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3.1 Introduction

In the decade or so following the publication of the General Theory economists

engaged in the Keynes v. Classics debate sought to clarify the arguments

of Keynes and the counter-arguments of his critics. For example, a major

theme of Modigliani’s (1944) paper was to show that, except for the case of

extreme wage rigidity, Keynes’s system did allow for a restoration of full

employment equilibrium via price flexibility, aside for some special limiting

cases. However, by the mid-1950s Samuelson (1955) declared a truce. He

argued that 90 per cent of American economists had ceased to be anti- or

pro-Keynesian but were now committed to a ‘neoclassical synthesis’ where

it was generally accepted that neoclassical microeconomics and Keynesian

macroeconomics could sit alongside each other. The classical/neoclassical

model remained relevant for microeconomic issues and the long-run analysis

of growth, but orthodox Keynesian macroeconomics provided the most

useful framework for analysing short-run aggregate phenomena. This historical

compromise remained the dominant paradigm in economics until the


The main purpose of this chapter is fourfold: first, to review one highly

influential orthodox Keynesian interpretation of Keynes’s (1936) General

Theory, namely the Hicksian IS–LM model for a closed economy, before

considering more fully the theoretical debate on underemployment equilibrium

in the context of that model (sections 3.3–3.4); second, to consider the

effectiveness of fiscal and monetary policy for stabilization purposes when

the model is extended to an open economy (section 3.5); third, to discuss the

original Phillips curve analysis and comment on the importance of the Phillips

curve to orthodox Keynesian analysis (section 3.6); and finally, in the light of

this discussion, to summarize the central propositions of orthodox Keynesian

economics (section 3.7).

The reader should be aware that throughout this and subsequent chapters

two recurrent and interrelated issues arise, concerning (i) the controversy

over the self-equilibrating properties of the economy and (ii) the role for

interventionist government policies. We begin our discussion with the early

orthodox Keynesian approach to these central issues within macroeconomics.