Methodological Issues and the New Keynesian Economics

While recent alternative approaches to macroeconomics have all begun with the presumption that macro-economic behavior ought to be derived from micro-economic foundations, they have differed in their views concerning the appropriate micro-foundations. This paper explores some of the key methodological issues, including those concerning the use of representative agent models, choices in parameterization, problems in aggregation and modeling adjustment processes and speeds, the imposition of ad hoc assumptions, such as that of instantaneous market clearing, and alternative approaches to validation of proposed theories. The paper summarizes the basic questions with which macro-economic theory should be concerned. Focusing on the labor market, it explains why New Keynesian Theories provide a better explanation of the observed phenomena than do alternatives.