Axel Leijonhufvud, Recalculation Theorist
By Arnold Kling
What I call the Recalculation Story has many origins. One of them is Axel Leijonhufvud. He recently wrote,
The economy is an adaptive dynamical system. It possesses the self-regulating, “equilibrating” properties that we usually refer to as “market mechanisms”. But these mechanisms do not always suffice to ensure the coordination of activities in the complex system. Almost forty years ago, I proposed the “corridor hypothesis”. The hypothesis suggested that the economy might show the desirable “classical” adjustment properties within some “corridor” around a hypothetical equilibrium path but that its self-regulating capabilities would be impaired in the “Keynesian” regions outside the corridor. For large displacements from equilibrium, therefore, the market system might not be able recover unless aided by stabilisation policy.
Read the whole thing. I cannot resist quoting these paragraphs:
Around the turn of the century the pendulum began to swing back – although not very far. “Freshwater” and “saltwater” macroeconomists came to a “brackish” compromise known as the New Neoclassical Synthesis. The New Keynesians adopted the dynamic stochastic general equilibrium (DSGE) framework pioneered by the New Classicals while the latter accepted the market “frictions” and capital market “imperfections” long insisted upon by the former.
This New Synthesis, like the Old Synthesis of fifty years ago, postulates that the economy behaves like a stable general equilibrium system whose equilibrating properties are somewhat hampered by frictions. Economists of this persuasion are now struggling to explain that what has just happened is actually logically possible. But the recent crisis will not fit.
Thanks to Mark Thoma for the pointer.