The teaching of economics has recently been in the news. One reason is the activities of Manchester University undergraduates who have formed the Post-Crash Economics Society to protest the monopoly of mainstream neoclassical economics in university lecture halls. A second reason is criticism of the neoclassical reasoning in Thomas Piketty’s runaway best seller Capital in the Twenty-First Century.

This criticism and calls for including heterodox economic theory in the curriculum have prompted a defense of mainstream economics from Princeton University’s Paul Krugman and Oxford University’s Simon Wren-Lewis. Both hail from the mainstream’s liberal wing, which muddies the issue because it is easy to conflate the liberal wing with the critics. In fact, the two are significantly different and their defense of mainstream economics is pure flimflam …

The mainstream’s flimflam defense involves a two-pronged response. The first prong is an assertion that mainstream economics is already a big tent that incorporates Keynesian economics. The second prong is the oversights that led mainstream economists to miss the crisis have been fully corrected. There was no deep conceptual failure, only a myopic failure to observe the real-world rise of shadow banking …

Krugman’s freshwater – saltwater characterization is profoundly misleading regarding the intellectual state of mainstream economics. Whereas the freshwater metaphor makes sense, the saltwater metaphor does not. The true saltwater school is the now eviscerated Cambridge (UK) School of economics that was home to the likes of Joan Robinson and Nicholas Kaldor. The MIT School is better described as brackish (or even putrid) water.

Why brackish? Because it has retained the nonsense of marginal productivity distribution theory while discarding the foundations of Keynesian economics. The essence of Keynes’ economics was the liquidity preference theory of interest rates and rejection of the claim that price and nominal wage flexibility would ensure full employment. New Keynesians abandon both. They replace liquidity preference theory with loanable funds interest rate theory and they use price and nominal wage rigidity to explain cyclical unemployment.

I have long argued that the new Keynesian nomenclature is a cuckoo tactic because it captures the Keynesian label while having nothing to do with Keynes, in a manner similar to the cuckoo which lays its eggs in other birds’ nests. In my view, it is better labeled new Pigovian economics since it relies on market imperfections and frictions, which were the hallmarks of Pigou’s economic thinking. That makes for bitter irony as Pigou was Keynes’ greatly respected intellectual opponent in the 1930s and his thinking now passes under the Keynesian banner, displacing Keynes’ own ideas.

Thomas Palley