What they do not teach in Undergraduate Macroeconomics

I want to devote today’s post to one of the hot debates in the Economics arena: The Macroeconomics Undergraduate Curriculum.

Currently the New-Keynesian (and Neoclassical) economic school of thought is dominating most universities. While post-graduates might have heard about other approaches, Economics undergraduates are mainly trained in New-Keynesian (and Neoclassical) Economics. Almost all mainstream Macroeconomics textbooks are written by scholars coming from this economic school of thought. Some of the most prominent textbook examples, that I have encountered, are Paul Krugman’s and Gregory Mankiw’s Macroeconomics or Blanchard, Amighini and Giavazzi’s Macroeconomics – A European Perspective.

Given the dominance of New-Keynesianism in the Economics profession today, there is little pressure for pluralism. Other economic schools of thought rarely sneak into the lecture hall. This creates a more or less a self-nurturing circle. Teaching mainstream economics nurtures ‘orthodox’ economic thinking and leaves little room for its counterpart, which is often referred to as ‘heterodox’ economics. However, given that the aim of the undergraduate Economics degree is to communicate the fundamentals of Economics, shouldn’t it teach all current approaches? I think that we are talking about the concept of ‘equality of opportunity’ here. Adopting the Stanford Encyclopedia of Philosophy’s definition (2015), equality of opportunity means that “the assignment of individuals to places in the social hierarchy is determined by some form of competitive process, and all members of society are eligible to compete on equal terms”. I would argue that this should also hold for economic schools of thought. Using the same terminology, the assignment of economic schools of thought to places in the overall hierarchy of economic thinking should be based on how well they perform in explaining our economy. Most importantly, all schools of thought should be eligible to compete on equal terms. This call for pluralism does not imply a defeat of New-Keynesian economics. It merely recognises that diversity in economic thinking adds value to the field. It enables critical thinking, challenges conventional wisdom and scrutinizes some of the simplifying assumptions in mainstream economic models.

It would be vital to expose Economics undergraduates to a more diversified Macroeconomics curriculum. How shall undergraduates develop their own brand, i.e. their very own ‘economic thinking’, if one half of Macroeconomics is withheld from them? I am far from advocating to turn all Economics undergraduates into Post-Keynesians. However, I think that the Post-Keynesian critique of neoclassical economics as well as other schools of thought have to sneak into the lecture hall as soon as possible. Teaching other approaches will enable Economics undergraduates to look over the rim of the Macroeconomics textbook teacup. We have to acknowledge that the standard Macroeconomic assumptions are not carved in stone and do not have to be taken for granted. At the moment, assumptions like rising marginal costs and diminishing marginal productivity or the view that the financial sector does not matter because it merely redistributes money from patient economic actors (lenders) to impatient actors (borrowers) are often perceived to be facts in their own right. They are rarely challenged, neither in the classroom nor in the core textbooks.

Yet I was lucky because my Macroeconomics professor touched upon Minsky’s Financial Instability Hypothesis and Fisher’s Debt Deflation Theory in the last lecture on Friday which dealt with business cycles and the struggle of neoclassical economics to explain the booms and busts modern economies encounter. In particular, the take-away homework of Friday’s lecture was to read Minsky (1992) and we will also continue with Minsky and Fisher in the next two weeks in the context of the Global Financial Crisis! So I took the homework as an opportunity to dive into the Post-Keynesian field. I was lucky to find a comprehensive introduction to Post-Keynesian Economics by Engelbert Stockhammer (2014) and by Steve Keen (author of Debunking Economics; 2014a; 2014b) and I have put the links into the references of today’s post. I would suggest to start with the lecture by Engelbert Stockhammer. In this introductory lecture Stockhammer provides an overview on the three main themes in Post-Keynesian economics: (1) fundamental uncertainty, (2) effective demand and (3) social conflict.

Firstly, Post-Keynesians acknowledge that ‘we don’t know’ and that people do not necessarily act rational but instead rely on conventions. People tend to believe that the future mirrors the past. In this world there is also the possibility for herd behaviour. In addition, due to fundamental uncertainty in the economy, money fulfils a different function compared to its function in neoclassical economics. In Post-Keynesianism money becomes a means to deal with uncertainty (liquidity preference) and economic actors can maintain flexibility by holding liquid assets. Post-Keynesians also recognise that in a world plagued by fundamental uncertainty there can be liquidity crises and panics (Stockhammer, 2014).

Second, in Post-Keynesian models there is social conflict due to asymmetry in the distribution of resources and asymmetry in investment decision making. Stockhammer (2014) points out that these models often have three classes: workers, capital and rentiers. In the Post-Keynesian economy, capitalists hire and fire workers and therefore workers face inherent job insecurity and potentially involuntary unemployment. Capitalists are the main investors while rentiers push forward capital and collect interest and dividends. In the Post-Keynesian economy distributional effects derive from the differing marginal propensities to consume, i.e. workers have a higher MPC than capitalists. Overall institutions are in place to address these inherent social conflicts. However, inflation remains apparent in the Post-Keynesian economic system, being the “outcome of unresolved distributional effects” (Stockhammer, 2014).

