閤 Price Flexibility and output Stability: An Old Keynesian view OR。 James Tobin The Journal of Economic Perspectives, Vol. 7, No. 1.(Winter, 1993), pp. 45-65 Stable url: http://inks.jstororg/sici?sici0895-3309%28199324%0297%3a1%03c45%03apfaosa%3e2.0.co%03b2-f The Journal of Economic Perspectives is currently published by American Economic Association Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyouhaveobtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the jsTOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at html Each copy of any part of a JSTOR transmission must contain the same copyright notice that ap on the screen or printed page of such transmission STOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support @jstor. org Thu Mar1522:15:352007
Price Flexibility and Output Stability: An Old Keynesian View James Tobin The Journal of Economic Perspectives, Vol. 7, No. 1. (Winter, 1993), pp. 45-65. Stable URL: http://links.jstor.org/sici?sici=0895-3309%28199324%297%3A1%3C45%3APFAOSA%3E2.0.CO%3B2-F The Journal of Economic Perspectives is currently published by American Economic Association. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/journals/aea.html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor.org. http://www.jstor.org Thu Mar 15 22:15:35 2007
Journal of Economic Perspectives-Volume 7, Number 1-Winter 1993-Pages 45-65 Price Flexibility and Output Stability: An Old Keynesian View James Tobin n this symposium I shall play the role in which I was cast, the unrecon structed old Keynesian. Time was when I resisted labels and schools naively hoping that our Aedgling science was outgrowing them. I had, to be sure, been drawn into economics when The General Theory was an exciting revelation for students hungry for explanation and remedy of the great Depression. At the same time, I was uncomfortable with several aspects of Keynes'theory, and I sought to improve what would now be called the microfoundations of his macroeconomic relations The synthesis of neoclassical and Keynesian analysis achieved in the 1950s and 1960s promised a reconciliation of the two traditions, or at least an understanding of the different contexts to which each applies. The hope and he promise were premature, to say the least. In the last 20 years, the dominant trend in macroeconomics has dismissed Keynesian theory. Nevertheless Keynesian models continue to prove useful in empirical applications, forecast- ing and policy analysis. Macro-econometric models are mostly built on Keyne- and practice, are chronic sources of malaise in our discipl a between theory sian frameworks. The gulfs between doctrine and observation, I have benefitted from Gregory Mankiw's"refresher course"in modern macroeconomics(1990). He writes that recent developments--methodological a James Tobin is Sterling Professor Emeritus of Economics, Yale University, New Haven, connecticut
46 Journal of Economic Perspectives new classical, and new Keynesian-are to old macroeconomics as Copernicus was to Ptolemy. It just takes time before Copernican truths can outdo Ptolemaic approximations in practical applications Considering the alternatives, i do not mind being billed as a Keynesian an old Keynesian at that. But old Keynesians come in several varieties, and peak for no one but myself. nor do I defend the literal text of The General Theory. Several generations of economists have criticized, amended, and elabo rated that seminal work. I shall argue for the validity of the major propositions that distinguish Keynesian macroeconomics from old or new classical macroeconomIcs Summary of the Keynesian Case The central proposition of Keynesian economics is commonly described as follows: " According to the Keynesian view, fluctuations in output arise largely from fuctuations in nominal aggregate demand. These fuctuations have real effects because nominal wages and prices are rigid"(Ball, Mankiw, and Romer, 1988, p. 1). On the contrary, I shall argue that Keynesian macroeconomics neither asserts nor requires nominal wage and or price rigidity. It does and require that markets not be instantaneously and continuously cle prices. That is a much less restrictive assumption, and much less contre It leaves plenty of room for flexibility in any commonsense meaning of the rd cr Keynesian models were said to be vulnerable to the charge that"the ucial nominal rigidities were assumed rather than explained, although"it ras clearly in the interests of agents to eliminate the rigidities they were assumed to create.. Thus the 1970s and 1980s saw many economists turn away from Keynesian theories and toward new classical models with flexible wages and prices"(Ball, Mankiw, and Romer, 1988, P. 2). Those market- clearing models have not just flexible prices but perfectly and instantaneously fexible prices, an assumption that is surely more extreme, more arbitrary, and more devoid of foundations in individual rational behavior than the imperfect flexibility of Keynesian models e central Keynesian proposition is not nominal price rigidity but the neous and complete market clearing, output and employment are frequentl onstrained by aggregate demand. In these excess-supply regimes, agents demands are limited by their inability to sell as much as they would like at prevailing prices. Any failure of price adjustments to keep markets cleared opens the door for quantities to determine quantities, for example real national come to determine consumption demand, as described in Keynes' multiplier calculus
