Definition
New Keynesian Economics is a contemporary school of economic thought that develops upon the principles of Keynesian economics. It defends the view that inflexible prices and wages lead to market inefficiencies, necessitating government intervention to achieve full employment and price stability. Its main tools are mathematical models and theories that explain the reasons behind market failures.
Phonetic
The phonetic pronunciation of the keyword “New Keynesian Economics” would be: “Noo Key-neezh-uhn Eh-kuh-nom-iks”.
Key Takeaways
1.
Price Stickiness: New Keynesian Economics heavily emphasizes the concept of price stickiness; prices do not immediately adjust to supply and demand. This idea suggests that markets don’t necessarily clear instantly, leading to an economy that doesn’t self-correct instantly too. This provides a rationale for government intervention to boost demand during recession periods.
2.
The Importance of Monetary Policy: Unlike the traditional Keynesian Economics, the New Keynesian Economics believes that the central bank’s monetary policy plays a crucial role in controlling inflation and stabilizing the economy. Thus, active policy measures (rather than passive) are deemed necessary for controlling the economic cycles.
3.
Microfoundations: A key difference of New Keynesian Economics is the emphasis on microfoundations to justify macroeconomic theories. It uses microeconomic principles and research to form macroeconomic models and ideas, in a move to integrate both micro and macroeconomics within a unified theory. So, for example, New Keynesian theory might use individual or firm behavior (microeconomics) to explain aggregate demand (macroeconomics).
Importance
New Keynesian Economics is important because it significantly influences fiscal and monetary policy decisions. This economic theory, which emerged in the early 1980s, revisited the Keynesian concept that aggregate demand influences economic activity, incorporating microeconomic factors. It suggests that in the short run, especially during recessions, governments can stimulate demand to prevent unemployment or market failures. This perspective contrasts with classical economists’ belief in laissez-faire, arguing that government intervention is crucial for managing market inefficiencies, stabilizing the economy, and promoting growth. Furthermore, the New Keynesian Economics theory offers a foundation to understand price stickiness (prices aren’t swift to change in response to economic shifts) and provides thorough insight into the role institutions, like central banks, play in managing the economy, thereby influencing macroeconomic policy-making.
Explanation
The primary purpose of New Keynesian Economics is to provide a theoretical framework that can explain why market imperfections could lead to issues of economic shortfalls and growth deviations from its potential over the short run. This theory is used to justify government intervention in the economy through monetary policy such as setting interest rates, or fiscal policy including managing public spending and imposing taxes. It aims to address how economic outcomes could be improved if these policies are used to influence aggregate demand, and therefore smoothen economic fluctuations.New Keynesian Economics is also used for modelling an economic framework that departs from classical assumptions of perfect markets. It incorporates factors like price stickiness (slow price adjustments in response to economic changes), imperfect competition, and short-run non-neutral money (where the money supply impacts real economic factors like production or employment). It offers understanding of how these microeconomic factors affect macroeconomic phenomena, sparking substantial improvements in macroeconomic modelling. This aids in policy forecasting and the formulation of strategies that steer the economy towards full employment and price stability.
Examples
New Keynesian Economics is an economic theory that recommends government intervention to stabilize output over the business cycle and promote economic stability. Here are three real-world examples:1. Federal Reserve Monetary Policy: In response to the 2008 Great Recession, the U.S Federal Reserve, under Chairman Ben Bernanke, a well-known New Keynesian economist, conducted a series of unconventional monetary policy measures – including slashing interest rates and quantitative easing programs – to try to revive the U.S. economy. These policies were in line with New Keynesian theories, which advocate for the use of monetary policy to stabilize the economy.2. Fiscal Stimulus Packages: During the same 2008 financial crisis, countries around the world, including the United States and many in Europe, implemented large-scale fiscal stimulus packages to boost their economies. This is another tactic recommended by New Keynesians. In the U.S, this came in the form of the American Recovery and Reinvestment Act, a $787 billion stimulus package designed to save and create jobs, and stimulate business investment.3. COVID-19 Pandemic Response: The relief packages passed by nations worldwide in response to the COVID-19 pandemic are another example of New Keynesian economics at work. The U.S., for instance, passed several relief packages, including the CARES Act and the American Rescue Plan Act. These packages involved checks sent directly to individuals, extended unemployment benefits, and loans to small businesses – all to bolster aggregate demand, as recommended by New Keynesian economics.
Frequently Asked Questions(FAQ)
What is New Keynesian Economics?
New Keynesian Economics is a modern macroeconomic school of thought that evolved from classical Keynesian economics. This school uses market failure theories, including rigid prices and imperfect competition, to argue for the necessity of government intervention in the economy.
Who are the main contributors to New Keynesian Economics?
Prominent contributors to New Keynesian Economics include economists Greg Mankiw, David Romer, and Olivier Blanchard among others.
How does New Keynesian Economics differ from Classical Keynesian Economics?
While Classical Keynesian Economics emphasizes government intervention to control inflation and unemployment, New Keynesian Economics focuses more on market imperfections such as rigid wages and prices, and the role of these imperfections in creating business cycles.
What factors led to the development of New Keynesian Economics?
Mainly, the failings of New Classical Economics to adequately explain economic realities such as unemployment and recessions in the 1970s and 1980s led to the development of New Keynesian Economics. It was also a response to monetarism, another economic school of thought prevalent during this period.
What role does government intervention play in New Keynesian Economics?
The New Keynesian theory advocates for government intervention due to the perceived inefficiencies of unregulated markets. This intervention can take the form of monetary policies or, in some instances, fiscal policies.
What are some criticisms of New Keynesian Economics?
Critics of New Keynesian Economics argue that it places too much emphasis on imperfect markets, and not enough on individual decision-making. Others claim that monetary policy cannot always solve problems related to inflation or unemployment, and that more focus should be placed on structural reforms.
Can you provide a real-world example of New Keynesian Economics in action?
During the 2008 financial crisis, governments globally adopted policies influenced by New Keynesian Economics, intervening with stimulus packages to regulate the economy and to reduce the impact of the recession.
How does the New Keynesian perspective view the short run and long run impacts of fiscal policy?
In the short run, New Keynesian Economists assert that reducing taxes or increasing government spending can stimulate the economy. However, in the long run, these policies could potentially lead to higher interest rates or inflation unless counterbalanced by monetary policy.
Related Finance Terms
- Sticky Prices
- Microfoundations
- Monopolistic Competition
- Nominal Rigidity
- Rational Expectations
Sources for More Information
