What Is New Keynesian Economics?
Let me explain New Keynesian economics to you—it's a modern take on macroeconomic theory that builds directly on the classical Keynesian principles you might already know. As someone diving into this, you'll see it emphasizes how prices and wages are 'sticky,' meaning they don't adjust quickly to short-term economic shifts. This stickiness is key because it accounts for things like involuntary unemployment and why monetary policy from the government has such a strong effect on the economy.
Key Takeaways
- New Keynesian economics puts a fresh spin on the macroeconomic ideas from classical Keynesian economics.
- It argues that prices and wages are sticky, leading to involuntary unemployment and making monetary policy highly influential.
- This approach ruled academic macroeconomics from the 1990s right up to the 2008 financial crisis.
Understanding New Keynesian Economics
You should know that British economist John Maynard Keynes came up with the idea after the Great Depression that boosting government spending and cutting taxes could spark demand and lift the economy out of a slump—this dominated thinking for most of the 20th century. But things shifted in 1978 with the publication of 'After Keynesian Macroeconomics.' In that paper, new classical economists like Robert Lucas and Thomas Sargent showed how the 1970s stagflation didn't fit traditional Keynesian models.
They aimed to strengthen Keynes' theory by adding microeconomic basics, focusing on price and wage rigidity. These elements tie into social theories and challenge the pure models of classical Keynesianism. From the 1990s to the 2008 crisis, New Keynesian economics became the go-to in academic circles.
This theory tackles issues like why prices behave sluggishly and what causes that, plus how inefficiencies can lead to market failures that might call for government action. Debates rage on about the upsides of such intervention. New Keynesians push for expansionary monetary policy, claiming deficit spending boosts saving more than demand or growth.
Criticism of New Keynesian Economics
Critics have pointed out that New Keynesian economics didn't predict the Great Recession and failed to explain the secular stagnation that followed. The core challenge here is accounting for why aggregate price levels are sticky. In new classical macroeconomics, competitive firms decide output, not prices, but in New Keynesian views, monopolistically competitive firms set prices and take sales levels as given.
From this perspective, two main points explain why aggregate prices don't mirror nominal GNP changes. Both schools assume rational expectations for agents like households and firms. But New Keynesians say these expectations get skewed by market failures from asymmetric information and imperfect competition. Since agents can't grasp the full economic picture, their info is limited—they won't expect others to change prices, so they keep their own expectations steady. This makes expectations central to price setting; if they don't shift, neither do prices, resulting in rigidity.
Other articles for you
The Morningstar Sustainability Rating evaluates mutual funds and ETFs on ESG factors using a five-globe scale to help investors assess sustainability risks.
An heir is someone who legally inherits a deceased person's estate without a will, following state laws on intestate succession.
Xenocurrency refers to any currency traded outside its home country's borders, often now called foreign currency or eurocurrency.
Enterprise risk management is a strategic, company-wide approach to identifying, assessing, and mitigating risks to protect operations and objectives.
A nonforfeiture clause in insurance policies ensures that policyholders receive benefits or refunds if premiums lapse.
Technical indicators are tools used in technical analysis to predict future price movements based on historical data like price and volume.
Yale School of Management is Yale University's graduate business school offering various master's and doctoral programs focused on leadership in business and society.
The expanded accounting equation breaks down stockholders' equity into detailed components to show how profits are used in a company.
Regulatory risk involves the potential harm to businesses or investments from changes in laws and regulations.
Counterparty risk is the chance that one party in a financial transaction defaults on its obligations, affecting credit, investments, and trades.