SummaryJohn Maynard Keynes marked a hugely important turning point in the history of Economics. For the first time, Economics had become positive, allowing for differences of opinion. This brought about a chasm in economic thinking: differences of opinion could bring about real differences in the lives of many.
Neoclassical synthesis (NCS) refers to an economic doctrine that appeared in the U.S. in the early 1940s, and would remain the dominant paradigm until the late 1960s, when monetarism took over. It was Paul Samuelson, in his book “Economics”, 1955, who gave this doctrine its sense of synthesis, since it can be described as Keynesian in the short run and neoclassical in the long run. This is, policy makers will be able to adjust the economy (especially using fiscal policies, seen by NCS’ economists as far more effective than monetary policy) in the short run, but considering also that equilibrium will be reached in the long run without the need for public intervention. Theoretical and empirical studies by NCS’ economists are mainly based on the IS-LM model and the Phillips curve.
The IS-LM model was first developed by John Hicks in 1937 and Hansen expanded and popularized it in 1949. It is built on the premises put forward by J. M. Keynes in his “General theory”, 1936, and gives fiscal policy a higher degree of efectiveness (IS-LM policies effects, NCS view).
The Phillips curve, derived from an empirical study, gave a relationship between unemployment and inflation, which was not explicit in Keynes’ analysis. The validity of this relationship has been highly criticized by different schools of economic thought, such as monetarism, the New Classical Macroeconomics and the New Keynesian Economics.
Other renowned NCS’ economists are Modigliani, for his analysis of consumption under an intertemporal utility maximization frame, known as the life-cycle hypothesis; Jorgenson, for his work on the investment function; and Tobin and Baumol, for their studies on the demand and supply of money.
The NCS as a macroeconomic mainstream started struggling in the late 1960s, following a high inflation episode in the U.S., which could not be explained using the theoretical framework of this doctrine. Not long after, in the mid-1970s, stagflation in the U.S. meant the rise of monetarism and the subsequent fall of the NCS.