Background
New Keynesian Economics is an evolutionary branch of Keynesian economics. It aims to integrate microeconomic foundations into Keynesian macroeconomic theories, addressing issues such as persistent involuntary unemployment and business cycle fluctuations, which classical economics has been deemed insufficient in explaining.
Historical Context
Emerging in the late 20th century, New Keynesian economics developed as a response to critiques that traditional Keynesian models lacked rigorous microeconomic underpinnings. Pioneering contributions in this field arose from economists seeking to reconcile Keynesian perspectives with advancements in microeconomic theory, significantly influenced by the failures and inadequacies in classic and neoclassical frameworks to predict economic phenomena, particularly during tumultuous periods such as the Great Depression and subsequent recessions.
Definitions and Concepts
New Keynesian economics encompasses several fundamental concepts:
- Capital market imperfections: Arise due to information asymmetry between lenders and borrowers.
- Price rigidities: Result from staggered price-setting behaviors among firms; relevant models explaining this include Calvo contracts and Taylor contracts.
- Wage rigidity: Explained through the efficiency wage framework, preventing wages from falling to market-clearing levels and causing unemployment.
- Interest rate rigidity: Leads to credit rationing.
- Coordination failure: Potentially leads to recession scenarios when firms’ price behaviors exert externalities on each other.
Major Analytical Frameworks
Classical Economics
Classical economics traditionally adheres to the belief that markets are always clear and individuals are fully rational, emphasizing the idea that involuntary unemployment is a transient phenomenon non-resistant to market forces.
Neoclassical Economics
New Keynesian theories differ from neoclassical economics by emphasizing information imperfections and market failures even when individuals possess forward-looking behaviors.
Keynesian Economics
New Keynesians build upon Keynesian principles, particularly the belief in market inadequacies and the role for government intervention to ameliorate economic downturns, but with enhanced microeconomic foundations.
Marxian Economics
Marxian analysis stresses class struggle and inherent weaknesses in capitalist economies, focusing on labor exploitation. In contrast, New Keynesian economics doesn’t primarily center around class dynamics but rather market imperfections.
Institutional Economics
New Keynesian economics includes aspects of institutional inefficiencies and information asymmetry within economic systems, aligning partly with institutional economics’ focus on foundational economic structures and behaviors.
Behavioral Economics
Behavioral Economics explores psychological factors, which diverges from New Keynesian economics’ focus on rational agents but does provide supplementary insights into non-optimizing behaviors.
Post-Keynesian Economics
While Post-Keynesian economics criticizes neoclassical foundations and vehemently supports Keynesian macro principles, New Keynesians more seamlessly integrate neoclassical elements into Keynesian ideas.
Austrian Economics
Austrian economics proposes minimal state intervention, sharply contrasting with New Keynesian advocacy for active monetary and fiscal policies to address inefficiencies and cyclical business fluctuations.
Development Economics
Development economics focuses on structural changes and policies facilitating economic growth in developing countries, whereas New Keynesian focuses on detailed aspects of market failures even within advanced economies.
Monetarism
Monetarism emphasizes the role of governments in controlling the amount of money in circulation. New Keynesian economics also recognizes the impact of monetary policy, but integrates the notion of price and wage stickiness into macroeconomic stabilization policies.
Comparative Analysis
Price and wage rigidities create disparities as analyzed between New Keynesians and classical/neoclassical schools. Their inclusion of micro-foundations introduces models explaining slower adjustments within economies, providing richer insights into handling moderating business cycles and market failures.
Case Studies
- Great Recession (2008–2009): Examines the role of staggered price setting and market imperfections under New Keynesian analysis.
- Eurozone Crisis: Studies excessive rigidity in wages and prices leading to prolonged unemployment.
Suggested Books for Further Studies
- Blanchard, O., & Fischer, S. (1989). “Lectures on Macroeconomics.”
- Woodford, M. (2003). “Interest and Prices: Foundations of a Theory of Monetary Policy.”
- Mankiw, N. G., & Romer, D. (1991). “New Keynesian Economics.”
Related Terms with Definitions
- Calvo Contract: A model describing how firms adjust prices infrequently at random intervals.
- Taylor Contract: A price adjustment mechanism based on staggered contracts.
- Efficiency Wages: Wages set above market level to incentivize productivity amidst higher unemployment rates.
- Coordination Failure: The failure of economic agents to coordinate actions for mutual benefit, potentially leading to suboptimal macroeconomic outcomes.
- Dynamic Stochastic General Equilibrium (DSGE)
