12.3 – A Heterodox Macroeconomic Perspective
Learning Objectives
By the end of this section, you will be able to:
- Explain the conditions of the Great Depression.
- Explain the limitations of orthodox economics in comparison to the Great Depression
- Analyze the influence of aggregate demand on the macroeconomy.
- Analyze the destabilizing aspects of the orthodox wage and price adjustment story.
The measure of any theory is its effectiveness in explaining real world conditions and events. In this regard, neither the neoclassical perspective nor the New Keynesian perspective can explain the events of the Great Depression (the very event responsible for the splitting of economics into two branches, microeconomics and macroeconomics):
| Year | Unemployment Rate | Change in GDP | Change in Price Level |
| 1929 | 3.2% | – | 0.6% |
| 1930 | 8.7% | -8.5% | -6.4% |
| 1931 | 15.9% | -6.4% | -9.3% |
| 1932 | 23.6% | -12.9% | -10.3% |
| 1933 | 24.9% | -1.2% | 0.8% |
The data in the table above depicts three events unfolding simultaneously, 1) declining production, 2) declining employment, and 3) declining overall price level. For all intents and purposes, these three conditions cannot and should not simultaneously occur according to either the neoclassical perspective or the New Keynesian perspective.
Consider, according to the orthodox perspective, the declining overall price level should return the economy to the full employment level of production. Assuming that a fully employed economy is one in which the unemployment rate is 4% or less, in Table 1 the decline in the overall price level is definitely not restoring full employment.
Alternatively, consider the data in contrast to the New Keynesian story. The New Keynesian model argues that sticky prices could conceivably explain a less than full employment circumstance. However, in Table 1, the unemployment rate increases even as flexible, certainly not sticky, prices coincide with less than full employment and price driven deflation.
Most significantly, contrary to both the neoclassical and New Keynesian perspectives, price flexibility during the Great Depression did not restore full employment! Simultaneously, nor does price stickiness seem to cause persistent unemployment. Clearly, orthodox economics does not have a firm theoretical grasp on the events associated with the Great Depression. To correctly account for the events of the Great Depression, another theoretical perspective is necessary.
In the next section we will explore “original” Keynesian thought. Deviating from both the neoclassical perspective as well as the New Keynesian perspective, the original Keynesian perspective will argue that the flexibility of wages and prices will worsen, as opposed to correct, economic instability.
Turning the Bowl Upside Down: A Heterodox Interpretation of Price Adjustments.
The orthodox economic story told above is the same story that was extolled by the neoclassical school of economists during the Great De