New Keynesian Economics
Introduction
The macroeconomic framework known as "new Keynesian economics" developed and the
neoclassical synthesis and combined aspects of microeconomic principles with Keynesian
economics. It first appeared in the 1980s in reaction to conventional economics' inability to
adequately explain the economy's cyclical swings.
Sticky pricing and nominal rigidities
• New Keynesians emphasized the importance of sticky pricing & nominal rigidities in economic
activity.
• New Keynesian models recognize that wages and prices do not react quickly to fluctuations of
demand or supply, resulting in short-term departures from the full-employment equilibrium.
Inadequate information and rational expectations.
• New Keynesian models assume imperfect knowledge and rational expectations.
• Economic agents may lack complete and precise knowledge, resulting in suboptimal decision-
making.
• Agents are believed to use current information efficiently to generate predictions about future
economic situations.
The Function of Monetary Policy
• According to New Keynesians, monetary policy is crucial for economic stability.
• Central banks can affect aggregate demand and stabilize output by adjusting interest rates and
money supply.2
• They contend that monetary policy can handle short-run volatility and lessen the negative effects
of nominal rigidities in the economy. Central banks can control aggregate demand & stabilize
productivity by adjusting interest rates and the money supply.
Fiscal Policies and Government Intervention.
• New Keynesians acknowledge the possibility of fiscal action to stabilize the economy through
recessions.
| Proponents argue that temporary government expenditure or tax cuts can encourage economic
activity.
• • Government intervention is viewed as vital to address market failures and maintain
macroeconomic stability.
Market shortcomings and externalities
• New Keynesians believe market flaws and externalities can lead to inefficient resource allocation.
• Imperfections in markets, or as monopolistic competition and asymmetric information, can lead
to suboptimal outcomes.
• Government action, such as regulation through corrective taxes, may be essential to solve these
market failures.
Long-Run Neutrality of Money
