Chapter 1: The Crisis in the Keynesian System
Now that the Keynesian system is in terminal disrepute, it is widely accepted that crises and business cycles must be the unwanted effluvia of profit maximizing by individuals and firms. Yet despite decades of theoretical effort, no one has been able to explain satisfactorily just how this maximizing behaviour could cause macroeconomic volatility. I will argue that it is not the behaviour of rational economic man, but the impossibility of behaving like rational economic man, which causes business cycles and crises. Macroeconomic phenomena are indeed the outcome of rational and self-interested decisions, but those decisions are not fully determinate when there is imperfect information. And just as there is indeterminacy in the market, so too there is an ineradicable indeterminacy in countercyclical policy, which likewise must respond to imperfectly understood situations. If it is said that these propositions are merely common sense, and that ‘everyone’knows them to be true, then common sense and the glaringly obvious are incompatible with macroeconomic theory. A full-scale search for the theoretical foundations of macroeconomics began in the 1970s, when economists first realized that Keynesian theory was inconsistent with the rational pursuit of selfinterest in the markets. This inconsistency is now widely recognized, and has been conceded by leading Keynesians. James Tobin refers to the ‘crisis in macroeconomics’, a term coined by John Hicks: The crisis results from the problem that Keynesian macroeconomicshas never been anchored in the normal paradigm of theoretical economics; 3 4 The Econoniics o Indeterminacy f that is, in a theory...
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