Power and Institutions in Macroeconomic Theory

While increasingly large segments of the economics profession cast themselves adrift in a sea of representative agents governed by the invisible hand, John Kenneth Galbraith has spent a lifetime studying and explaining the realities of the advanced industrial state. These realities are dominated by problems that stem from the accumulation and exercise of power by large corporations, and the obligation of government to counter this power in the public interest. This focus has made Galbraith a persistent critic of economic theories that give power and institutions at best a very minor role, and more usually none at all, in influencing economic performance. He finds this neglect of power and institutions, typical of mainstream economic theories, seriously diminishes their capacity to improve our understanding of the real world and its problems. In this chapter we find that recent radical changes in economic theory, initiated and propagated primarily by American economists, reaffirm Galbraith’s assessment. This shift has resulted in an entirely new formulation of macro theory, profoundly different from that associated with Keynes’s General Theory. We focus on how macroeconomic theories explain unemployment, because the treatment of unemployment is at the centre of this revolution in macroeconomic analysis and policy. By contrasting the core features of the original Keynesian macroeconomics with the new mainstream macroeconomics (hereafter referred to as Keynesian and New Keynesian macroeconomics respectively), we can more easily identify the shortcomings and misrepresentations that result when power and institutions are omitted from theory.