Know Your Schools of Macroeconomics: a (hopefully) informative Self-Post; xposted from r/economics (by suggestion)

OK, so in another thread I made this post, and then I decided that now was as good a time as any to post something I've been thinking of since I started posting on r/economics. There's a lot of confusion out there as to what beliefs belong to what specific schools of economic thought, so I want to shine some light on that topic. I will make no attempt to mask my own views, which come from within mainstream economics (I am a PhD student in econ, my current research is in behavioral macroeconomics), on heterodox schools of thought. Also, pretty much any terms that are capitalized you can look up on Wikipedia.

First, I'd like to point out that economics is more than macroeconomics; a large majority of academic economists study other things, and don't even take sides in the big macro debate. But that's just a side note.

1. Austrian economics is very much a heterodox school of economics and here's why: the view from within mainstream economics is that Hayek et al had some excellent points (the subjective theory of value, for one) but that they ultimately fail on scientific grounds because of their refusal/inability to a) produce falsifiable theories (see Popper), and b) their refusal to use formal logic and mathematics. I'm happy to have a debate another day (or in the comments) about the use of mathematics in economics, but suffice it to say that mathematics is nothing more than an extremely efficient tool for making internally consistent arguments based on pure logic. Anyways, because of these two critiques, Paul Samuelson and company took the good ideas like subjective valuation and abandoned the Austrian mode of analysis in favor of mathematical modeling, which developed into contemporary economics, which I'm about to describe in too much detail. But why are so many Redditors fans of the Austrian school? Well, why are so many psychology enthusiasts fans of Freud? Because he (Hayek or Freud) provides an easy framework for analyzing problems ex post, and because the non-falsifiability of his claims leads one to a false sense of understanding. Note that academic psychologists have taken Freud's few good ideas (the unconscious mind, trauma, etc) and abandoned the rest of psychoanalysis...the parallels are very strong in my mind. That, and the lack of math in Austrian analysis, makes people gravitate toward the Austrian school.

2. Anyways, like most of you know because of the youtube video of the rap battle, Hayek's main opponent was John Maynard Keynes, whose theory of Keynesian economics was pretty damn influential. I'm going to assume most of you know something about the Keynesian prescription for how to deal with a recession (cut taxes, increase government spending, increase the money supply), and thus of his view of the government's role in the economy. The only thing that I'll point out, for personal reasons, is that Keynes only gets trotted out by the politicians during a recession. Keynes would have us run surpluses during prosperous times, but the federal government has run a surplus in 3 of the last 30 years.

3. So, like I said, Samuelson and company start to write mathematical models. From the first attempts to model the macroeconomy based on Keynes thought came NeoKeynesian macroeconomics. NeoKeynesian macroeconomics as I understand it was just Keynesian macroeconomics, but with stronger mathematical foundations. At that time (1940s-1970s-ish), economists also talked about Neoclassical economics, which was less a school of macro than an approach to modelling involving micro-based theory of competition and equilibrium (called classical because the intuition behind these mathematical models came from Adam Smith and friends). Goddamn this is confusing. One quest of this period was to reconcile NeoKeynesian Macro with neoclassical micro, which was called the neoclassical synthesis. If you learned the ISLM model as an undergrad, know that the ISLM model is NeoKeynesian.

4. A major problem in this process of synthesis was the absence of dynamics (movement through time) and expectations about the future from the NeoK model. Enter Milton Friedman, who was pretty much convinced that ISLM and NeoKeynesian thought were bunk, and who gave the intuition behind government spending crowding out investment and consumption, and actually having a negative effect on the economy. Friedman's ideas were developed into a (heavy-duty) mathematical model first by Robert Lucas, whose "Lucas critique" basically shows exactly how rational expectations can destroy the predictions of NeoKeynesian Macro models. Then the stagflation of the 1970s vindicated Friedman and Lucas in a very strong way, and New Classical Macroeconomics was born. That's right, New Classical and Neoclassical are totally different things, as (we're about to find out) are New Keynesian and NeoKeynesian. Anyways, most of New Classical economics is contained in the ideas of Real Business Cycle (RBC) models, and it's called New Classical because a) it is founded entirely on the mathematical theory of competition (it has microfoundations) and b) it's policy perscriptions are pretty lassez faire.

5. In response to this, some economists you've heard of like Mankiw and David Romer developed New Keynesian models, which challenged the assumptions of New Classical models: by adding some market imperfections (specifically sticky prices, the idea that prices and wages don't respond very quickly to changes in economic conditions) they were able to rescue the Keynesian implications of the model, most prominent among them the fact that discretionary fiscal and monetary policy could ameliorate recessions. The New Classical and New Keynesian economists duked it out quite a bit. Two side notes: First, if you're wondering, some things Paul Krugman says make him look more Old Keynesian than New Keynesian but he's in a small minority among academic economists in that regard. Second, freshwater macro=New Classical Macro, because it was at schools like Chicago and Minnesota. saltwater macro=New Keynesian Macro, Harvard, MIT, and Berkeley, among others.

6. Both New Classical and New Keynesian models use the same theoretical tool: that of Dynamic (movement through time) Stochastic (there's uncertainty) General (all goods and services are in the model, agents own the firms) Equilibrium (supply=demand) models, or DSGE models. In the present day, the distinction between NK and NC (New Keynesian and New Classical) is fading in favor of the DSGE models of various market imperfections, such as (notably) financial or housing market frictions (frictions is a fun name for imperfections). The game is figuring out which frictions matter the most, and it's heavily influenced by current events. There's still a healthy debate about the optimal monetary/fiscal policy, and while economists largely agree that this approach to modelling will lead to the best understanding of the macroeconomy, they still disagree on whether discretionary fiscal spending like the stimulus has an impact, and there are a lot of empirical papers on this topic. I haven't talked a lot about empirical papers, but let me just say that a) there's been some obsessive studying of data, and the methods of data analysis have evolved along with the models, and b) the reason the data don't speak clearly on some issues is that we just don't have enough of it and the macroeconomy is damn chaotic.

And finally, something I feel compelled to add is that there are obvious flaws to the NK and NC frameworks, and macroeconomists are probably more aware of the problems than a casual observer...or an Austrian economist. In behavioral macroeconomics, for example, David Laibson has shown that time-inconsistent preferences (weighting present welfare more than future welfare, regardless of how far in the future it is) can destroy important implications of the standard NC model. The difference is that working from within mainstream modern macro, one can actually propose alternatives to critiques of the workhorse models, and then see how much the veracity of that particular assumption matters, and what happens when it fails. So macro is in a very self-critical phase right now, and IMO it's likely that there will be a great deal of change in the way we think about the macroeconomy over the next 10 years.

OK I think I'm done. Knowledgeable folks feel free to correct any mistakes that I made. I'm also happy to listen to any critiques; sorry I was so hard on the Austrians. I hope someone finds this useful.

tl;dr Everything you learn as an undergraduate about Macroeconomics reflects very poorly the current state of thought in the field. Also be careful when using words like "neoclassical" if you're not sure exactly what they mean.

Edit: My main purpose in creating this was to illuminate schools of thought within the mainstream. I decided to include Austrian economics because it's getting a lot of attention lately and it's popular on Reddit. I don't really have much to say about heterodox schools that you couldn't read about on Wikipedia. Remember that mainstream economics is much more a mode of analysis than it is a system of beliefs; I think the case is quite strong that any logical, falsifiable argument can be expressed in the language of mainstream economics.