James Tobin 47 For this reason, Keynesian macroeconomics alleges that capitalist societies are vulnerable to very costly economy-wide market failures. Individuals would be willing to supply more labor and other resources in return for the goods and services the employment of those resources would enable them to consume now or in the future, but they cannot implement this willingness in market transac tions. As the quotation from Ball, Mankiw, and Romer suggests, many contem porary theorists cannot believe any theory that implies socially irrational market failures. They suspect that individual irrationalities are lurking somewhere in the theory. In continuously price-cleared competitive markets, they know, individually rational behavior implies collectively rational outcomes. But this theorem does not apply if markets and price-setting institutions do not produce perfectly flexible competitive prices. Individual rationality does not necessarily create the institutions that would guarantee"invisible hand"results. Keynes as not questioning the rationality of individual economic agents; he was arguing that their behavior would yield optimal results if and only if they as citizens organized the necessary collective institutions and government policies In the same spirit though in different contexts, some modern theoretical research has shown that welfare-improving policies may be designed even when asymmetries of information and incompleteness of markets prevent the achievement of global optima Ball, Mankiw, Romer and others style themselves as New Keynesians Their program is to develop improved microeconomic foundations for imper fectly fexible prices. In the process, they hope to illuminate the paradox that individually rational or near-rational behavior can result in significant collective market failures. These are certainly laudable objectives. In the end, I suspect the program will not change the essential substance of Keynesian macroeco- nomics. But it will make Keynes more palatable to theorists In Keynesian business cycle theory, the shocks generating fluctuations are generally shifts in real aggregate demand for goods and services, notably in capital investment. Keynes would be appalled to see his cycle model described as one in which "fluctuations in output arise largely from fluctuations in nominal aggregate demand"(Ball, Mankiw, and Romer 1988, p. 2). The difference is important. The impact on real purchases of a one-time one percent shock to aggregate nominal spending will be eroded if and as nominal prices increase in response, and eliminated once prices have risen by the same one percent as nominal spending did. But suppose it is real demand that initially rises one percent. At the prevailing prices nominal spending will rise one percent too. But if and as prices rise in response the one percent real demand shock becomes an ever larger amount of nominal spending. Its impact is not mechanically eroded by the price response; if it is absorbed, the process subtle and indirect The big issue between Keynes and his"old classical"opponents was the efficacy of the economy's natural market adjustment mechanisms in restoring full employment equilibrium, once a negative real demand shock had pushed
48 Journal of Economic Perspective the economy off that equilibrium. Keynes and Keynesians said those mecha nisms were weak, possibly nonexistent or perverse, and needed help from government policy. That is still the major question of macroeconomic theory and policy, even though new classical economists finesse it by assuming that the economy can never be pushed out of equilibrium even for a moment. Keynes classical contemporaries and predecessors would never have drawn real-world lessons from theories based on such an assumption. Their successors strain redulity when their models imply that markets are cleared and joblessness oluntary when measured unemployment is 10 percent as truly as when it is 5 percent. Keynesian theory of nominal wage stickiness does not deserve the disdain with which it is commonly regarded. It is not dependent on"money illusion But Keynes certainly would have done better to assume imperfect or monopolistic competition throughout the economy, in both product and labor markets. In markets of these kinds, nominal prices are decision variables for sellers or buyers or are determined by negotiations between them. They therefore move only at discrete intervals. Despite considerable effort over the years to give macroeconomics improved microfoundations along these lines there is plenty of scope for the"New Keynesian"program of theoretical and empirical research on this topic In the absence of perfect flexibility, does greater fexibility of nominal prices strengthen the equilibrating mechanisms, or does it weaken them? Keynes doubted that the problems of involuntary unemployment and underuti lized capacity would be mitigated by greater flexibility of nominal wages and prices. On the whole, he favored stable nominal wages. Critics of Keynesian macroeconomics forget this strand of the argument when they assume that without absolute"rigidity"aggregate demand could never be deficient. Fortu nately, this issue has been receiving greater attention in the last few years, witl considerable support for Keynes position Macroeconomics with effective demand Constrained The empirical relevance of Keynesian economics is based on its assertion that situations of pervasive excess supply often occur. An advanced capitalist industrial economy is frequently in a state in which most labor and product markets are not clearing at prevailing prices. As a result, workers are involun tarily unemployed and capital capacity is underutilized. The effective constraint on output is the aggregate demand for goods and services; like he effective constraint on employment is the amount of labor required to produce that Keynesian unemployment must be differentiated from both frictional and lassical unemployment. Frictional unemployment occurs because of