With myriads of crises plaguing the world economy, the right combination of policies is the need of the hour as 2025 is coming to an end. What lessons can we draw from old classics and modern Neo-Classics? The correct policy responses need reformulation of macroeconomic policy framework with insights from great thinkers without based on mutual exclusion principle. 

John Maynard Keynes—the father of modern macroeconomics–said: “In the long run, we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean will be flat again.” Robert Lucas said that ‘Keynesian economics is dead’ in 1979 and during heydays of Monetarism and New classical macroeconomics, he commented that ascribing ‘Keynesian’ label to the economists would be an offence. After passing way of Robert Lucas Jr. on 15th May 2023—the most cited and influential macroeconomist of the late 20th century–this time is the ripe moment to revisit how the ideas from two great economists and subsequent followers could be useful for addressing current problems. 

The World Economy is going through a tumultuous time and passing through cusp of changes. Three-pronged crisis–Climate change, War and Macroeconomic disruptions (inflation and banking crisis in Europe and the USA)—coupled with post-Covid sluggish recovery and deglobalization, has destabilized almost all the economies. Most importantly, unfolding of the banking crisis, the debt crisis in the US, devastating war between Russia-Ukraine and a strained geopolitical tension with arch-rival China have instigated numerous problems.

Sailing through this troubled water needs wise policy choice. Monetary and fiscal policy are popular tools. The continuous evolution of different frameworks—Keynes versus the Classics, Monetarists versus the New Keynesian Schools—have bothered the policy makers searching for appropriate measures to cure the malaise. Macroeconomics as a discipline has undergone sea changes with ideas enriching different schools of thought. If ‘ideas’ are to solve problems at critical junctures, then embracing them is the best option as the problems come back cyclically over time with limited predictability. For example, in the late 1970s stagflation jolted the world economy and apparent inefficacy of Keynesian policies became the main points of criticism. Doubts were cast on familiar trade-offs between output-unemployment (Okun’s law) and inflation-unemployment (famously Phillips curve). Although resurgence of Keynesianism (his magnum opus ‘General Theory’) occurred during 2007-2009 crisis, right now with fears of stagflation resurfacing policy dilemma prevails. Will we see the resurgence of the Lucasian policy paradigm or, do we admit, as monetarist Milton Friedman once said: “We are all Keynesians now”?

Without viewing the crisis as an isolated phenomenon, a synergistic eclectic policy approach is necessary. Reconciling the policy insights from both thinkers could help ameliorate the current crisis.  During the great recession of 2007-2009, Paul Krugman called it a ‘Dark Age of Macroeconomics’ as designing macroeconomic policy was difficult. Robert Skidelsky’s book ‘The Return of the Master’ reinstated the relevance of Keynesianism. Insights from Robert Lucas’s three main contributions—viz., roles of rational expectations, agents’ behavioral foundations, and mechanics of economic growth–could be valuable along with Keynesian ideas of ‘Animal Spirits’ and follow-on effects of chain of events popularly known as ‘investment multipliers’. In fact, ‘Lucas critique’—the idea of policy ineffectiveness without building in behavioral changes and expectations of economic agents in response to policy changes–was not full-proof for taming business cycles during 2008-2009 crisis.

Policymakers across the world took recourse to stabilization policies via stimulus package and credit-channel (quantitative easing) to revive the economy. Much-needed government project spending to boost demand can induce cascading benefits as investment could be used to tackle energy-environment crisis, food crisis, and pandemic. In this connection, Bob Lucas’s pioneering contribution on the role of ideas and human capital could be useful for tackling the health-wealth trade-off through, say, innovation in vaccine research as well as investing in biomass, energy efficient buildings, green car, and agricultural innovation. In fact, Lucasian notion of mechanics of growth laid the foundation of endogenous growth models on which subsequent works by Paul Romer fetched Nobel. In 2025 the Nobel prize awarded to Philippe Aghion, Peter Howitt and Joel Mokyr is due recognition of the fact that technology-driven growth and sustainable inclusive growth via public policy is instrumental to handling crisis and balancing ‘creative destruction’ of unbridled capitalism creating enormous gaps between the rich and the poor.  

As has been said by Paul Samuelson: “Science is a parasite: the greater the patient population the better the advance in physiology and pathology; and out of pathology arises therapy. The year 1932 was the trough of the great depression, and from its rotten soil was belatedly begot a new subject that today we call macroeconomics.  Thus, at this juncture—plagued by War and Pandemic as wells as the fear of clear and present danger of Generative AI-technology—probably, it’s wise to reconcile Lucas’s thesis on role of exchanging ideas for human ingenuity and Keynesian idea of role of stabilization policy with supportive institutions to overcome the three-pronged crisis. 

‘Animal spirits’ underlie the episodes of bank failure in SVB, Signature bank and Swiss National Bank, as well as the widespread embrace of AI and imminent danger of extinction as espoused by Geoffrey Hinton. For addressing these credible policy designs with rational decision-making is necessary. For that, we need smart policy makers who could imbue us with confidence based on rational expectations. Thus, working towards a synthesis of classical and Neo-Classical paradigm and beyond is necessary. 2024 Nobel prize winning trio economists Acemoglu-Jonson-Robinson’s work on role of ‘good’ effective institutions for avoiding state failure or role of regulation for technology-driven inequality across occupations is also crucial at this juncture.  

The best way to restore the global economy’s health is to protect the vulnerable and fragile economies with sufficient regulation and supervision of the financial systems based on fairness, coordination, and solidarity among nations. Great ideas are always avenues for great escape from crisis. For making the world a better place in 2026 so that New Year could usher in hope for peace and prosperity, we need novelties of policy design combining ‘old’ recipes with ‘new’ ingredients of success.

© Eurasia Review