The Old Keynesian Model

Articles from the 1970s applied a general-disequilibrium framework to the determination of output and employment with sticky nominal prices and wages. Quantities are determined on the short sides of the goods and labor market and involve non-price rationing. With general excess supply, where prices and wages are “too high,” output and employment are determined by the Keynesian demand multiplier, based on the marginal propensity to consume. In the case of general excess demand, where prices and wages are “too low,” output and employment are determined by a supplier multiplier, based on the marginal propensity to work. In these two cases, output and employment are independent of the real wage. However, starting from general market clearing, deviations from the general-market-clearing real wage in either direction reduce output and employment. The New Keynesian Model, which also relies on sticky prices, amounts to an extension of the general-excess-supply case of the Old Keynesian Model. The New Keynesian Model assumes that quantities are always demand determined, but this assumption is tenable only under general excess supply. A promising alternative to the non-price rationing of quantities in the Old Keynesian Model is a setup with search-and-matching frictions in the markets for goods and labor.