assumes there is only one viable (optimal) level of output and that is the one at full employment.

    Don't the DGSE modellers rely on frictions and the like to account for some form of unemployment.

    Isn't it that simple? I must be missing something?

    Henry Rech

    1. There’s thousands of DSGE models. Some of them have various mechanisms to allow for something like a recession. My question is: do any of these mechanisms offer anything that is not already available from PK theory?

  2. Well, neoclassical theory is good at predicting that workers desire more leisure when recessions begin. I'm not sure PK theory provides such insight. How about Ricardian Equivalency- is post Keynesian analysis capable of showing how government spending is not stimulatory? Seems like neoclassical theory might be useful there- if you believed any of that crap.

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