New keynesian economics

New keynesian economics
See also
Consumption function Short run aggregate supply curve Global demand Environmental economics Endogenous growth theory Competitive equilibrium Functions of public finance Law of supply and demand Labor supply curve

New Keynesian Economics is an economic school of thought that combines the macroeconomic insights of Keynesian Economics with insights from neoclassical economics. It is based on the idea that market participants are forward-looking and that prices and wages are slow to adjust to changes in the economic environment. This means that monetary and fiscal policy can have an effect on economic activity. The New Keynesian approach emphasizes that policy makers should focus on the stability of economic growth and the sustainability of economic welfare. It also stresses the importance of policies that help to ensure that the economy runs at its full potential.

Example of new keynesian economics

• The Federal Reserve's monetary policy is an example of New Keynesian Economics in action. The Fed adjusts its short-term interest rate (the federal funds rate) to influence the level of economic activity. When the economy is weak and inflation is low, the Fed will lower the federal funds rate in an effort to stimulate economic activity. Conversely, when the economy is strong and inflation is high, the Fed will raise the federal funds rate to slow economic activity and help keep inflation in check.
• Another example of New Keynesian Economics in action is the use of fiscal policy. The government can use fiscal policy to increase economic activity by cutting taxes and increasing spending. Conversely, the government can use fiscal policy to slow economic activity by raising taxes and decreasing spending. By adjusting taxes and spending, the government can influence the level of economic activity.
• Additionally, policymakers can use New Keynesian Economics to improve the functioning of the labour market. For example, the government can use policies such as minimum wages, job protection laws, and unemployment benefits to encourage workers to stay in their jobs and to discourage employers from laying off workers during recessions. These policies are intended to help ensure that the labour market functions efficiently and that workers have access to job opportunities that match their skills and abilities.

Usage of new keynesian economics

New Keynesian Economics can be used to help inform policy makers on a wide range of issues. Specifically, New Keynesian Economics can be applied to:

• Monetary Policy - New Keynesian Economics can be used to inform the design of monetary policy that considers the effects of inflation, unemployment, and economic growth. It also provides insight into the effects of different types of interventions, such as quantitative easing, and the effects of different types of monetary instruments, such as interest rates.
• Fiscal Policy - New Keynesian Economics can be used to inform the design of fiscal policy that considers the effects of taxation, government spending, and government borrowing. It can also be used to assess the impact of changes in government spending, taxation, and borrowing on economic growth, unemployment, and inflation.
• Labor Market Policy - New Keynesian Economics can be used to inform the design of labor market policies that consider the effects of labor market regulations, minimum wages, and unemployment benefits. It can also be used to assess the impacts of changes in labor market regulations and policies on employment, wages, and inequality.
• Macroeconomic Stability - New Keynesian Economics can be used to inform the design of macroeconomic policies that consider the effects of business cycles, inflation, and economic growth. It can also be used to assess the impacts of different types of macroeconomic stabilization policies, such as fiscal and monetary policies, on economic stability.

Types of new keynesian economics

New Keynesian Economics covers a range of topics and theories, including:

• Price Stickiness: This theory suggests that prices and wages have a tendency to remain unchanged, even when the economic environment is changing. This means that changes in monetary and fiscal policy can have an effect on economic activity.
• Real Rigidities: This theory suggests that even if prices and wages do adjust, there may be other rigidities in the economy, such as in the labour market, that will prevent the full effects of monetary and fiscal policy from being felt.
• Imperfect Competition: This theory suggests that imperfect competition in the markets for goods and services can lead to inefficient outcomes.
• Expectations: This theory suggests that expectations of future economic conditions can influence the decisions of market participants, and thus the performance of the economy.
• Hysteresis: This theory suggests that prolonged periods of unemployment can lead to a permanent lowering of the natural rate of unemployment.

Limitations of new keynesian economics

The limitations of New Keynesian Economics include:

• Its emphasis on short-run solutions rather than long-term solutions to economic problems.
• Its assumption that market participants are always rational, which does not account for irrational behavior in the real world.
• Its reliance on models that assume a static, rather than dynamic, environment.
• Its limited ability to capture the full range of interactions between different economic variables.
• Its limited ability to account for the effects of global economic forces and external shocks.
• Its focus on prices and wages as the primary determinants of economic outcomes, ignoring the role of other factors such as technology and productivity.
• Its limited ability to account for the role of uncertain expectations in the economy.
• Its focus on macroeconomic aggregates, which can be difficult to interpret in terms of real-world economic outcomes.

Other approaches related to new keynesian economics

New Keynesian Economics is related to numerous other approaches, all of which seek to provide insights into how macroeconomic policy can foster economic growth and welfare. These include:

• Neo-Wicksellian Economics, which emphasizes the role of policy credibility, the importance of inflation targeting, and the need for effective coordination between fiscal and monetary policy;
• Real Business Cycle Theory, which suggests that the economy is driven by fluctuations in technology and preferences;
• Monetary Disequilibrium Theory, which focuses on the role of money and credit in the macroeconomy;
• New Monetary Economics, which seeks to understand the relationship between money and economic activity;
• New Institutional Economics, which examines how institutional structures influence economic outcomes; and
• Behavioural Economics, which emphasizes the role of human behaviour in decision-making.

In summary, New Keynesian Economics is closely related to a number of different economic approaches, all of which are focused on understanding the macroeconomic environment and the role of policy in fostering economic growth and welfare.

Suggested literature

• Gordon, R. J. (1990). What is new-Keynesian economics?. Journal of economic literature, 28(3), 1115-1171.
• Galí, J. (2018). The state of New Keynesian economics: a partial assessment. Journal of Economic Perspectives, 32(3), 87-112.