Third, there is the concept of effective demand. In particular, the Investment-Savings identity is modified as follows: I(Y) = S(Y). Stockhammer (2014) points out that it is income which adjusts the Investment-Savings equilibrium rather than the interest rate. Whereas in neoclassical economics there is something like a natural interest rate which equilibrates investment and saving, in Post-Keynesian economics this function is taken over by income. However, it should be noted that there is no constraint on investment; rather it is investment that drives the equation. This holds because investment is more or less determined by the availability of finance (from banks) rather than by the amount of savings available in the economy. This assumption seems plausible for modern economies and fractional reserve banking as banks are not only intermediating but also primary lenders. Overall, Post-Keynesians argue that investment expenditures – not being constrained by saving – are the main cause of business cycles. Large fluctuations in investment growth impact GDP growth while consumption growth is a lot less volatile and therefore not the primary cause of booms and busts.

In addition to these three themes – fundamental uncertainty, social conflict and effective demand – Post-Keynesianism also takes into account involuntary unemployment and a bigger role of money and finance. While neoclassical economics argues for a natural rate of unemployment and a self-adjusting labour market in the long-run, there can be involuntary unemployment in Post-Keynesian models. They argue that real wage cuts have a contractionary effect and that the labour and goods market are therefore correlated. In terms of money and finance, money is endogenous rather than exogenous in this economic school of thought. While central banks have the possibility to determine the official interest rate, it is the banks that lend to the public at a rate which reflects their own liquidity preference. Banks mark up a risk premium on the interest rate of the central bank which they see fit given the state of the economy. Furthermore, in Post-Keynesian economics financial markets suffer from instability, aggravating booms and busts and causing debt cycles (see also Minsky’s Financial Instability Hypothesis). This part of Post-Keynesian Economics sounds a lot like one of the causes of the Global Financial Crisis and makes a compelling argument given the recent events in the global economy. Financial institutions are eager to lend during a prolonged boom but credit freezes up as the economic outlook deteriorates because the banks’ liquidity preference fundamentally changes. Thereby financial institutions have the capacity to fuel investment booms (sub-prime lending).

In his introduction to Post-Keynesian Economics, Engelbert Stockhammer also provides an overview on the key differences of the economic schools of thought with which I want to end my post today. The table reproduced below neatly summarises the differences regarding key concepts, behaviour, markets, money, unemployment and policy recommendations:

  Neoclassical theory Keynesian theory
Key concepts Rational behaviour, equilibrium Effective demand, ‘animal spirits’
Behaviour Rational behaviour by selfish individuals Animal spirits (non-rational behaviour) and conventional
Markets Market clearing <- price adjustment Some markets do not clear
Money Classical dichotomy (money is neutral) ‘Money matters’ (has real effects)
Unemployment Voluntary or due to rigidities Involuntary, due to lack of demand in goods markets
Policy Laissez-faire: markets are self-regulating and government should not intervene Market economies are unstable and result in unemployment; government should intervene

(Source: Stockhammer, 2014, YouTube Video ~ 43:51-44:12 min)

There is clearly more to Post-Keynesianism than what I covered in my post today. For a more comprehensive introduction Steve Keen recommended the book The Elgar Companion to Post Keynesian Economics, edited by J.E. King (2012). Personally I have to say that I found this discourse very rewarding and enlightening and I think that the second half of macroeconomics is too important to be left out of the undergraduate Economics curriculum. Pluralism in economic thinking at university should receive more attention and I will certainly follow up more on Post-Keynesianism and on other economic schools of thought in the future.

Thanks for reading,




Keen, S. [ProfSteveKeen]. (2014a, December 2). Free University Berlin: Demand, Competition and Money [Video file]. https://www.youtube.com/watch?v=WRvgOykCCkM

Keen, S. [ProfSteveKeen]. (2014b, December 7). Hamburg 2014: Post Keynesian economics, falling marginal cost, and money [Video file]. https://www.youtube.com/watch?v=MgCUzIRadRU

King, J.E. (2012). The Elgar Companion to Post Keynesian Economics (2nd ed.). Cheltenham, UK: Edward Elgar Publishing.

Minsky, H.P. (1992). The Financial Instability Hypothesis (Working Paper No. 74). Annandale-on-Hudson, NY: Levy Economics Institute of Bard College. Retrieved from: http://www.levyinstitute.org/pubs/wp74.pdf

Stanford Encyclopedia of Philosophy (2015, March 25). Equality of Opportunity. Retrieved from: http://plato.stanford.edu/entries/equal-opportunity/

Stockhammer, E. [Rethinking Economics]. (2014, October 21). Rethinking Economics: Stockhammer’s Intro to Post-Keynesian Economics, London 2014 [Video file].  Retrieved from: https://www.youtube.com/watch?v=ajb2f82L51M



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