Old Keynesian Economics *

I provide an outline of how a modern theory of search, modelled by a two-sided matching function, can be used to form a microfoundation to Keynesian economics. This search theory of the labor market has one less equation than unknown and, when combined with the idea that investment is driven exogenously by ‘animal spirits,’ the marriage leads to a microfounded theory of business cycles. This alternative theory has very different implications from the standard interpretations of Keynes that has become enshrined in new-Keynesian economics. I call the alternative, ‘old-Keynesian economics’ and I show that it leads to a model with multiple belief driven steady states. 1 Keynes and the Keynesians In his (1966) book, On Keynesian Economics and the Economics of Keynes, Axel Leijonhufvud made the distinction between the economics of the General Theory (Keynes 1936) and the interpretation of Keynesian economics by Hicks and Hansen that was incorporated into the IS-LM model and that forms the basis for new-Keynesian economics. In that book, he pointed out that although the new-Keynesians give a central role to the assumption of sticky prices, the sticky-price assumption is a part of the mythology of Keynesian economics that is inessential to the main themes of the General Theory. In this paper I will sketch an alternative microfoundation to Keynesian ∗This paper was prepared for a Conference in honor of Axel Leijonhufvud held at UCLA on August 30th 31st 2006. Although I am certain that Axel will not agree with everything that I say in this essay, I hope that he will recognize a trace of the Leijonhufvud influence creeping through the pages. †This research was supported by NSF award SES 0418074.