New Keynesian Macroeconomics Notes
New Keynesian Macroeconomics
Introduction
By the early 1980s, the Keynesian view of business cycles was losing favor.
The Keynesian framework relied on strong assumptions:
Fluctuations in output are due to fluctuations in aggregate demand.
Changes in demand had real effects because of price and wage rigidity.
Nominal rigidities were assumed rather than explained.
Problem: Why assume prices and wages are fixed in the short run when it's in agents' interests to eliminate the rigidities?
In the 1970s and early 1980s, many economists moved away from Keynesian theories toward new classical models with flexible wages and prices.
With rational expectations and full price flexibility, systematic policy changes do not have real effects.
New Keynesian theory:
Keep rational expectations but introduce some nominal rigidities.
Microfound these rigidities rather than just assuming them.
Consequence: policies (even systematic ones) can have real effects on output in the short-term.
New Classical vs. New Keynesian Theory
New Keynesian:
Rational Expectations
Microfoundations
Price rigidities
Monopolistic competition
New Classical:
Rational Expectations
Microfoundations
Fully flexible prices
Perfect competition
Price Rigidities
Two main ways price rigidities are modeled in New Keynesian settings:
Staggered price- or wage setting
Price-setting decisions are not synchronized across firms/workers.
E.g., a law restricts firms from changing prices too often, or different unions bargain wages once a year at different times.
"Menu costs"
Changing prices comes at a cost to the firm.
Could be literally the costs of printing menus but also interpreted more generally (alienate customers with frequent changes, permanent reoptimization needs effort, etc.).
Staggered Prices/Wages
See projector
Menu Costs
See projector