Theoretical Schizophrenia and the Neoclassical Synthesis: The Marriage of the Walrasian Theory of General Competitive Equilibrium to Keynesian Macroeconomics

We can only speculate on what Keynes would have made of the Keynesian policies carried out in his name. What we can see more clearly, with the benefit of hindsight and experience, is that at the theoretical level Keynesian economics created schizophrenia in the way that economics was taught, with courses in microeconomics typically concentrating on issues relating to allocation, production and distribution (questions of efficiency and equity) and courses in macroeconomics focusing on problems associated with the level and the long-term trend of aggregate output and employment, and the rate of inflation (questions of growth and stability). The Keynesian propositions of market failure and involuntary unemployment expounded within macroeconomics did not rest easily alongside the Walrasian theory of general competitive equilibrium, where the actions of rational optimizing individuals ensure that all markets, including the labour market, are cleared by flexible prices. In the Walrasian model, which dominated microeconomics, lapses from full employment cannot occur. Although Paul Samuelson and others attempted to reconcile these two strands of economics, producing a ‘neoclassical synthesis’, Keynesian macroeconomics and orthodox neoclassical microeconomics integrated about as well as oil and water. During the ‘Golden Age’ this problem could be ignored. By 1973, with accelerating inflation, it could not. As Greenwald and Stiglitz have argued, from this point there were two ways in which the two sub-disciplines could be reconciled. Either macro theory could be adapted to orthodox neoclassical micro theory (the new classical approach) or micro theory could be adapted to macro theory (the new Keynesian approach). As we shall see, these attempts at reconciliation have been a dominating influence on macroeconomic theorizing during the past three decades.

--Brian Snowdon and Howard R. Vane, Modern Macroeconomics: Its Origins, Development and Current State (Cheltenham, UK: Edward Elgar Publishing, 2005), 21.