Is new always better than old? On the treatment of fiscal policy in Keynesian models
The paper traces the treatment of fiscal policy in mainstream Keynesian models, from IS-LM over simple dynamic New Keynesian models to the most sophisticated New Keynesian dynamic stochastic general equilibrium (DSGE) models and compares it with stylized empirical facts on the impact of fiscal policy. It is found that the traditional simple Keynesian models such as IS-LM and Mundell–Fleming actually come to very similar conclusions on the effectiveness of fiscal policy as the most complex DSGE models, and are very much in line with stylized empirical facts found in most recent studies. In contrast, the dynamic models used during most of the 1990s and 2000s perform very poorly. It is hence questioned whether the change in modeling approaches over the past 60 years really constitutes progress in economic insight given the growing complexity of modern models.